The FSA's Final Notice to Barclays imposing a £290m fine reveals the rather unspectacular nature of the fraud that Barclays committed, but more than that, it shows quite how unsuitable our global financial instituions are for a world after the end of gentlemanly capitalism.
What is LIBOR (London Inter Bank Official Rate)?
It is one of the most widely used benchmark interest rates. A benchmark interest rate is very widely used in debt contracts. For example, say a manufacturing company that takes 3 weeks on average to build the objects that it then sells. An order comes in, the company spends on fulfilling, the order ships to the customer and the customer pays. Say that whole process takes 3 months. The company may well want to go to a bank and ask for working capital to cover fulfillment costs over those 3 months. The bank might offer a fixed interest rate - say, in good times, 5% per annum; but the manufacturer does not mind taking n a bit of interest rate risk and asks for a rate that varies with the bank's own borrowing costs. The three month LIBOR is a meant to be a good measure of what a serious London-based bank's borrowing costs are. So the manufacturer might, rather than take 5% fixed, accept som percentage over LIBOR, the cost of funds to London banks from other London banks.
How is LIBOR Fixed?
The British Bankers Association (yes, the industry group that has been so vocal through their then head, Angella Knight, in defending the banks from any blame for any part of the crisis) appoints a panel of the banks most active in London in the various debt markets (maturities and currencies); every day by 11am, these banks are expected to submit to the BBA a table that describes their cost of borrowing were they to try to raise funds from other banks. The BBA then calculates an average and that is LIBOR for that maturity in that currency.
How is LIBOR well and truly Fixed?
It turns out that when Barclays filled out its daily forms for the BBA, it would wonder whether it was good for Barclays for some rate to be slightly higher or slightly lower. And it would fib. So, for example, in 2008, at the height of the crisis, Barclays - along with everyone else - was looking shaky. What does shaky mean? It means that it is very expensive to borrow from anyone who understands your predicament. And yet LIBOR wasn't going up. They were pretending that everything was just fine when it very distinclty was not.
What happened to old-fashioned 'fessing up?
Whenever I try to understand the City, I try to picture an analogous situation at the elite private ("public") school that I went to, which sent so many of its brightest pupils straight from elite university into the City. It is usually a good way to understand the culture of what's happening there. Here's what the technique delivered in this case.
I remember a boy, rather naughty, quirky and old-fashioned, who was one day held up to us as an example to us all of how to behave when caught doing something wrong.
He would stand quite straight in class; he would go red in the face, matching his red hair. But he would never deny the the charges against him. "Yes, Sir!" was all he would say when asked if he understood how bad his behaviour - chewing gum in Latin, let's say. He was often in trouble, and his quirks meant that the trouble did not translate into "cool".
One day, a kind English teacher remarked to the whole class that this was exactly how to behave when caught at something wrong: accept the charges, accept the consequences and do so with minimal fuss all the while retaining your pride.
Of course, the reason that it needed to be pointed out was that this was an ethos that was no longer the default behaviour amongst the young elite-to-be (was it ever? maybe not ... that is another question ...). Say somene less eccentric was caught in some rule-bending - a prefect, perhaps (those are the ones who have tended to go straight into the City), was discovered to be outside the dormitory late at night; maybe out on the town drinking. He, if caught, would be full of denials and excuses. All of them implausible.
But his position was unassailable: he was a prefect, he was maintaining the system. If he was called out on his blatant lie, the legitimacy of the order that had placed such power in him would take a knock. So there was wriggle-room, and it was duly used by those with power.
How does this fit the LIBOR fixing story? Barclays was in trouble. Everyone who matters in finance knew it was not immune from the trouble in the market. Instead of admitting its weakness and its fault, it decided to lie its way out of the tight corner. As it turns out, it was in the habit of using the lie wherever that might give it some advantage.
Of course, once you realise that there is connivance in your lying - that far from being called out, it seems that everyone who matters knows just what is going on, then why not use the same small lies for even small matters of profit, and not just in extremis? And that, it turns out, is just what Barclays had been doing. When their own positions would see advantage from a higher LIBOR, they would lie ever so slightly to the BBA. When the trading desk asked for lower LIBOR, the reporters obliged.
The gentleman's club of finance was meant to be operated by the ethos shown by the proud, old-fashioned boy held up as an exemplar. He would never have lied to the BBA, even if it had shown up Barclays' weakness. He might have gone down, made a genuine public display of shame and lost his shareholders the money. But he wouldn't have lied. Barclays, on the other hand, was the swggering prefect - "I am the system; I'm allowed to do this".
Of course, the quirky boy was always the ideal. And the existence of the ideal can work in complicatedly negative ways - for example, to hide the habitual reality. The system of fixing such a crucial price by self-regulation needs that ideal to be real if it is to function - whether in actual fact or even as fig-leaf. What is clear today is that Barclays acted like the swaggering prefect - they were invulnerable, they were the system. But now we know the ethos behind the swagger, we really can't let it go on.