The LIBOR scandal is just one more example of the wide-ranging downstream effects of having a weak link in the financial chain of command.
Long before the news broke, reports in The Wall Street Journal in 2007 and 2008 made us wonder why no one other than academics raised questions about the risk inherent in allowing banks to self-report their estimated (not actual and not independently verified) cost of borrowing – numbers that would be used to calculate LIBOR, which has such far-reaching impact on interest rates.
Self-reported numbers that reflect on a financial institution’s soundness, combined with pressure on banks from traders – with whom some banks may have a symbiotic relationship – provides a prime recipe for fudging.
If Bernie Madoff hadn’t been allowed to essentially make numbers up, perhaps his scheme would have been caught long before it reached $60 billion. And public pension funds, including California’s largest, might have better balance sheets today if more had been known about the markups imposed on non-negotiated foreign exchange rates by State Street Corp. and Bank of New York Mellon.
Earlier this year, it was reported that some pension funds have begun negotiating more of their own trades. It’s a lesson that can’t be learned often enough: Knowledge is power.
State Street and Bank of New York Mellon are vigorously defending themselves against allegations. State Street is accused of concealing price markups on non-negotiated trades that were significantly higher than those on negotiated trades. Its lawyers contested in court papers that the bank was following the same rules as Costco Wholesale Corp. in not disclosing the spread between wholesale and retail prices to its customers, and therefore there was doing nothing fraudulent by neglecting full disclosure.
But apparently, back in 1998, State Street told the Arkansas teacher pension fund that there would be no charge for currency trades. This is lack of disclosure on at least two different levels.
And this much should be self evident, we hope: Buying consumer goods in bulk and managing future income streams for hundreds of thousands of people are two wildly different things.
When Franklin Roosevelt tapped Joseph P. Kennedy as the first head of the SEC back in 1934, it was because Kennedy had a knowledge of how the securities business worked – and, more important, how it didn’t. He knew its vulnerable places because he himself had taken advantage of them during the Roaring Twenties – and had become rich enough to help FDR get elected.
The irony may be rife, but historians view Kennedy’s role in building the SEC as his finest achievement because of his penchant for fixing problems and then getting out of the way.
These days, we’d love to have a Joe Kennedy-type help fix the mess we’re in. But we’re not likely to get him – or her – because it would take a miracle for the colorful record possessed by such an individual to survive the modern-day vetting process.
Today’s regulators are so busy reacting to problems from five years ago – fixing the appraisal system, licensing originators, more tightly regulating subprime loans, and so on – that they’re missing today’s abuses.
We can’t just fine the wrongdoers we catch (otherwise known as the Full Employment Act for Litigators). We need a regulatory system that knows what to look for, and to question why crucial numbers are self-reported.
These regulators need the legal standing – and the know-how – to be able to demand of the institutions they regulate what the good math teachers in Arkansas and everywhere else have always demanded of their students: Show us your work.
