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Barclays' Admission of Moral Bankruptcy is Just the Beginning

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“Duuuude,” begins a note that will go on to exhort committing fraud on a global scale, “what's up with ur guys 34.5 3m fix... tell him to get it up!” The writer was attempting to get the recipient to knowingly falsify a three month interest rate upwards, so that the writer could profit. The note emerged in an investigation of Barclays PLC (NYSE: BCS) for attempting to manipulate a financial metric called the LIBOR, or London Interbank Offered Rate. Barclays has admitted that it lied about data used to calculate the LIBOR on hundreds of occasions, and regulators believe it succeeded. The LIBOR is a global benchmark that affects over $800 trillion in financial instruments and transactions. If Barclays and other banks were able to successfully falsify this rate, even slightly, the result might be the largest securities fraud ever known. 

Perhaps more worrying than the scale and scope of this criminal endeavor is the callous, even humorous manner in which the traders involved perpetrated fraud and conspiracy. Confiscated memos show traders offering each other small favors like coffee or champagne, or even nothing but thanks and high fives, in return for participating in a banking conspiracy; calling each other “dude” and “big boy” all the while. Apparently in the world of high finance, amoral profiteering is as commonplace as it is fun.

The LIBOR is supposed to be the rate at which an individual bank could borrow funds from another peer bank if it wanted to. It is calculated by the British Banker's Association, which solicits 18 banks to submit estimates for their own borrowing costs daily. The banks involved, as well as many third parties, then use the LIBOR as a benchmark to set all kinds of other rates, including mundane things like home mortgages, student loans, and small business financing. A false LIBOR, therefore, means false rates throughout the global economy.

Between 2005 and 2007, Barclays has admitted that its traders conspired with the submittal desks to knowingly produce false rates in order to produce an inaccurate LIBOR and increase returns on proprietary trades. This could also cause home owners, students, and businesses to cumulatively pay billions of dollars more in interest payments than they should have. Later, during the onset of the financial crisis, Barclays knowingly submitted borrowing rates that were far too low, in an attempt to look more financially healthy than they really were.

Initially, Barclays CEO Bob Diamond tried to blame the whole mess on a few “rogue traders,” as is common, and refused to resign. However, when it became clear that a culture of corruption permeated the company, Diamond changed his tune, telling a Parliamentary Treasury Select Committee that, yes, Barclays had lied and he would resign, but everybody else was lying, too. The first explanation—that fourteen individual traders would have the power to independently manipulate the world financial system—is scary enough, but it appears to be the second that's actually true. Memos show Barclays traders communicating and collaborating with desks at other banks, and now investigations have been opened against Bank of America (NYSE: BAC), Citigroup (NYSE: C), HSBC (NYSE: HBC), and JPMorgan Chase (NYSE: JPM), amongst others. Based on the communications unearthed at Barclays, it seems inevitable that at least some other banks will be charged with rate-fixing fraud. Mr. Diamond's head will not be the last to roll.

At the moment, the financial implications for the banks look small. Fines imposed on Barclays by the British and American governments totaled $450 million, one of the largest such penalties ever imposed. Barclays, which turned a profit of nearly $19 billion last year alone, may have noticed the loss of this walking-around money (there goes the coffee-and-champagne-in-return-for-fraud budget!) but shareholders are unlikely to be affected—by the fine, at least. The real trouble for implicated banks will be civil suits and other legal ramifications. Their counterparties may be able to walk away from deals based on a knowingly false LIBOR, and agents who lost money due to an artificial LIBOR may be able to sue the conspirators for damages. Some analysts have called the coming crisis banking's “tobacco moment,” calling to mind the settlements in which cigarette companies were found liable for years of harm and were forced to pay out hundreds of billions.

What's more, this last scandal may finally be the catalyst to spur the kind of financial reform that would end the big universal banks as we know them. I would suggest three reforms to limit the incentive and ability of banks to damage the global economic system.

First, the investment and retail lending operations of banks must be separated. The best thing for shareholders and the public would be to break up the banks, but at a minimum banks need a stronger firewall between the departments.

Second, a larger number of banks should be consulted on their borrowing costs to calculate the LIBOR. Only 18 banks currently contribute to the LIBOR, and this concentrates a vast amount of economic power in the hands of a small elite, which makes it all too easy to form the sort of cabal that they did. It would be far more difficult for a hundred banks to coordinate a cartel.

Finally, regulators should have the power to audit a banks' borrowing cost estimates by requiring potential lenders to corroborate the figure. Banks frequently found to have badly misjudged their real borrowing costs should be tossed out of the pool.

What Barclays—and probably other banks—did should not have been allowed to happen; and it should not be allowed to happen in the future. Let this scandal stand as yet another nail in the coffin of the idea that the banks can successfully “self-regulate.” Frankly, it isn't the banks' job to regulate themselves and they shouldn't be expected to. How much more do we need to see of what happens when we trust banks to care about moral rectitude instead of profits? Why is it that we keep letting our banks steal from us?

Daniel Ferry wouldn't touch any of the stocks mentioned above with a thirty-nine-and-a-half-foot pole. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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