Barclays' Libor Scandal Could Rattle the Banking World
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Poor Robert Diamond. Riding pretty much on top of the banking world just a few months ago, he is out of a job today. And the irony is that at the same time, his former employer, Barclays (NYSE: BCS), the seventh largest bank in the world measured by assets, and one of the Financial Stability Board's 29 banks too big to fail, was preparing its report to the FDIC. This report, like all resolution reports, focused on how excellent the big bank has functioned since last decade's meltdown. It is now being disclosed that Diamond played a central role in one of the worst financial scandals I have ever seen.
Diamond, an American national steeped in trading culture from his time at Morgan Stanley, ascended to lead bond trader at Barclays in 1997, and committed to turn the ancient, venerable, and very traditional bank, into a financial juggernaut. And he pretty much succeeded, apart at least from last decade's financial meltdown. In 2011, Barclays' investment bank had revenue of $4.7 billion in a dismal year for most investment banks, and overall earnings were about $6 billion. As a bank with at least $250 billion of non-banking assets and a presence in the U.S., Barclay's was required by the Dodd Frank act to put together a written plan, a “living will” on how, in an economic upheaval, the bank could be unwound so as not to jeopardize the entire financial system or require a taxpayer funded bailout.
But first, the very future of Barclays is at risk right now. It has been determined that under Diamond's leadership, traders at the bank concocted a scheme to falsify data that affected the key London Interbank Offer Rate (LIBOR), an index that underpins pricing involved in trades throughout the financial world worth over $360 trillion per year. The idea was that to help inspire confidence in the banking industry after the 2008 meltdown, Barclays would falsify its credit costs to make it appear that it was paying less in interest than it actually was paying. This impact on the LIBOR index would have rippled through economic systems worldwide, unjustly transferring as much as hundreds of billions of dollars due to faulty interest rates.
Diamond claims that executives at the Bank of England encouraged the manipulation, as it would make Barclays and the entire British banking system seem sounder than it was. Bank of England vehemently denies that, and the fact is that Barclays already paid a fine of $455 million for rigging the LIBOR. Diamond, who was CEO of Barclay's investment bank at the time, was front and center in the plan.
Regulators with the Bank of England made it clear that they did not appreciate the “Americanization” of Barclays' corporate culture, which pointed directly toward Diamond. The bank had been under pressure in Europe due to its American style aggressiveness and American sized pay packages. There is little doubt that current hearings going on in Great Britain will seek to make an example of both Diamond and Barclays as being out of touch with the traditions of British banking. I have a hard time believing, even assuming Barclays defrauded the investment public on its credit costs, that Barclays alone could have had much impact upon the interest rates without some other large banks and investment houses also being involved.
Rumor is that Royal Bank of Scotland (NYSE: RBS) is about to be fined 185 million euros, or about $230 million. HSBC (NYSE: HBC) and Lloyds (NYSE: LYG) will also face some sort of fines. According to a report from The Telegraph, Deputy Bank of England Governor Paul Tucker was aware of the misconduct, yet turned a blind eye. Despite the news, Royal Bank of Scotland has been hovering around $6.40 since the start of this week. HSBC has dropped slightly to around $43, while Lloyds has remained stagnant at around $1.85. The carnage from this may well spread to American banks with European investment houses, such as Citigroup, JPMorgan Chase, and Bank of America with its wholly owned Merrill Lynch unit.
What is bad news for some is not bad news for all. Barclays’ stock has fallen over 30% since May 1, and that is blood in the water to hedge funds. Well known European hedge fund manager Crispin Odey, added another $15.6 million to his already existing stake of about $94 million in Barclays stock, and in so doing called Barclays the “cheapest stock in the world.” And he does have a point. It is trading now at a five year PEG of a microscopic 0.20, suggesting a highly undervalued equity. And, since most other western banks which generally compete with Barclays are likely to be in the same boat as the British bank on the LIBOR issue, there is nothing to be gained by looking elsewhere.
Barclays is a dominant bank, and will continue to be even while missing Diamond and several other Board members and managers. This may well be a historic opportunity. That “may” is due to the small possibility that if the magnitude of the fraud is endemic to all large European investment houses, there may be real moves to separate investment banks from commercial banks, a la Glass Steagall. In a world where an increasing concentration of assets is in the hands of the very largest banks, and with much of those banks assets tied up in their trading operations, a great deal of systemic risk could be removed worldwide by segregating commercial banking from market making and trading operations.
It really does seem a never ending soap opera of greed and corruption among the large investment banks and, of course, the commercial banks that own them. The United States, Europe, Japan, it does not matter. Modern banking needs greed buffers, as greed brings about the very kinds of risks that created not just LIBOR manipulation, but the London Whale, and countless others as well. If banks were segregated from investment operations, at least depositor or taxpayer money would not be going into these inherently unpredictable and unstable divisions.
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