London, City of Scandal: Why Britain’s Banking Culture Needs Fixing

If you search the internet for Bob Diamond, the chief executive of Britain’s Barclays Bank who resigned on July 3 amid the latest financial scandal to roil markets across the world, the two adjectives that most often pop up are American and brash. It’s easy to see why. Diamond, 60, is a hard-charging trader from Concord, Mass., who rose to the top at Barclays — founded by Quakers in 1690 — by building its investment-banking division into a global powerhouse and helping the bank grow to Europe’s sixth largest, with assets of $2.3 trillion. Among his boldest coups was the purchase of the remains of Lehman Brothers within days of its bankruptcy in 2008.

That all makes for a simple, clichéd narrative: uncouth and ambitious foreigner arrives in London, makes buckets of money and lots of enemies before it all ends in tears. Diamond, who has earned more than $150 million at Barclays since 2005, didn’t help his cause when, summoned before a parliamentary hearing on July 4, he insisted on addressing the members by their first names while MPs continued to address him, frostily, as Mr. Diamond.

(MORE: How Barclays Loaded the LIBOR Dice)

Foreigners have indeed played key roles in some of the greatest financial disasters brewed in the U.K. capital. When JPMorgan Chase incurred a multibillion-dollar loss because of a derivatives trade gone awry, attention focused on Bruno Iksil, a Frenchman based in London, whose huge portfolio of deals had earned him the nickname the Whale. American Joe Cassano and the financial-products division of AIG that he headed — whose catastrophic losses almost toppled the giant American insurance company at the height of the 2008 financial crisis — also operated out of London. And it didn’t take investigators poring over Lehman’s books long to discover that, among other shenanigans, the London operation of the failed investment bank had attempted to disguise its death agony by shifting billions of dollars across the Atlantic.

But take a closer look. From the South Sea bubble in 1720 to the 1990s implosions of the Bank of Credit and Commerce International and of Barings Bank and through a gallery of rogue traders and dodgy deals that have posed existential threats to financial institutions on several continents during the past quarter of a century, the common factor is not that they were caused by foreigners in London. London itself, especially its compact financial district known as the City, is implicated.

(MORE: Libor Manipulation: The Markets’ Worst-Kept Secret?)

The latest scandal — the alleged rigging by institutional insiders of LIBOR, a key money-market rate that is used as a benchmark for an estimated $350 trillion in financial products and services, and at least as much again in financial-market transactions around the globe — threatens to be the biggest, extending far beyond Barclays to banks in the U.S., Europe and Asia. It surfaced on June 26, when Barclays was fined $450 million by British and U.S. regulators for attempting to manipulate that rate for several years, starting in 2005. The case has sparked a parliamentary inquiry and a criminal probe by the U.K.’s Serious Fraud Office. Investigations of more than a dozen other banks continue in continental Europe and across the Atlantic, where the U.S. Commodity Futures Trading Commission (CFTC), helped by the Justice Department and the FBI, has played a key role in blowing the whistle — and where armies of class-action lawyers are sharpening their pencils. “There is an industry-wide problem coming out now,” Diamond told the parliamentary committee. No criminal charges have yet been filed in London or elsewhere, but it’s already clear that this problem — Congressman Barney Frank called it “outrageous,” and Nation columnist Robert Scheer dubbed it “the crime of the century” — affects far more than the industry that produced it. Just about anyone anywhere who has a credit card, mortgage or other form of loan was potentially impacted.

Individuals and institutions may end up on trial. Yet a swelling sentiment would like to see a bigger entity in the dock: London. It’s no longer enough to explain the City’s supremacy as a global incubator for scandals by citing its global supremacy as a center for international finance, the world’s most potent competitor to New York City, a place where transactions covering literally trillions of dollars, pounds and euros are executed every day.

(MORE: Libor Scandal: The Crime of the Century?)

The scandal also lays bare serious failings in the British system — failings of regulation and of culture. In a globalized financial system, such failings have global repercussions, yet responsibility for fixing the system rests locally, with the flawed system itself. Trust in public life is sliding everywhere, but British institutions are especially fragile, according to a report by Democratic Audit published in July that compared data across E.U. and OECD countries. Politicians, police, regulators, corporations and the media, which should hold the rest to account, have been enmeshed in a series of confidence-sapping scandals. “Who guards the guardians?” asked Justice Brian Leveson at the start, in November, of the independent inquiry into the phone-hacking scandal that came on the heels of revelations about British parliamentarians milking their expense accounts. As the LIBOR imbroglio unfolds, and the weaknesses at the heart of the British establishment create problems around the world, that question is gaining breadth and urgency.

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Giving the Lie to LIBOR
The money-market rate at the core of this scandal, the London interbank offered rate, or LIBOR, is set daily by a panel of 18 banks — including Bank of America, Bank of Tokyo-Mitsubishi UFJ, BNP Paribas, Citigroup, Deutsche Bank, JPMorgan Chase and UBS — that report the rates at which they would be willing to borrow U.S. dollars and nine other currencies. Thomson Reuters, acting on behalf of the British Bankers’ Association, lops off the top and bottom numbers and calculates the averages of the rest, which it and other organizations publish as the official LIBOR rates. These are by far the most important money-market rates in the world. Most instruments of consumer credit are pegged to LIBOR. But it’s also critical for traders of financial derivatives and other products who use LIBOR as the basis for complex swap transactions.

That this rate should be set in London is testimony to the city’s pre-eminent role in global finance. It’s the main hub for foreign exchange, accounting for about 37% of total turnover, as well as being the dominant location for trading international bonds and financial derivatives. It’s also a global center for shipping, insurance, pension funds and commodity markets.

(PHOTOS: The Global Financial Crisis)

But as the world discovered in 2008, when you’re too big to fail, that’s a problem. The International Monetary Fund, for one, watches London very closely, since British-based financial institutions accounted for more than half of the generation of global funds during the boom years before 2007; in other words, they provided the majority of the world’s financial liquidity. “The size and interconnectedness of the U.K. financial sector make it a powerful originator, transmitter and potential dampener of global shocks,” according to an IMF report last year on London’s global “spillover” potential.

The stakes are high, yet LIBOR is set by participating banks through a process of self-regulation. This meant individuals working for the banks that were seeking to ride out the global financial meltdown in 2008 may have lowballed LIBOR submissions to disguise the true, high costs of borrowing that reflected market concerns about their survival chances. It also made it possible for traders working for Barclays to game the system — allegedly in some cases for personal gain — for at least three years before the banking crisis. The CFTC launched its investigation as early as May 2008, but even before that, there were suspicions in the market. One London bank treasurer was quoted in the Financial Times in September 2007 as calling LIBOR rates “a bit of a fiction.” Details of LIBOR rigging became fully public when the Barclays settlement was announced together with a slew of incriminating messages from Barclays traders to the team that was involved in fixing the rates. The messages are shameless. “Always happy to help, leave it with me, Sir,” reads one reply to a request to fix the rate below a specific level.

At the parliamentary hearing, Diamond said he felt “physically sick” reading these e-mails. But Diamond himself was caught up in the affair. In October 2008, a month after the collapse of Lehman, Diamond held a phone conversation with a top Bank of England official, Paul Tucker. According to Diamond’s notes at the time, Tucker expressed concern that Barclays’ rates were higher than those of other banks. Barclays itself says it was consistently submitting the highest rate that month, as much as half a percentage point higher than the second highest rate. (In September 2008, the three-month sterling LIBOR rate peaked at 6.3%.)

(MORE: The Barclays Libor Scandal Is a Clear Case for Greater Consumer Protection)

One possible explanation for what followed is that Diamond’s colleagues at Barclays interpreted Tucker’s comments as a tacit O.K. to put in artificially lowered rates in order to project an image of strength. Diamond suggested in his testimony that other panel banks were already fiddling with LIBOR, and investigators in Germany, the U.K. and the U.S. have confirmed that they are looking at other banks as part of their inquiries. Tucker has denied that he condoned any attempt to artificially lower Barclays’ submissions.

Banking on Change
London’s success as a financial market has been underpinned by an increasingly quaint notion of British gentlemanly business practice: that the market itself is clean, even if some players are not. In the mid-1980s, Britain’s Conservative government instituted an oversight regime in the City that relied heavily on self-regulation. Labour, after winning power in 1997, continued the light-touch tradition. But serial scandals inspired a rethink on self-regulation. The 1995 collapse of Barings Bank, in particular, led to the creation of the Financial Services Authority (FSA), a unified regulator for the whole financial-services sector. But self-regulation still prevails in LIBOR, a state of affairs that now looks like a serious omission.

Legislation was already in the pipeline to eliminate ambiguities in the existing system that divides responsibilities among the U.K. Treasury, the Bank of England and the FSA. But reform is fraught with tension as Labour, again in opposition, and the Conservative-led coalition government devote as much energy to blaming each other for the imperfections of the system as to fixing them.

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Yet it is critical for London’s future as the key global financial center to rebuild confidence, and quickly. If Britain doesn’t root out the conditions that allowed the conflicts of interest and illegal practices in the LIBOR affair to flourish in the first place, it may find not just its economy in peril. Its position in the world, already crumbling, is at stake.
— with reporting by William Lee Adams and Kharunya Paramaguru / London

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