First of all, who is Jack Lew, nominated for Treasury secretary by Barack Obama? He’s a Citibank alumnus, a former White House budget director, under Clinton and Obama, then became Obama’s chief of staff.
So what can we expect? What kind of secretary do we need? And what will we really get? Here’s how the U.S. Department of the Treasury describes his and their daunting mission:
“Maintain a strong economy while creating economic and job opportunities, and by promoting the conditions that enable economic growth and stability at home and abroad. Strengthen national security by combating threats and protecting the integrity of the financial system, and manage the U.S. Government’s finances and resources effectively.”
Note what the mission statement does not say: that Treasury exists only to preserve the vestiges of a crony capitalist system. Or that it’s only about saving financial players rather than enforcing the law. Or that it’s supposed to be incompetent in bailout negotiations.
Yet somehow since the days of the Clinton administration and Robert Rubin, the office of Treasury secretary has morphed into the custodian of Wall Street interests, paying little or no heed to the concerns of Main Street on matters of economic growth or employment. This new-fangled secretary tends to ignore the mandate to establish a genuinely stable financial system. It’s all about papering over cracks with bailouts or easements and simply setting us up for a bigger financial crisis down the road.
If we are to judge from the discussions of the likely new Treasury secretary, it appears that nothing will change. It is sad and ironic that the last person to occupy this office who cared at all about US interests outside of finance was James Baker. Even under the presidency of George W. Bush, Enron executives were jailed, yet over the past few years we have read much of widespread criminality and a total disregard for ethics and values. Led by Treasury, however, the authorities have seen fit to go soft on the banks and will prosecute only a few rogue traders when it seems many were involved.
The point is that we are not talking about the isolated act of a rogue trader or two. Criminality and greed are deeply embedded in the culture of the financial sector and only major reform will get rid of it. Unfortunately, the Obama administration, largely through the actions (or non-actions) of Tim Geithner, has been a major impediment to adopting the kinds of reforms that would allow Treasury to genuinely fulfill its ambitious mission statement. If Lew gets in, the probability would be business as usual.
We have a financial system today in which the volume of financial transactions in the global economy is 73.5 times higher than the entire world economic output (GDP). The overall increase in financial trading is exclusively due to the spectacular boom of the derivatives markets. Most of the financial flows comprise wealth-shuffling speculation, transactions that have nothing to do with the facilitation of trade in real goods and services across national boundaries.
In fact, we’ve really done nothing but tread water economically since the onset of the Great Recession of 2008. In the United States, financial institutions are still failing and as of May 2012, a whopping 441 FDIC-insured banks had failed. The employment-population ratio has dropped sharply. Nine million jobs were lost from the peak of January 2008, and at the current pace of sluggish job creation, it will take at least seven and half years to regain them.
Only in the Great Depression did it take longer for employment to recover in the U.S. Worldwide, as of May 2012, 50 million jobs are still missing compared to the pre-2008 crisis, thanks largely to our ruling financial plutocracy, who believe outsourcing jobs and burying profits in Cayman tax havens are just part of doing business. According to the International Labor Organization, the jobs are not expected to be regained until late 2016. And that might as well be a number pulled out of a hat.
Australian Economist Bill Mitchell details the depth of LIBOR corruption impacting the world economy
Over the next few days, Mitchell writes, he will be involved in transferring some of the major IT infrastructure for his research centre from his firm’s Newcastle office to their Melbourne office. This is the first stage of their plan to virtualize their server capacity, reducing costs, making it easier to manage, and giving them more independence in our new multi-campus structure. Sounds like fun doesn’t it? He writes . . .
Not! It also wasn’t much fun reading the documents published by the UK Financial Services Authority (FSA) and the US Department of Justice last week concerning their investigations into the UBS LIBOR manipulation scandal. We read of widespread criminality and a total disregard for ethics and values. The authorities have, however, seen fit to go soft on the bank and will prosecute only a few it seems when many were involved.
The point is that this is not the isolated act of a rogue trader or two. Systemic reform should start with the withdrawal of the license of USB to operate and then progressively the outlawing of the derivatives market and the scaling back of what banks can legally be involved in. Such major reform will not happen but until we get close to it the bad boys will continue to run loose.
The title of today’s blog is “Bank criminals sail away on their yachts,” in reference to an exchange between a UBS trader and a broker as reported in the—UBS Statement of Facts—issued by the US Justice Department: “mate yur getting bloody good at this libor game . . . think of me when yur on yur yacht in monaco wont yu . . .”
But as we know, the application of the law is very uneven across income and wealth cohorts in most nations. This is clearly evident in the way the US and UK governments have handled the UBS scandal.
The US Department of Justice announced last week that the bank (its Japanese subsidiary) would plead guilty, NOTICE, to felonious behavior where they manipulated the London Interbank Offered Rate (LIBOR), benchmark interest rates over many years.
According to the Bank of International Settlements (BIS) the “notional amount of over-the-counter interest rate derivative contracts was valued at approximately $450 trillion” in the last 6 months of 2009. The LIBOR is the “benchmark interest rate” for settlement of these contracts. Further, the LIBOR is often used as the reference rate for “mortgages, credit cards, student loans, and other consumer lending products.”
For those not familiar with the LIBOR, it is published by the British Bankers’ Association, which is “the leading trade association for the UK banking and financial services sector” with “over 200 member banks from 60 countries.”
Its board is made up of senior executives from the big banks and it aims to “engage with government, devolved administrations and Europe as well as the media and other key stakeholders to ensure the industry’s voice is heard.” In other words it is a lobbying organisation and has been a force in the deregulation of the financial sector in Britain.
The LIBOR is defined as: The rate at which an individual contributor panel bank could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size, just prior to 11.00 am London time.
The rate is “an indication of the average rate at which a LIBOR contributor bank can obtain unsecured funding in the London interbank market for a given period, in a given currency” and is computed after “submissions from LIBOR contributor banks, which are then averaged under a “trimmed mean” methodology.”
So every “contributor bank is asked”: At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?
The BBA note that the LIBOR is “not necessarily based on actual transactions, as not all banks will require funds in marketable size each day in each of the currencies/ maturities they quote and so it would not be feasible to create a full suite of LIBOR rates if this was a requirement.”
Now we know that there is an additional reason why the LIBOR is not based on actual transactions or market conditions.
The UBS Statement of Facts issued by the US government is a sorry tale indeed. The scandal also extends to the Euro Interbank Offered Rate (Euribor), the reference rate overseen by the European Banking Federation, and the Euroyen Tokyo Interbank Offered Rate (TIBOR), which is the reference rate overseen by the Japanese Bankers Association. The US Justice Department said that these benchmark rates “play a fundamentally important role in financial systems around the world.”
We now know that: Beginning in 2006, in Zurich, Tokyo, and elsewhere, several UBS employees engaged in sustained, wide-ranging, and systematic efforts to manipulate Yen LIBOR and, to a lesser extent, Euroyen TIBOR, to benefit UBS’s trading positions. This conduct encompassed hundreds of instances in which UBS employees sought to influence benchmark rates; during some periods, UBS employees engaged in this activity on nearly a daily basis.
The official inquiry documents are full of lurid conversations and E-mail interchanges between the various criminals, which not only record their conspiracy but also demonstrate that these characters are rather primal (uncouth) and are seriously tested by basic English spelling skills.
There were multiple trading techniques used to manipulate the market illegally to the benefit of the bank and those within it who were receiving tens of thousands of dollars in commissions each month.
The US Justice Department estimates that the US government housing agencies, Fannie Mae and Freddie Mac, are among those damaged by the manipulation. The estimate is that they lost more than $3 billion because of the criminal behavior of UBS and others.
The list of victims will expand. But who benefited? A narrow group of over-paid traders and managers in the banks concerned did. The US Attorney General said that behavior “defrauded the company’s counterparties of millions of dollars. And they did so primarily to reap increased profits, and secure bigger bonuses, for themselves.”
There are so many lurid exchanges documented. The one getting most attention is a transcript of a telephone conversation on September 18, 2008 between a trader and a broker. It related to what the British FSA called a “wash trade . . . i.e. risk free trades that cancelled each other out and which had no legitimate commercial rationale” (Source: Final Notice for UBS AG):
“ . . . if you keep 6s [i.e. the six month JPY LIBOR rate] unchanged today . . . I will fucking do one humongous deal with you . . . Like a 50,000 buck deal, whatever . . . I need you to keep it as low as possible . . . if you do that. . . . I’ll pay you, you know, 50,000 dollars, 100,000 dollars . . . whatever you want . . . I’m a man of my word . . .”
In their, Final Notice for UBS AG, we learn that UBS was making “corrupt payments of £15,000 per quarter to Brokers to reward them for their assistance.”
The arrogance of those involved is captured by the names they gave themselves (as reported by the FSA): “the three musketeers [sic],” “SUPERMAN,” “BE A HERO TODAY” and “captain chaos [sic]” . . . The criminals also guided so-called “honest banks” to move submissions in a certain direction. They said “hopefully the sheep will just copy.” The disdain is evident in their terminology.
The evidence is now clear—the Bank had clearly indulged in criminal behavior. However, according to the, UBS Non-Prosecution Agreement, the United States Department of Justice, Criminal Division, Fraud Section (“Fraud Section”) will not criminally prosecute UBS AG and its subsidiaries and affiliates (collectively, “UBS”) . . . for any crimes . . . related to UBS’s submissions of benchmark interest rates, including the London InterBank Offered Rate (known as LIBOR), the Euro Interbank Offered Rate (known as EURIBOR), and the Tokyo InterBank Offered Rate (known as TIBOR) . . .
Why? Apparently, UBS has been a cooperative criminal and promises not to do it again. The US Justice Department also claimed that imposing criminal charges on the Bank would endanger financial stability.
A few individuals are being prosecuted only. The authorities could withdraw the license to operate from UBS and there would be no danger to financial stability. There could also be safeguards on the deposits put in place without any issue.
In the “Deferred Prosecution Agreement” we learn that: UBS executives knew that UBS’s cross-border business violated the law . . . They refused to stop this activity, however, and in fact instructed their bankers to grow the business. The reason was money; the business was too profitable to give up. This was not a mere compliance oversight, but rather a knowing crime motivated by greed and disrespect of the law.
Across the Atlantic, the British Financial Services Authority (FSA) issued a press release on December 19, 2012 that read, UBS fined £160 million for significant failings in relation to LIBOR and EURIBOR, which relates to the same LIBOR manipulation in the UK jurisdiction.
The FSA concluded that the UBS “misconduct was extensive and widespread” and involved “traders, managers and senior managers.” They join Barclays among those already outed but the list of major global banks that are implicated in the criminality will expand.
Several things need to be understood
First, the vast proportion of the transactions (“trades”) that are involved here are unproductive, in the sense they add nothing to our real standard of living. Please read my blog Financial markets are mostly unproductive for more discussion on this point.
Financial markets are, in the most part, unproductive and produce very little of any value to the broader community. That is at the best of times. But the recent crisis has demonstrated that when they over-extend they have lethal consequences for the real economy.
People and nations now suffering unemployment, poverty, and, in some cases, starvation, had nothing to do with the development of all the shady products that the geniuses on Wall Street invented and pushed often fraudulently, onto ignorant investors.
Further, if private cost-benefit is to be the arbiter of where activity is best focused then a significant number of projects that obviously generate social wealth would never be funded. Society would be much worse off as a consequence. I can think of countless examples where the private markets would never have provided a socially-beneficial activity or resource.
In other words, there is a serious flaw in the proposition that financial markets are the best judges of social costs and benefits. Even mainstream microeconomics textbook have sections (if you can find them) on the divergence between social and private calculations and the need for non-market interventions to resolve the differences.
A study from WIFO (Austrian Institute for Economic Research), A General Financial Transaction Tax: A Short Cut of the Pros, the Cons and a Proposal, traced the explosion of global financial flows and derivative markets in the period leading up to the financial crisis.
WIFO made two general observations:
• Futures and options trading on exchanges has expanded much stronger since 2000 than OTC transactions (the latter are the exclusive domain of professionals). In 2007, transaction volume of exchange-traded derivatives was 42.1 times higher than world GDP, the respective ratio of OTC transactions was 23.5% . . .
• In other words, most of the financial flows comprise wealth-shuffling speculation, transactions which have nothing to do with the facilitation of trade in real goods and services across national boundaries.
In some cases, transactions that involve hedging and speculation are beneficial if they facilitate trade flows and provides security to a trading company. When we talk about hedging in this context we are referring to a strategy to avoid foreign exchange risk (sometimes called covering an open position).
Please read my blog A global financial tax? for more discussion on this point.
The important point is that the risk is transferred to the speculator and it is likely that arrangements like this increase the volume of international trade because the trading firm bears none of the risk of the exchange rate exposure involved in the cross-border transactions. In this context, the speculative behavior helps to facilitate trade in real goods and services which improves material standards of living (in general).
But that sort of transaction is a very small proportion of the total volume of financial transactions that occur on any single day.
The Over the Counter (OTC) derivatives market has long been a source of contention. In the US, regulators who sought to regulate the growing and secretive OTC derivatives market were met with great resistance from the likes of Robert Rubin, Alan Greenspan and Larry Summers. The latter three were touted as the “Committee that Saved the World” by Time Magazine on February 15, 1999.
Please read my blog, Being shamed and disgraced is not enough, for more discussion on this point.
Similarly, the British labor government coined the term “soft regulation,” which meant virtually none and what there was left would be applied loosely. The result: the banking disasters we have witnessed.
The other point to note is that the funds that the wealth-shufflers are playing with and cheating each other have ultimately come from major redistributions in real income to profits and away from wages.
A characteristic of the neo-liberal era has been the concerted effort by capital to suppress real wages growth and allow the gap between it and productivity growth to widen, thus redistributing real national income away from wages.
While this presented a realization problem, who would consume the increasing production, the answer was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments.
This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers.
The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold.
And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.
The largesse also allowed these investment banks (a misnomer if there ever was one) to garner the kitties they required to engage in their derivative trading.
Then the criminal greed took over and we have the sort of behavior that has been revealed in the most recent UBS reports.
Please read my blog, The origins of the economic crisis, for more discussion on this point.
We often hear of the term “rogue trader” as the characterization of the problem. In the decade or so before the financial crisis, as the financial sector was growing rapidly as governments relaxed regulations and watered down the oversight functions, there were scandals but these were typically dismissed with the “rogue trader” defense.
What we now know is that there is a culture of deceit and criminality that permeates the sector as a whole. There are many rogues.
Given that most of this behavior is of no consequence to the material standards of living of most of us on a daily basis but can cause severe damage to those standards when a crisis emerges, I prefer the line of argument that was outlined in this Bloomberg Op Ed (December 24, 2012), UBS Libor Manipulation Deserves the Death Penalty, which concludes that:
There is no point in mincing words: “UBS AG (UBSN), the Swiss global bank, has been disgracing the banking profession for years and needs to be shut down . . . an even more emphatic message needs to be sent to UBS by its prudential regulator in the U.S.: You are finished in this country. We are padlocking your Stamford, Connecticut, and Manhattan offices. You need to pack up and leave. Now.”
The article documents a litany of UBS-related scandals over a number of years that are separate from the LIBOR manipulation. For example, on February 18, 2009, we learned that “UBS Enters into Deferred Prosecution Agreement, which related to the Bank laundering money for US citizens so that they could avoid their tax obligations.
From a Modern Monetary Theory (MMT) perspective, the only useful thing a bank should do is to facilitate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk. In that regard, here is a sketch of what I would do with the commercial banks by way of regulation.
Banks should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets. This would stop all third-party commission deals which might involve banks acting as “brokers” and on-selling loans or other financial assets for profit. It is in this area of banking that the current financial crisis has emerged and it is costly and difficult to regulate. Banks should go back to what they were.
Banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully.
Banks should be prevented from having “off-balance sheet” assets, such as finance company arms which can evade regulation.
Banks should never be allowed to trade in credit default insurance. This is related to whoever should price risk.
Banks should be restricted to the facilitation of loans and not engage in any other commercial activity.
In other words, closing the OTC markets would be a preferable step,
As is clear—the white collar criminals typically get away with it while the most disadvantaged among us pay for every little misdemeanor. The system is stacked most against those with the least.
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As to Mr. Jack Lew from CitiBank, I would suggest to President Obama that a more public, in-depth vetting is required on the above issues as well as others, before he is signed on (unless his appointment is already a done deal, which would be a shame and a sham), mild-mannered, clever fellow that Mr. Lew is.
Jerry Mazza is a freelance writer and life-long resident of New York City. An EBook version of his book of poems “State Of Shock,” on 9/11 and its after effects is now available at Amazon.com and Barnesandnoble.com. He has also written hundreds of articles on politics and government as Associate Editor of Intrepid Report (formerly Online Journal). Reach him at email@example.com.