The Bankwatch

Tracking the consumer evolution of financial services

LIBOR is the catalyst of the next banking crisis

“The culture of the trading floor is remarkably immune to shame.”

This statement by the Financial Times John Gapper sums up where we are today with banks.  Most big banks have transitioned to a CEO from the investment side of the bank and this brings with it a host of unintended consequences.  I actually resent that banks run by the Bob Diamonds of the world are called banks.

Banks were traditionally run by stewards of peoples money.  The concept highlighted by Diamond in 2011 “[Banks] put capital at risk in order to discover what the market is willing to pay” is a traders view of the world.  Banks look after peoples savings, and carefully lend money to customers and businesses based on sound credit criteria based on transactional risk.

Traders don’t care about individual transactions involving customers.  There is no money in that.  They need large globs of aggregated money into financial instruments such as Asset Backed Paper, Swaps, Derivatives etc.  So it makes perfect sense when the Chinese walls came down between investment banking and high street banking, that this attracted traders who could lever this new found wealth of available capital and take large risks that gave them quick benefits in pay and bonus personally, but created long term weak companies that used to be banks.

Traders are thick skinned.  Go back to the opening quote.  Bankers are thin skinned.  Traders are cowboys.  Bankers are stewards.  Thinking back to my early days in training, one of the central banks primary tools was “moral suasion”.  This was a defined concept whereby the Central Bank would telegraph its intentions and desire regarding rates to the banking community.  Banks were partners in the management of the economy and would adhere.  Of course if they didn’t the Central Bank could always extract adherence in other ways, but that time was based on trust and co-operation.

Fast forward to 2012.  Imagine the ‘moral suasion’ language of Paul Tucker in that 2008 conversation with Bob Diamond.  I listened to Diamond in today hearings on BBC and it is clear that no matter what question is asked, that he answers with a series of points that highlights his greatness.  The pomposity and arrogance was quite visceral I thought.  “The Barclays that I love”.  They forgot to instruct him to say that with meaning.

But here while he cannot articulate it because he is a trader there is a point to be made that I hinted at in my last post.

The design of LIBOR harks back to the earlier age of banking that I speak of here.  It predates banks being taken over by Merchant Bankers.  It was designed in an age where there was a co-operative regime that had the best interests of the country in mind.  When you have a ‘country’s best interest’ person speaking to a trader, you have a recipe for complete misunderstanding.  I have to accuse Tucker for not recognising that too.  If I can see the sweeping changes that have affected banks over the last 30 years, then surely the Bank of England can see that too.

Finally, this meme is only just beginning.  The loose methodology around LIBOR setting will engulf all large banks in Europe and USA.  This is the next subprime crisis.  A relatively small subprime mortgage portfolio was a catalyst.  Forget Europe … LIBOR is the catalyst of the next banking crisis.

Written by Colin Henderson

July 4, 2012 at 17:48

Posted in Uncategorized

2 Responses

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  1. Mathematically the world economy appears to be an inherently unstable system. Small disturbances create enormous effects which spiral out of control rather than dampen out automatically. (too much mechanical advantage and too little damping)

    The ‘Financial Industry’ created the system so who is going to fix it?

    Perhaps the Industry should be working together with our elected Politicians rather than always relying on the ‘Markets’ telling the Politicians where to go.

    I see the painful discourse between the EU and G20 as a good example of that happening.

    The Scot Bicycle

    July 5, 2012 at 03:16

    • The mechanical advantage is an interesting analogy. In financial terms its called leverage and insufficient capital. Re working co-operatively, the Bob Diamonds/ Jamie Dimons of the world need to be told. They will rarely give in.

      Colin Henderson

      July 5, 2012 at 07:58

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