“We are therefore being dishonest by definition and are at risk of damaging our reputation in the market and with the regulators.” — Barclays staff responsible for LIBOR submission, email December 4, 2007.
By now you’ve undoubtedly heard about Barclays’ manipulation of its submissions to the calculation of the London Interbank Offer Rates (LIBOR), or rather rates. The Barclays employee quoted above obviously understood the ramifications of the bank’s actions on the banks, unfortunately what he missed was something more important, the extent to which such actions would undermine the public’s support for both markets and finance, two key ingredients for a wealthy society. This I fear will be the more long‐lasting impact of the LIBOR scandal and those of us who support free‐market should be among the loudest condemning Barclays’ behavior.
It is not that I believe Barclays (or banks in general) is any more dishonest than say government politicians and bureaucrats, because in fact I believe bankers to generally be more honest than your typical politician (a low standard I know), but because banking is a business fundamentally built on trust. As we learned so painfully from the financial crisis, all the credit scores and data in the world does not guarantee that someone will honor the contract they’ve signed their name to. One of my greatest concerns is this loss of trust among market participants that makes any society function. The truth is that rules, courts and regulations are always going to be costly ways to monitor society. Trust is one of the great economizers of transactions costs. When we lose it on a broad scale, society is immensely poorer.
Of course trust alone is often insufficient. Incentives should be aligned so as to reduce misbehavior. As it relates to LIBOR, my first suggestion would be to move away from survey based borrowing measures, like LIBOR, and instead rely on market measures, based upon actual transactions, which are less subject to manipulation. Perhaps surprisingly, market measures are likely to be more volatile than surveys (compare the daily LIBOR and federal funds rates for instance), but such volatility would be a more honest assessment of market conditions. In fact one of the ironies, at least to me, is that looking at the various manipulations presented by the FSA, it isn’t clear, pre‐crisis, that Barclays was even able to move the market with its false submissions. Of course it isn’t the result here that matters, but the intent. And if our intent is to have a freer and wealthier society, then those who abuse our trust should be held to account.