Friday, July 13, 2012

LIBOR scandal Fubarnomics and the pressing need for real reform

Several years ago I published a book called Fubarnomics that argued that most of the FUBAR ("fouled" up beyond all recognition) aspects of our economy -- including construction, healthcare, higher ed, and the financial crisis -- were rooted in hybrid failures, in both market and government failures in other words.

The recent scandal over LIBOR is no different. The market failure here is palpable: asymmetric information allowed the bankers to lie about how much it cost their banks to borrow. The government failure is more subtle but is perhaps best exposed by the question: wtf? More specifically, how was it that these crucial transactions were not monitored? that even after it became clear there were problems with self-reporting nothing substantive was done? The answer, of course, is regulatory capture. The Fed, the Treasury, and the FDIC are Wall Street's hand maidens, not its policemen.

The LIBOR scandal is just another indication that the financial system is badly broken. I think we need to return to basics: non-profit, plain vanilla depository institutions (credit unions) for the bulk of us; mutual insurers; mutual asset managers paid by performance (mutual funds); partnership-only investment banks/LCFIs/hedge funds; deposits guaranteed up to $25,000 and life insurance to $250,000, and everyone else on the hook for losses. If any company, financial or otherwise, becomes Too Big To Fail (TBTF) it needs to be broken up before it crashes the economy and causes taxpayers billions. Anyone in a fiduciary position caught stealing or lying needs to expect serious jail time and a lifetime of poverty.

But ahhhh there is that regulatory capture again. Sensible reforms are impossible until Americans make them happen. Traditionally, they are supposed to do so at the polls but what to do when both political parties have also been co-opted and only offer a choice between Frick and Frack? Revolution? Not yet. First Americans need to flex their economic muscles and stop doing business with big banks, political parties, and anyone else standing in the way of serious reform.


Reluctant Speculator said...

Why is this so difficult? If libor was determined by one set of market participants giving them the means to manipulate to their benefit, you just need an open market traded at any exchange that wants to trade it to determine prices like we do with most other things. This way all participants compete for prices and the exchanges compete for the best prices with the tightest spreads.

The interesting question is why this corruption-vulnerable scheme was established in the first place. I'm guessing that it was to speed up information flow before the days of electronic exchanges. What's interesting is why no one offered a competitive scheme to compete with the BBA's cartel.

The authors regulatory solutions are a bit naive. Regulation is the means for corruption. How can it be the remedy?

Robert E. Wright said...

I'm not sure why a dolphin is so interested in human financial systems or what "Reluctant Speculator" means when s/he asks "why is this so difficult?" This what? Maintaining a honest metric of nominal interest rates? I also don't understand the reference to plural authors or what regulation s/he refers to. Nevertheless, I am happy to see that someone errr.... some species is interested in the topic.

Reluctant Speculator said...

I assumed that given your advertized historical interest in finance you might be interested in a question regarding the origin of the LIBOR arrangement. But I can see now that you would rather insult my typos, loose language, and anonymity strategies.