The Wests financial industry remains broken, and Western politicians continue to flail about in their halfhearted attempts to pretend that theyre confronting the problem. This weeks titan-turned-villain is Bob Diamond, until Tuesday the head of Britains Barclays Bank. The American-born Diamond ran the investment arm of the bank half a decade ago, when it consistently manipulated the London Interbank Offered Rate, better known as Libor—the interest rate that big banks report having to pay to borrow funds from global markets. If Libor is low, things are good; if Libor is high, things are bad. Libor helps determine the rate for $350 trillion in global bonds and loans, from floating-rate American mortgages to power-plant financing in Brazil.
Nobody ever checked if global banks were telling the truth about Libor. Barclays wasnt. Now, American and British investigators have levied a $450 million fine against the bank for lying about the rate, starting in 2005, to increase its own trading profits and then, during the 2008 financial crisis, to avoid the scrutiny of a panicked financial system (when reporting a high rate indicated trouble). Diamond stepped down earlier this week. Investigators are assessing the extent to which other banks, alone or in collusion, manipulated Libor.
Does Diamond deserve to be glum and out of a job? Sure, and now hes both—and, horror of horrors for one of the global elite, he also has to move back to America. But if fixing finance depended solely on purging or shaming bad people, finance would be in good shape by now. Just think back to January, when Sir Fred Goodwin, former head of the Royal Bank of Scotland, lost his honorific. The Queen, acting on government orders, snatched away Goodwins knighthood as belated punishment for having sent RBS into a massive tailspin that required a government bailout beginning in 2008 (taxpayers still own the bank).
Or think of Angelo Mozilo (Countrywide Financial), Richard Fuld (Lehman Brothers), E. Stanley ONeal (Merrill Lynch), Charles Prince (Citigroup), Jon Corzine (Goldman Sachs, the State of New Jersey, and MF Global), and other former big shots who cant show their faces in polite company these days. Jamie Dimon (JPMorgan Chase) and Lloyd Blankfein (Goldman) have kept their jobs and their cocktail-party status, but Congress periodically has hauled them before panels to serve as punching bags.
And yet the White House and 10 Downing Street still think that one more disgraced CEO will surely do the trick. Call it the fat-cat strategy of dealing with the financial crisis, after the terminology that President Obama used in 2009 to describe bankers. Wednesday, British chancellor of the exchequer George Osborne praised Diamonds resignation, saying that the departure could be a first step towards a new culture of British banking. Last week, the Financial Times declared that for there to be a real change of heart and expectation, it may therefore be necessary to retire this generation of flawed [bank] leaders. Londons top financial regulator, Adair Turner, said the question was how to purge the industry of the culture of cynical entitlement.
Sorry, no. The harshest punishment for the bankers would be to leave their fate to the marketplace. If the West had let markets work in the years leading up to 2008 and beyond, thered be no need to get rid of this crop of bad actors. When bubble-era banks went out of business because of their disastrous mistakes and mischief, they would have taken their failed leadership with them.
Yes, a few firms did fail, but not enough to change the institutional culture of Wall Street and the City (Londons financial district). Instead, institutions that should have gone under, including the Royal Bank of Scotland, have forged ahead, dragging problems that should have been solved by now into the future and harming economic growth. Why wouldnt bankers feel entitled and cynical? The leaders of bad banks can see that the government desperately needs them to exist, and the leaders of good banks that didnt need direct bailouts (including Barclays) understand that the playing field is not level.
What should outrage people arent Diamonds actions, but the governments. The United States, for one, has said it wont prosecute Barclays for its Libor-rate manipulation as long as it cooperates in the future. But if faking the worlds most important interest rate isnt an existence-imperiling crime, what would be? The truth is that America and Britain are terrified at the prospect of a company like Barclays going out of business and the turmoil such a bankruptcy would inflict on the global financial system. From the perspective of the financial institution, paying a fine, weighed against that useful terror, isnt such a big deal. In fact, over the past few years, household-name banks have paid nine-figure fines each for everything from manipulating municipal finance (JPMorgan) to money-laundering (ING). Theyre still around, so you can forgive them and their competitors for not worrying.
The answers to our problems are straightforward. When a bank egregiously breaks the law, it should run the risk of a criminal convictions throwing it out of business. Let a company whose business model isnt law-breaking have a go at it. And when a bank, through perfectly legal mistakes, loses so much money it endangers itself, it should face the marketplace, not government rescuers. If America and Britain cannot devise a way for investors to believe that large financial firms can go bankrupt, then its time to break up those institutions. Are we going to continue this state of economic suspension for another half-decade?
Making it clear that banks are subject to market discipline, not government bullying, will help solve other woes as well. It would be much harder for hundreds of small banks than for just a dozen or so big banks to conspire to fix Libor rates. Why dont Western governments take this route? Because the West, both in its private and public sectors, remains addicted to cheap debt to keep its consumption-dependent economies sputtering along. The West is also dependent on a too-big financial sector, which gives lots of voters, both in America and in Britain, seemingly good and stable jobs.
On that note, if anyone has been manipulating interest rates to pretend that everything is A-OK, its Western governments. In recent years, central banks in America and Britain (and in Europe) have bought hundreds of billions worth of bonds in an effort to keep global interest rates low, financial firms afloat, and middle-class borrowers placated. Governments have also pushed banks to take ill-advised steps: part of Barclayss defense involves making it known that British regulators told the bank that it wanted to see low Libor rates reported in the fall of 2008.
Western politicians still need what the banks are selling. If youre President Obama or British prime minister David Cameron, youve got to think its better to have people angry at Lloyd Blankfein and Bob Diamond than angry at you for allowing markets to tell us that interest rates should be higher because weve borrowed too much. We may be rid of Bob Diamond, but someone will replace him, because the West needs someone to do its dirty work of keeping the middle classes quietly indebted and (mostly) employed. Its a job that pays pretty well.
The Libor scandal, Adair Turner said, has caused a huge blow to the reputation of the banking industry. The only rational reaction to that statement is a snort: What reputation?