Sooner or later, the global inquiry into the rigging of Libor will have to deal with a sticky issue: what to do with the British Bankers’ Association, the trade group that was supposed to guarantee the integrity of one of the world’s most important financial benchmarks.
Founded in 1919, the BBA exists primarily to lobby for the interests of its member banks. In the 1980s, it took on the added responsibility of overseeing the London interbank offered rate, which is supposed to provide an objective measure of banks’ borrowing costs. Calculated every workday morning, Libor is used to determine payments on at least $300 trillion in mortgages, corporate loans and derivative contracts worldwide.
If the BBA had set out to design a system that its members could manipulate, it couldn’t have done a much better job. Instead of using the interest rates from actual transactions, the association relies on banks to report their borrowing costs. The chairmen of the committees that are supposed to oversee Libor, investigate misbehavior and impose sanctions are all from contributing institutions. Absurdly, the BBA won’t say whether the committees have ever taken any enforcement actions, and keeps secret the names of all the committee members. That amounts to letting the banks act as police, judge and jury in a Star Chamber.
We now know that bankers exploited Libor’s flaws as early as the 1990s. They manipulated their numbers to improve traders’ profits and to hide their financial troubles. All the while, the BBA demonstrated its utter inability -- or unwillingness -- to stop it. There is even evidence suggesting the BBA was complicit.
Consider, for example, a conversation between a senior Barclays Plc manager and a BBA representative cited in the bank’s settlement with the U.S. Commodity Futures Trading Commission. In April 2008, when a Wall Street Journal article questioned the integrity of Libor, the manager “informed BBA in a telephone call that it had not been reporting accurately, although he noted that Barclays was not the worst offender of the panel bank members. ‘We’re clean, but we’re dirty-clean, rather than clean-clean.’ The BBA representative responded, ‘no one’s clean-clean.’”
The BBA’s response has been a case study in self-regulation gone wrong. Throughout the period of manipulation, the BBA consistently claimed that Libor was reliable. Only in November 2008, after about seven months of deliberation, did the BBA make minor changes in the Libor process. Judging by the CFTC order, which says the manipulation continued through at least mid-2009, the BBA’s changes had little effect.
In a surreal 2010 annual report, when the investigation of Libor was well under way, the BBA said that Libor “has attracted widespread acclaim and its strengths lie in the fact that it is simple, transparent and market-led.”
Given the BBA’s history and inherent conflicts, it’s hard to imagine how it could be found fit and proper to manage Libor. This is a big problem, because the association owns the Libor trademark. Hundreds of trillions of dollars in financial contracts cite BBA Libor. Even if the market moves to a different benchmark, as Bloomberg View has advocated, those legacy contracts will be around for decades.
What to do? One option is to bring the currently unregulated Libor process under the purview of U.K. financial authorities. Regulators could sit on the Libor oversight committees and set enforceable rules for contributing banks. They could also mandate more transparency by requiring contributors to publish information on actual borrowing transactions, against which a bank’s Libor quotes could be checked.
Ideally, the BBA should be removed from the picture. U.K. regulators persuaded Barclays Chief Executive Officer Robert Diamond to step down; they should put similar pressure on the BBA to sell Libor. An organization such as a financial exchange or financial information company would have an incentive to guarantee the benchmark’s accuracy. (Disclosure: Bloomberg LP, the parent of Bloomberg News, has proposed its own alternative to Libor, and is a competitor of Thomson Reuters Corp., which conducts Libor surveys on behalf of the BBA.)
U.K. authorities have the power to make Libor better. They should use it.
Today’s highlights: the editors on King Abdullah and Jordan’s subsidy addiction; Jeffrey Goldberg on power failures and Mormon food hoarding; William Pesek on China’s education policies in Hong Kong; Ramesh Ponnuru on how much Romney could actually accomplish as president; Betsey Stevenson and Justin Wolfers on whether we’re better off; Barry Nalebuff on why New York should ban calories in beverages.
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