Should we be shocked that traders at leading investment banks conspired to rig the Libor rate? (Libor is the London Interbank Offered Rate — a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market. Many other interest rates are pegged to the Libor.) By now no criminality by investment banks should surprise us. Talk of a few rotten apples, rogue traders, etc. should be put aside as the intellectual whitewash it is. So too should we dismiss President Obama’s excuse for inaction, the claim that many of the acts of investment banks were immoral but not illegal. Breaking the law has been the business model of these banks for over a decade. And many of these crimes, like the Libor bid rigging, are not complicated at all. They are simple garden-variety price fixing or fraud.
University of Texas economist James Galbraith has done more than any other economist to emphasize the role of criminality in this crisis. Remarks he made a year ago about the role of economists, law, and technology deserve even more attention now.
The breakdown of law was massive and sweeping: “… crime and corruption are everywhere: from the terms of the original mortgages to the appraisals of the houses on which they were based to the ratings of the securities against those mortgages to gross negligence of the regulators to the notion that risks could be laid off by credit default swaps, a substitute for insurance that lacked the critical ingredient of a traditional insurance policy, namely loss reserves.”
Mainstream economists not only failed to address this problem they contributed to its emergence. Part of the much-touted concept of financial deregulation was the notion that mortgages could be treated as tradable commodities to be sliced and recombined in new and complex ways in accordance with complicated, computer- enabled formulas and then sold and resold in international markets.
“[T]he theory of exchange requires the commodification of tradable artifacts. Without that, there is no supply and demand. A world of contracts, each backed by a separate and distinct set of promises each only as good as the commitments made specifically and the ability of the laws and courts to enforce them, is a different sort of world. Just because you can call a set of such contracts by a name, ‘collateralized debt obligation’ or ‘credit default swap,’ and just because you can create something called an exchange to trade them on — does not make them into commodities with a meaningful market price.
“Complexity here is what is going to defeat the market with ... more distinct features than one can keep up with. In great volume, contracts of these kinds are per se hyper-vulnerable to fraud.”.
Fraud was not a bug in the system, it was a feature: ”It is the world of technology at play in the form of quasi mass produced legal instruments of uncontrolled complexity. It is the world of, in other words, of evolutionary specialization in the never-ending dance of predator and prey. In nature, when predators achieve an overwhelming advantage, the prey suffer a population crash, from which the predators in turn suffer later on. In economics it’s a financial crash, but process and dynamics are essentially similar.”
Galbraith knows that corporate fraud is not new: “What was new here was the scale and complexity of debt obligations, backed by mortgages. Mortgages are not like, say, common stocks which although issued in the millions are each an identical claim on a company’s net worth. Mortgages are each a claim on the revenue stream of a different household, backed by homes of a diversity made irreducible by the simple fact that each one is in a different place. Long-term mortgages have existed since the New Deal, in the US, but they were rendered manageable for decades by their simple uniform structure, their substantial margin of safety and the fact that the secondary markets were public and imposed standards on what could be issued and on what could be passed on to the agencies created for refunding those markets. And what this meant was that supervision was possible. There could be a well understood code covering what was right and what was wrong along side practitioners who understood the ethics of the matter and enforcement officers who could work with them fairly smoothly for the most part and intervene when abuses became apparent.”
Galbraith is clear — and convincing — in his claim that we cannot revert to the pattern of banking 2005, even if trading of these complex securities were to be through regulated public exchanges. It is not just that trust has been destroyed. These products and the computers and fancy math used to construct them are designed to deceive.
The best hope of a more egalitarian capitalism lies in an older notion, that one’s home and the assets it represents cannot be a commodity traded on speculative exchanges. A modern version of such firewalls can never be all enduring. Periods of stability lead to overreach and risk taking, but we can put off the latter as long as possible. This is especially imperative now, no matter how politically tough a job.
Our banks are back to go-go speculation, with the risk of an even greater collapse than 2007. But Obama has been given a redo should he choose to exercise it. Libor scandal is simple to explain and outrageous. It could become an occasion to expose the criminality at the heart of modern investment banking. I will have more on the future of banking in subsequent columns.
John Buell lives in Southwest Harbor, Maine, and writes regularly on labor and environmental issues. Email firstname.lastname@example.org.
From The Progressive Populist, October 1, 2012
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