Predictably enough the Barclays Libor scandal is generating rampant theatrics amongst both journalists and politicians. It is not easy to keep grip on what actually matters. And yet this is vital when it comes to deciding what the next steps should be.
One piece of theatre is a sort of whodunnit, amongst Barclays senior managers, and government and regulatory officials. How much did they know? What did they authorise? One line of attack concentrates on Bob Diamond, the former Barclays Chief Executive, whose evasions at a parliamentary select committee yesterday created predictable anger. The real point behind this is the question of how far up the chain of command should responsibility for unethical behaviour go? Should bank chief executives be like Royal Navy captains, as John Kay suggested yesterday in the FT, and take full responsibility for everything that happens on their ship?
A further twist comes from the thought that there may have been an element of government connivance in the second phase of manipulation, as the financial crisis was in full swing. The hope amongst government politicians is that something can be pinned on Labour figures such as Shadow Chancellor Ed Balls. That looks a long shot. Experienced political operators like Mr Balls don't leave fingerprints, and there were legitimate reasons at the time for an interest in the behaviour of Libor. But the Labour's case wasn't helped by a radio interview with Baroness Vadera, Gordon Brown's economic adviser, yesterday lunchtime. She was evasive, confusing the two very different phases of the scandal (i.e. the first phase of manipulation for to make trading profits, and the second of official manipulation for wider politcal purposes). It gave the impression there was something to hide. Other key Labour figures, such as Mr Balls and Lord Myners, the former City minister, are giving much more confident performances, though.
Centre stage for the theatrics today is the argument as to whether any enquiry should be a full judicial one, like the Leveson Inquiry into the press, which Labour are asking for, or the government's preferred option of a quicker parliamentary one. Both options have merit. A judicial enquiry gives the whole thing an air of importance, and legal interrogators are much more effective than grandstanding politicians; it would keep the City types on the ropes for longer. But lawyers are unlikely to contribute much of value to designing a solution. A parliamentary enquiry would be a quicker way to actually change the law, as well as creating less complications for any parallel criminal investigations. What is actually needed is an expert commission - but we've already had one of those, the Vickers Commission - which indeed pointed towards some of the solutions.
But what actually needs to be done? In principle this isn't difficult. Investment banking activities do play a useful role in the modern economic system, and aggressive trading culture can help the process of what economists call "price discovery" - spotting and correcting where the prices of financial instruments don't reflect the world's realities. Short-selling the shares of badly performing companies looks ugly, for example, but it does improve accountability. But the usefulness of investment banking is distorted by two problems:
- Using other people's money. Where traders use borrowed money to trade with, which is the bulk of what they do, then they are not taking full responsibility for the rsiks they are taking, and the whole balance of incentives gets skewed. Trading soon escalates to levels beyond the socially useful. The volume of borrowed money used has risen massively over the last couple of decades, and many traders probably don't even understand the idea of using their own capital to bet with.
- Trading culture struggles to recognise ethical boundaries. A disagreement over price is one thing, but manipulating systems designed help people is another. Fiddling Libor (especially in the first phase of this scandal) was one such transgression, as are various scams to exploit the way mutual funds are priced. The UK regulatory authorities can be too soft on this.
So in essence what needs to happen is this:
- Isolate banks' trading and derivative activities from ordinary economic deposit-taking and commercial lending, and attach separate regulatory regimes to each.
- Clamp down hard on unethical behaviour - with chief executives and directors taking full responsibility for what happens in their organisations. Ignorance should not be a defence - and if that means some organisations become impossible to manage, then they should be broken up. Sanctions should hurt, and include the criminal law (though remember that its higher burden of proof can get in the way).
- The money supply to investment banking operations needs to be choked off, so that only those that fully understand the risks are supplying it. Isolation will help here, but may not be enough.
The principles are easy, but the details are all important. The problems are global but it will be very hard for us in Britain. The City is so important for our overall economy that we are easily scared away from being too tough. But if the attraction of the City is that it is easier to do unethical business, then this is not a recipe for long-term success. We can still have a thriving financial services industry with niche operations based on genuine knowledge and expertise of the real world, and the provision of solid, well designed infrastructure and systems.
Next steps? I think an enquiry is a bit of a distraction, so the government's option is probably better. the government perhaps using this enquiry as cover, must go back to the Vickers proposals and implement them in full. Going beyond Vickers to enforce the full separation of investment and commercial banking should be considered. And as for culture change, that needs to happen at the regulators, including the Bank of England, as much as the banks themselves. A change of senior personnel would help here.