The First Global Financial Crisis – Coming Soon?

Are you perhaps thinking the biggest financial crisis in the world is the Greek crisis? Well, think again! While Greece is being treated like the “identified patient” of the Eurozone and assaulted with slings and arrows from outraged Germany, France and others, an even bigger tsunami is looming over the world’s banks from Asia to America.

This week more than a dozen investment bank traders have been fired, suspended, or put on leave for possibly colluding in “rigging” the  Libor.

“The what?” you ask. The Libor (London interbank offering rate) is the main global inter-banking loan rate used by big banks here and in the UK. As mind-boggling as this may seem, the Libor rate, used for setting interest rates on over $350 trillion of financial products such as mortgages, car loans, loans to corporations, futures and options contracts, and structured investment bank products and derivatives, is not based on actual trades: it is merely based on daily estimates, estimates sent in by traders and brokers to a committee of global bankers.

Numerous banks are involved in the growing scandal: Barclays (UK); Citigroup (US); Deutsch Bank (Germany); JP Morgan Chase (US); Nomura (Japan); Royal Bank of Scotland, and UBS (Switzerland). There are also three inter-dealer brokers being investigated as part of the possible Libor collusion: Icap, the largest in the world, Tullett Prebon and RP Martin.

Reputedly traders at these institutions did not want the high rates they paid for inter-bank loans to signal their institution was “weak”. Traders also personally earned a golden reputation if they could keep their inter-bank lending rates low. At least one trader at a bank being investigated moved on to a hedge fund, and hedge funds regularly bet on the Libor rates. Investigators now want to know too if hedge funds and traders knew the Libor rate in advance of everyone else.

Citigroup found two employees tweaking the Libor lower because a third employee blew the whistle on them. Citigroup has already written down $50 million in losses after unwinding the two traders’ deals. But here’s the kicker. According to the Financial Times (Libor penalty 2/12-13/12). Should a bank or two be found guilty of manipulating the rate by, say .03 percentage points over 10 years, the theoretical compensation could be $1 trillion.” It’s not just the Libor rate either. Nine enforcement agencies in the US, Europe, and Japan are looking into two smaller interbank loan rates as well. The are the Eurbor for European banking and the Tibor (Tokyo interbank offered rate) for Japanese banking.

The bottom line is that there could be trillions of dollars of losses from this scandal. No governments or institutions in the world will be large enough to bail out these global banks for that sum. While Hollywood is busy entertaining us with visions of the end of the world via natural catastrophes, nuclear destruction, and alien invasions, the real global catastrophe could be as close as our own wallets.

What is the message here?

In just four years we’ve gone from a problem of individual institutions that create havoc when they fail, to a problem with a global banking system that is itself big enough to fail. The investigation of the Libor may or may not reveal the first “international bankers conspiracy”. However, in a lawsuit against the Bank of Scotland, an employee in Singapore who was fired has alleged that all the bankers on the floor knew Libor rates were being falsified. His lawsuit adds that clients of the bank regularly submitted requests to traders to rig rates in order to maximize their profits on derivatives based on the Libor that they owned.

What is the cause of this remarkable global financial crisis? Dr. Susan Pomeroy suggested to me that it was a the lack of global financial regulation which caused the last crisis. Clearly that cause might be even more true in this case.

Why do we need international financial regulation?

I have a friend who is afraid of buying a new car for fear of being “ripped off”. Like many Americans, my friend practices a religion that believes in the notion of “original sin” for mankind. Yet my friend also belongs to a political party that has no problem embracing a philosophy which says the “free market” will take care of everything in the end.

My question is, if we are all possibly sinners, precisely how will the free market prevent fraud?

In Adam Smith’s day, the answer to how the “invisible hand” of the market could regulate fraud was easy. it was an era of small villages. Everyone knew each other. If you ripped off your neighbor, everyone would find out, and no one would patronize your business anymore. Or if they did, they’d be forewarned and on the lookout.

This certainly isn’t the case in a world with a human population that just surpassed seven billion. Yes, the Internet is a great source of information. Sites like Yelp or ConsumerLab can keep a lot of small businesses and large companies in line. But the banking industry is something else entirely.

These people don’t make things; they make up things. Expensive things. And then they sell these made-up (“structured”) products to the richest people and institutions in the world.

Who will pay when the things they make up for their own profit fail? The answer is “no one,” because no one has enough money to fix that kind of problem on the global scale. If governments are not allowed to regulate the banking industry in a way that prevents these kinds of abuses, how else can they be stopped? As far back as 2007, the British Bankers’ Association was being called upon to overhaul how the Libor rate is set, and it simply ignored the Libor’s critics.

The magic of vanishing wealth

The “market” does not create wealth. Neither does money. Both of these entities are merely the mechanism by which wealth changes hands. They are the “medium of exchange,” not the actual wealth itself. This is why trillions of dollars can and sometimes do vanish overnight even in a free market.

True wealth is made by the hands, hearts, and minds of human beings who actually work for a living. While there may be smarter ways of working and earning more, what is happening now is way beyond that. What we see happening now are the biggest pyramid-building schemes since the days of the ancient Egyptians.

Pity the poor Greeks! They lost their beautiful Helen to the Trojans and spent years and many lives in war to get her back, and now they are about to lose their shirts as well. Their government had been ordered pirate pension funds and jettison jobs to pay for the magically-vanishing “wealth” products created by global bankers and sold to foreign institutions.

Who will pay for this outrage? The answer is “no one” and “everyone”. Not only do we have no means of global financial regulation; we have no global system of justice for financial fraud. We barely even have national systems of punishment for financial fraud in place. We will all end up paying for this one way or another.

Governments, including the US government, are frantically suing one bank and brokerage firm after another for the frauds alleged to have occurred in the first financial crisis. The fines exacted in this country by the SEC are ludicrously low, and probably simply go to pay attorneys, bureaucrats, and the courts.

So, who do we imagine will try those international bankers who rigged the Libor, Tibor and Eubor? Will each country punish them differently? Will they be punished at all? So far only the Japanese authorities have placed any sanctions against the banks involved. Will proof be found to convict the rest? One has to ask too, what good will trying them in national courts or even an international court do, if the money is all gone because it was never even there in the first place?

Said one senior financial industry figure to the Financial Times (“Libor probe grows as scale of problem emerges” 2-10-12) “This is just another example of the slow drip of sleaze across the industry. How much more can it take?”

Indeed, and how much more can we take?

Follow Nancy Humphreys on Twitter @brucenomics

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#1 Susan Pomeroy on 02.13.12 at 6:35 pm

Great article, Nancy. I wonder what kind of entity will evolve to fill the regulatory gap, or perhaps a coalition based on population and geography—a collaboration of US, UK and Eurozone, perhaps, creating similar regulations in various nations/regions?

#2 Nancy Humphreys on 02.14.12 at 8:56 am

Regional regulatory groups? That’s an idea. No doubt we’ll see groups emerge in the Middle East and in Africa in this century too.

#3 Raoul Martinez on 02.14.12 at 6:54 pm

Very informative Nancy. the potential for these global financial crises is alarming, I’ll admit, particularly with the inability to regulate the industry.

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