In 2008, Donald MacKenzie expounded to LRB readers with admirable clarity the workings of Libor (the London Interbank Offered Rate), which establishes the benchmark terms on which hundreds of trillions of dollars are lent and borrowed across the world every day.[*] It sometimes comes as a surprise to the uninitiated to learn that Libor has never been based on transactions which have actually taken place but on the interest rates at which the participating banks say they could borrow money if they chose. This has meant, inevitably, that there is an incentive for the traders to manipulate their inputs in order to nudge the rate up or down to their advantage. There are mechanisms in place, including the systematic elimination of outliers – the lowest and highest quartiles of the estimated borrowing rates – which make it difficult; but it can be done.
By the time MacKenzie was writing, the stage had been set for the drama which seven years later was to land Tom Hayes with a 14-year prison sentence (since reduced by three years) following his conviction as ringleader of a scheme that confirmed the misgivings seasoned observers, particularly in New York, had long been voicing about how Libor was being set. It cannot be defensible to enlist brokers to move fractions of percentages in a direction they wouldn’t otherwise go and reward them with fees generated by arranging for two banks to place identical bets on lending rates against the other in which neither wins or loses. But will the length of the sentence have the deterrent effect the judge intended? Many criminologists will tell you that the most effective deterrent is seldom if ever the severity of the penalty. It’s the certainty of being caught and the shame attached to that.
To look back at the regulation of the City of London over the past half-century and more is to see something of a paradox in the mutual feedback between stricter control and more widespread misbehaviour. Wherever large sums of money are changing hands, there will always be bad people getting up to bad things, good people who pride themselves on winning by honest means, and normal people who, when they become aware of people around them misbehaving, start to wonder why they shouldn’t misbehave too. But as standards change, behaviour can change in ways not always foreseeable. Reputational sanctions started to lose their restraining influence in a world of globalisation, amalgamation, technical innovation, internal reorganisation, depersonalisation, deregulation and relentless increase in the pace and volume of transactions. New rules spawned increasingly ingenious strategies for circumventing them. In the world of Libor, transparency generated enhanced opportunities to mislead. The merchant banks, which used to complain that they had the brains while the clearers had the deposits, began to admit to their dining rooms clients to whom their predecessors would have shown the door, and the clearers to engage in practices their predecessors would never have contemplated, let alone condoned.
It is difficult not to see a Gresham’s Law at work in all this by which bad practices drive out good. When trading is as fast, large-scale, continuous and impersonal as it has become, nobody can possibly know more than a tiny amount of what there is to be known about who is doing what, when and how. Whistle-blowers come to be seen not as upholding standards but as letting down the side. A gun-slinging ethos can all too easily spread in which greed is good, nice guys finish last, and if you want loyalty go get yourself a cocker spaniel. By a further irony, human rights and employment law have made it harder for directors to uphold standards when their HR departments are strongly advising them to settle with dodgy employees in cash and pass them on elsewhere rather than be taken before a tribunal.
I have never been involved in banking supervision. But in 1986, I was – to my astonishment – summoned by the governor of the Bank of England to be asked if I would serve as a lay member of what was then called the Securities and Investments Board. I barely knew what it was. But I remember mumbling some nonsense about believing that if the government of the day asks you to do a job you should do it, and I duly remained a regulator until retiring in 1998 as deputy chairman of what was by then the Financial Services Authority, after the system had been rejigged by Gordon Brown under the mantra of ‘modernisation’. But the problems posed by conflicting objectives, uncertain penalties, overlapping responsibilities and ever more ingenious financial products were, and are, still there.
My learning curve at the SIB was predictably steep. But I was soon persuaded that the only sensible way to oversee financial markets is statute-backed self-regulation. It can’t be left to civil servants round whom the traders will run effortless rings. And it can’t be left to practitioners, who in an intensely competitive environment will inevitably subordinate the public interest to their own to a greater or lesser degree. The problem is the drafting of the statute. The act under which the SIB was operating was demonstrably flawed, but there was no consensus about how its flaws should be put right. When, later on, Kenneth Clarke was chancellor of the exchequer and we trooped along to 11 Downing Street to ask for primary legislation, he told us with characteristic outspokenness that we were wasting both his time and ours. Ministers who in the run-up to a general election are concerned not to be pilloried as being soft on the City are quite capable, once the election is won, of turning on the regulators and upbraiding them for over-regulation. There will never be non-partisan agreement about where, let alone how, Parliament should draw the line.
The SIB was much concerned with the protection of the small investor, a need recognised by even the hardest-nosed advocates of the principle of caveat emptor. But how do you protect people who are incapable of protecting themselves? The producers can be required by law to bombard their prospective customers with as many health warnings and give them as long a cooling-off period as you please. But they go on being seduced. It is understandable that the public in general should have been unprepared for the banks with which they deposit their money to be guilty of malpractice as well as errors of judgment of a kind they had no reason to suspect. It is understandable too that having been alerted to the realisation that they are victims of unscrupulous promotion and concealed mis-selling many people are slow to pursue claims for redress. But nothing the regulators can do will ensure that those with modest savings or investments will seek the authentically independent advice they need.
If new legislation is on the cards, would-be reformers need to have a clear and credible wish list. What is the relative importance of averting systemic failure, preventing fraud, holding bosses to account for the conduct of their subordinates, securing compensation for the wronged, and stamping out abuse of process by advisers who take duty to the client to unacceptable extremes? Tighter statutory restrictions are not going to be effective if the traders take their infringement no more seriously than exceeding the speed limit. Compliance will be merely box-ticking unless the peer-group has, as sociologists put it, internalised the norms. The threat of criminal penalties will not be as effective as it should be if juries are reluctant to convict, the judiciary hostile to plea bargaining, and prosecutors unsure of meeting the criminal standard of proof. Traders under constant pressure to improve their performance will continue to be tempted to transgress their limits if they’re not closely monitored (particularly if they’re posting unusual profits). Not even the most experienced parliamentary drafting team can come up with a statute that will send Gresham’s Law into reverse.
Toughening the rules can be not only ineffective but counter-productive. In a global financial community, traders who have chosen to operate in London will continue to do so only for as long as it suits them. When, the other day, I heard a Conservative member of the House of Lords say that London has become the money-laundering capital of the world, my immediate reaction was that he was joking. But was he? International harmonisation isn’t legally, technically or ideologically feasible. One culture’s commission is another’s bribe. One culture’s avoidance of tax is another’s evasion. One culture’s legitimate hype is another’s false prospectus.
Restraint of uninhibited greed is not a problem unique to capitalist societies. The glaring inequalities of wealth and privilege in both socialist and authoritarian regimes are similarly sustained by practices their critics denounce as corrupt but which have a way of re-emerging after whatever measures, if any, are periodically imposed to punish or deter offenders. Governments can’t make people who want to make money want to make it only by strict adherence to rules they see as giving unfair advantage to their rivals. Honesty is the best policy only if being seen to be honest is good for the bottom line. It can be, even (or particularly) when standards of conduct are perceived to be falling, but only if the rule-makers have the practitioners on side.
And then, what about spectacular errors of judgment that aren’t remotely criminal in intent but have the potential to cost shareholders and ultimately taxpayers as much as or more than any rogue trader? Banks used to be bywords for caution and reliability, but in recent years they have not only attracted financial penalties on an unprecedented scale, but further tarnished their image by decisions which turned out to be not just over-optimistic but reckless to the point of disaster. Not even the most punitive commentators argue that bank directors should go behind bars because it didn’t cross their minds that there might come a day when they couldn’t borrow in the market to cover their short-term commitments. But even the least punitive may question whether selective resignations and carefully worded expressions of contrition are enough to restore public trust. It is difficult, if possible at all, to conceive that when Oliver Franks, the epitome of the ‘great and good’ of his day, was chairman of Lloyds Bank (1954-62), it could commit the sins of both omission and commission that it did in and after 2009.
Laments for the good old days should always be listened to with caution. But the recollections of people who came into the City before or not long after the Second World War leave a consistent impression of a system which worked rather well. It really did seem (or so I’ve been told by people who remember it) like a club – for men only, needless to say. The club’s veteran members were assumed to know what they needed to know about who could be trusted to abide by the rules and who was ‘not the sort of chap you would want to do business with’ or ‘sailing a bit too close to the wind’. They weren’t constantly reaching for their lawyers. Informal relationships and shared social conventions suited them nicely. Mergers and acquisitions were negotiated by agreement rather than pursued as jungle warfare between predators and prey. The people at the top had no incentive to undermine the accepted standards and every incentive to keep potentially troublesome outsiders at bay.
At the same time, the accepted standards were nothing like as strict as they became. Nobody had any hang-ups about insider dealing. Stockbrokers were expected to have good contacts with the directors of quoted companies and to use them for the benefit of their clients. Directors bought and sold their own shares as and when they pleased. Recruitment was by personal recommendation, family connections and class-bound patronage. Male chauvinism was unchallenged. Amateurism was rife. Nobody worked very hard: the saying was that the ‘thrivers’ caught the four o’clock train home, the ‘wivers’ the five o’clock and the ‘strivers’ the six o’clock. Then as since, two very different verdicts could be pronounced with equal conviction. The reasons for those being good old days for some make them bad old days for others. But on one conclusion, all can agree. For better or worse, the culture of independent, non-statutory, reputation-based self-regulation is irrecoverable.