Comment: What did the regulators know about Libor fixing?

Bob Diamond, the chief executive at Barclays has resigned today, saying that “the external pressure has reached a level that risks damaging the franchise.”

Mr Diamond will appear before a Treasury Select Committee (TSC) tomorrow to face questions over the Libor interbank rate rigging scandal, what he and other senior Barclays staff knew about it and, potentially, what regulators and senior politicians knew about the fixing of Libor.

It is possible that other banks could be implicated through Mr Diamond’s testimony. Now that he has resigned he will, perhaps, be free to be more candid at the TSC than if he were still trying to cling on to his position. It will be extremely interesting to hear what he says and it is clear that what is in the public domain at the moment is just the tip of the iceberg.

Treasury Select Committee

There are a number of potential issues that could be triggered by Mr Diamond’s testimony and that of outgoing chairman, Marcus Agius, who will appear before the TSC on Thursday.

How much did senior politicians in both the current coalition government and the previous Labour administration know about Libor rigging?

Did the regulators and the Bank of England know that rate-rigging was occurring? Why did they not take steps to stop it? And, was there any sort of agreement, either formally or tacitly that it was “ok” for traders to record inaccurate rates to hide the real levels of interest that banks were prepared to lend to each other between 2005 and 2009.

It is very likely that more evidence will come out at the TSC and through the inquiries being set up by the government, but let’s take a look at what is currently in the public domain.

Politicians – What did they know?

It is unclear if any politicians knew what was going on between 2005 and 2009. Clearly there was a strained relationship between the Chancellor in the latter part of that period, Alistair Darling, and the Governor of the Bank of England, Sir Mervyn King, which, it could be surmised meant that there was not much communication going on between the two.

The City Minister at the time, Ed Balls, boasted of Labour’s ‘light touch’ approach to regulation as Labour tried to position themselves as “business friendly.” However, the Conservative party was arguing for even lighter touch regulation than Labour.

It is almost impossible to know at this stage who knew what at the top level of politics. Maybe some revelations will come out at the TSC or one of the two public inquiries.

However, I think that the approach by both main parties at the time suggests that they were not looking too closely at the detail of what was going on with banks at the time and the government, like the regulators, missed many clues that were to prove vital contributors to the problems that caused the banking crisis in 2008.

Regulators – What did they know?

The vital question that needs uncovering is whether any regulators knew that the manipulation of bank’s Libor bids was going on but did nothing to stop it or communicate to anyone that it was going on.

The Financial Services Authority (FSA) was widely criticised for not spotting the behavior that caused the banking crisis that resulted in the part-nationalisation of two of the UK’s main banks, The Royal Bank of Scotland and Lloyds and the run on Northern Rock.

In the FSA’s own words in a review undertaken to analyse the mistakes made and lessons that could be learnt from the financial crisis, the FSA said in its annual report published today that “the crisis made it crystal clear that the pre-crisis system of prudential regulation had been severely deficient in three important respects:

“Woefully deficient rules on bank capital and liquidity;

“A deficient and under resourced approach to Prudential supervision; and

“And a dangerous vacuum, an “underlap” between the Bank of England and the FSA, an absence of systemic analysis and macro-prudential policy tools.”

This covers the wider financial crisis and illustrates how the main financial regulator at the time missed vital signs that led to the banking crisis. It seems likely that the level of scrutiny on banks was insufficient for the FSA to do anything about the manipulation of Libor.

Again, at this stage, there are more questions than answers. Did the FSA know what was going on but not have sufficient confidence or resources to go about tackling the rate fixing or was there a tacit admission that it was going on but that, at this stage, there was no will or no idea to do anything about it?

Did the Bank of England know about the Libor manipulation? It has emerged that Bob Diamond had a conversation with Paul Tucker, the Deputy Governor of the Bank of England in 2008 about Barclays submissions to Libor.

The outcome of that conversation appears to be that Barclays managers believed they had been granted permission to submit artificially low estimates. This illustrates that the communication from the top at Barclays was deficient because that was not the case.

However, the Bank of England says: “It is nonsense to suggest that the BoE was aware of any impropriety in the setting of Libor.

“If we had been aware of attempts to manipulate Libor, we would have treated them very seriously.”

US settlement documents from the US Commodity Futures Trading Commission (CFTC) reveal that Mr Tucker did not give Barclays any instruction to submit incorrect Libor rates and that Mr Diamond did not believe he had given his employees permission to do so. Mr Diamond’s testimony at the TSC on Wednesday will be pivotal for Mr Tucker’s ambitions to succeed Sir Mervyn King as Governor of the Bank of England.

Mr Diamond will be carefully considering today what he will say at the TSC, depending on what he actually knows of course.

The conversation between Mr Diamond and Mr Tucker has been cited in the settlement documents from both US and UK regulators that were released last week when Barclays was fined by both the FSA and US authorities. From this it seems clear that the Bank of England or at least some of its staff must have known that Libor manipulation was going on.

The British Bankers Association (BBA) has not emerged from this controversy very well. It is supposed to be in charge of the Libor process but contracts out its administration to Thompson Reuters and appears to have effectively washed its hands of any responsibility for the Libor process going wrong.

Indeed, it has asked the government to come up with a new system to ensure Libor is managed in a more professional and transparent way. The fact that Barclays Marcus Agius has resigned his position as chairman of the BBA as well as chairman of the bank at the heart of the Libor scandal that was in the ownership of the BBA is one of the very ironic parts of this situation.

US authorities hold perhaps the most important position in how prosecutions and liability for the Libor scandal will conclude. Separated from both UK personnel and institutions, it will perhaps be easier for US authorities to get to the bottom of what actually happened and who knew what when.

Senior bankers – What did they know?

We will, perhaps find out what Bob Diamond knew tomorrow when he appears before the TSC and from the conversations that he had with Paul Tucker, that he has not denied having, it seems clear that Mr Diamond knew that the manipulation of Libor was happening.

The question and what could be at the heart of tomorrow’s questioning and any potential criminal action against Mr Diamond and any other senior banker is whether they thought they had tacit permission to act in this way.

If Mr Diamond did know about the manipulation of Libor, then it is likely that other chief executives at other banks that were involved in the same process also knew.

The argument for a full judiciary review

In conclusion, the Libor manipulation is just one of a number of scandals that involve banks behaving unethically.

People at the top of the banking industry were directly responsible for encouraging behavior that was not sustainable, resulting in ordinary taxpayers having to bail-out the banks.

They allowed policies to take place whereby banks lent in an irresponsible manner, leading to the credit crunch.

There have been a number of mis-selling scandals uncovered, including the mis-selling of payment protection insurance that has led to a total re-dress to customers of over £5 billion.

Additionally, senior bankers have overseen cutbacks to staff numbers that has affected service. This is evident in the technical problems suffered by NatWest over the last two weeks.

Despite all of this reckless behavior and incompetence senior bankers have gone on collecting big bonuses, whilst ordinary staff at the coalface have faced redundancy and the ire of customers who would like to vent their anger at the perpetrators of the financial crisis.

To add insult to injury, banks have failed in their promises to lend to small businesses.

It really is hard to believe that the government does not think that a full independent inquiry led by a judge with a full range of powers is not necessary.

Although the phone-hacking scandal in the media that led to the Leveson inquiry into media standards was seriously criminal behavior, it is hard not to see that the cumulative behavior of the banking sector is not equally as serious and does not require a full inquiry, not just into the behavior of bankers but also the regulators and the politicians who presided over this mess.