LIBOR Suction II: A Lack of Institutional Control (Update)

Sometimes it is difficult to comprehend the structure and implications of Wall Street banking regulations, and the relationship between the bankers and the regulators.  While all arguments by analogy break down at some point, perhaps if we look at the recent problems at JPMorganChase and Barclays in a framework roughly analogous to the NCAA and collegiate athletic programs the broader picture can be rendered a bit more comprehensible.

When the NCAA penalizes an athletic program for a “lack of institutional control” the organization is applying this definition:

A lack of institutional control is found when the Committee on Infractions determines that major violations occurred and the institution failed to display:  (1)  Adequate compliance measures.  (2) Appropriate education on those compliance measures.  (3)  Sufficient monitoring to ensure the compliance measures are followed.  (4) Swift action upon learning of a violation. [NCAA]

Some of the same issues about athletic program administration and banking administration arise in terms of how rules are promulgated and applied. What, for example, constitutes a “full meal” offered to those on athletic scholarships, not available to other students on campus?  How many times, when, and under what circumstances may a recruiter send texts or e-mails to a prospective recruit?  The rules are complicated, subject to interpretation, and some institutions have been known to tread into the gray areas — witness the recent problems at USC.

The classic example of a lack of institutional control is, of course, Southern Methodist University, the most recent application of the “death penalty” to a Division I football program (1987-1988).  SMU may be the most infamous, but it is certainly not alone.  The  penalty was applied to Kentucky men’s basketball in 1952 and 1953, University of Louisiana (Lafayette) men’s basketball in  1973-1975, the Division II men’s soccer program at Morehouse College for the 2005 and 2005 seasons, and the Division III men’s tennis program at MacMurray College 2005-2007. [Wiki]

What we are addressing here are problems related to the culture of the programs and their administration.

So, when Adair Turner, head of the UK’s Financial Services Authority, says of revelations concerning the manipulation of the LIBOR rate that the bankers “must purge a culture of “cynical entitlement” [Bloomberg] we can interpret this to mean that there is a culture in which there is a lack of institutional control.  The lack of control yielded this result:

“The cynical greed of traders asking their colleagues to falsify their Libor submissions so that they could make bigger profits has justifiably shocked and angered people, in particular when we are facing hard economic times provoked by the financial crisis,” Turner said.

Turner, who has been chairman of the FSA since 2008, recommended the board of Barclays think about the “challenge they faced in enacting sufficient culture change to put the problems of the past behind them,” he said, adding that he “respects and understands” Diamond’s decision to resign. [Bloomberg]

In other words the “program” is egregiously tainted and the coach has cleared his personal effects from the office.   What “cultural attributes” lead to the lack of institutional  control?

Were there adequate compliance measures?  It doesn’t seem so.  As in the case of the SMU football program which was already on probation when repeat violations occurred, Barclays had been warned:

“Andrew Bailey, head of banking supervision at Britain’s Financial Services Authority (FSA), attended a meeting of the entire Barclays board in February and told the bank to change its ways, the source told Reuters on Thursday.

“It was made clear that there were some cultural issues that needed to be addressed and some perceptions of the firm that they pushed the boundaries on certain things,” the source said.” [Reuters]

There are those “cultural issues” again.   In any human activity in which winning is the only acceptable result there are bound to be combinations of acceptable practices which upon reflection shouldn’t have been acceptable at all.  The writer for the Guardian summarized the situation at Barclays:

“In dozens of interviews over the past nine months with people working in finance, this question has come up time and again: why does finance, in spite of considerable investments in internal policing, fail to self-correct? The short answer is greed, but there is more.

Going over the interviews, all of which can be read online, it is clear that at least some people in finance are not primarily driven by money. But they are afraid, powerless, or both. Indeed, if you had to design a working environment that encouraged short-termist conformism and discouraged whistle blowing, then the finance sector would be your blueprint.” [Guardian]

Or, could it be that the winner take all mind set of the field, the pitch, or the court was embedded in the “short termist conformism?”   This is not an environment which exudes evidence that there are adequate compliance measures in place.

Was there Appropriate education on those compliance measures? Evidently not. Consider the following paragraph from the Guardian article, and compare it to statements commonly associated with head coaches on their way out the door:

“Most people try to switch banks or roles every few years. Imagine when you know there is a huge problem in your bank – you also know it’s time to move on to the next job.

As this derivatives trader put it: “There are just cycles of new guys coming in. It’s like an election cycle, really. They fire the senior guy and bring in a new guy, for x million. New guy kicks out four more guys and brings in his own. When after three years it hasn’t worked out, the bank fires those five and it starts all over.”  [Guardian]

Note, that when the problems are recognized it’s NOT time to blow the whistle, call the NCAA (or the FSA, SEC), take the problem to the top,*  and hunker down to fix the issues — “it’s time to move on to the next job.” If this sounds familiar, review Pete Carroll’s exit from the USC football program to the NFL:

“Carroll may have looked at the top of the mountain and realized he’s not on top anymore. He may have peered into the gloaming and seen the NCAA coming, a pitchfork in one hand and pictures of the Bush family manse in the other.” [ESPN]

In a corporate culture in which the cycles of coming and going combine with the “short-termism” in addition to the ideal that he who dies with the most money wins, there may be some education into the culture, but it is not likely to be one in which compliance measures are emphasized.

We’ve seen this movie before, and it usually ends the same way — it once starred Michael Milkin, who it could be said caused the death penalty to be applied to Drexel Burnham Lambert.   Kenneth Lay was convicted of ten criminal counts, but died before sentencing for his part in the Enron Debacle.  Jeffrey Skilling is in jail after his “short-termist” culture of quick profits failed, the ‘head coach’ aka architect of the Enron scheme is still appealing.  Andy Fastow, the offensive coordinator (CFO) at Enron is now a law clerk in a Houston, Texas, office. **   Dick Fuld is said to be trying to build a “tiny investment advisory boutique.” [MoneyCNN] Anyone remember who the SMU football coach was from 1982 to 1986?

Was there sufficient monitoring to ensure the compliance measures are followed? Doesn’t seem so.   When the culture of an enterprise is such that there are few, if indeed any, internal controls, then the result is predictable:

“Read the emails that the Financial Services Authority made public between traders at Barclays and you know what this former treasurer meant when he said: “If you go public about something in the bank you believe to be wrong, in one stroke you place yourself outside of that world. It’s not just your job – it’s your identity.” [Guardian]

Replace the word “world” with “bank” or “corporation,” and it’s clear whistle blowing is an unwanted interruption in the smooth functioning of the corporate team.  Winning is equated to beating analysts’ expectations in the quarterly earnings report, and winners are rewarded with bonuses, or trophies, or letters, or decals for their helmets.

Was there swift action upon learning of a violation?  No score here either.   The official FSA report outlined the dates of Barclay’s manipulations of the LIBOR rate:

“Barclays acted inappropriately and breached Principle 5 on numerous occasions between January 2005 and July 2008 by making US dollar LIBOR and EURIBOR submissions which took into account requests made by its interest rate derivatives traders (“Derivatives Traders”). At times these included requests made on behalf of derivatives traders at other banks. The Derivatives Traders were motivated by profit and sought to benefit Barclays’ trading positions.”  [FSA pdf] (emphasis added)

If the violations had been ongoing from January 2005, when did management know of them?  We know that as of May 29, 2008 Bloomberg News reported that Tim Bond, a strategist at Barclays Capital commented on banks repeatedly mis-stating borrowing costs to the British Bankers Association. When did the ‘head coach’ say he found out?  According to the BBC, Barclay CEO Bob Diamond said he only found out “this month,” i.e. in the month before July 4, 2012. [BBC]

Not only was there no “swift action taken upon learning of a violation,” the CEO says (if we take him at his word) he didn’t find out for 4 years of any untoward manipulations of the LIBOR rate.

If there are no adequate compliance measures; If there has not been
ppropriate education on those compliance measures; If sufficient monitoring to ensure the compliance measures has not been followed; And, if swift action upon learning of a violation has not been taken — Then what we have in the Barclays example is a classic case of a lack of institutional control.  The question now expands to how many other “teams in the league,” or banks in the financial sector are equally guilty of that lack of institutional control?


References: Fortado & Moshinsky, FSA’s Turner Says Banks Culture One of ‘Cynical Entitlement’, Bloomberg News, July 3, 2012.   BBC News, FSA’s Turner Says Banks Culture One of ‘Cynical Entitlement’ FSA boss denounces ‘cynical greed’ at investment banks, July 3, 2012. Steve Slater, FSA boss denounces ‘cynical greed’ at investment banks
UK regulator warned Barclays over aggressive culture, Reuters, July 5, 2012.   Joris Luykendijk, Barclays emails reveal a climate of fear and fierce tribal bonding among traders, Guardian, June 28, 2012. FSA, Final Notice: Barclays Bank Plc, 27 June 2012. (pdf)   Finch & Gotkine, “Libor banks misstated rates…,” Bloomberg News, May 29, 2008.

Updated information and analysis:  Cora Currier, “Beyond Barclays: Laying out the LIBOR Investigations,” ProPublica, July 6, 2012. Zaharia & Donovan, “Analysis: Scandal-hit LIBOR faces change but has no real rivals,” Reuters, July 6, 2012. ProPublica, Barclays DoJ Statement of Facts, July 2012.

*Dan Ackman, “Sherron Watkins had whistle, but blew it,” Forbes, February 2, 2002.   ** CNBC, “The Faces of Enron: Where are they now?”

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