An Epidemic of Price Fixing in the Financial Markets

Nothing is more antithetical to the principles of free enterprise than price fixing.  Rigged prices undermine the efficient functioning of markets and defeat their ability to maximize economic welfare.  Sadly, we've had an epidemic of price fixing in the financial markets, frequently involving the largest and most important banks.

The London Interbank Offered Rate has been the subject of governmental investigations in Europe and the U.S. for alleged years-long collusion. Billions of dollars of fines, penalties and other payments have been assessed on various big banks, and the investigation of other major banks continues.  Trillions of dollars of loans and contracts were priced based on Libor, and the potential impact of this price fixing is massive.

Foreign exchange rates have been investigated for rigged prices, and billions of dollars of fines, penalties, etc. have been paid in government and private civil lawsuits.  Again, some of the largest banks are implicated.

Now, word comes that the market for interest rate swaps has been under investigation for price fixing via the alleged collusive manipulation of the ISDAfix, a benchmark swap rate that is used in the pricing of a variety of financial products.  The interest rate swaps market, although obscure to the general public, involves hundreds of trillions of dollars of financial products (in notional value) sold to corporations and other commercial customers to offset interest rate risk.  Big banks are reportedly involved this collusion and the fines, penalties, etc. could total perhaps billions.

There are also reports of investigations of price manipulation by big banks in the metals markets.  These might involve restricting supply and other maneuvers to rig prices.  If wrongdoing is uncovered, more large fines, penalties, etc, can be expected.

Many of the banks involved in these matters are likely to be too big to fail.  In other words, while conspiring against the public in very large and important markets, these banks enjoyed the explicit and/or implicit backing of the taxpayers.  This backing helped them attain Brobdingnagian size, which in turn probably facilitated their ability to rig markets. 

The financial markets are the central venue of the capitalist system, being the place where holders of capital and borrowers of capital meet to determine the allocation of society's financial resources.  The largest banks are at the center of the financial markets, and their conduct ripples through the financial markets and the entire free enterprise system.  That such crucially important players are so regularly conspiring against the public and the public interest presents a galling spectacle that damages the credibility of the capitalist system.  Are markets truly socially beneficial or are they simply a means by which the rich and powerful fleece others? 

The world's largest banks have the legal and social responsibility to refrain from such reprehensible conduct.  However, their sad record of massive, multi-market price fixing seems to tell us that their chances of upholding these responsibilities aren't very high.  Their collusive activities often arise in markets that have a bi-level structure:  an inner inter-dealer market where the big banks and other financial firms trade among themselves, and an outer market where the dealers trade with the public at usually marked up prices.  The inside inter-dealer market is a perfect venue for price-fixing, as the dealers have to talk and trade with each other every business day.  As Adam Smith put it in The Wealth of Nations, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices."

Thus, the challenge falls on regulators and law enforcement authorities to be vigilant and firm.  The sheer magnitude of the wrongdoing, as demonstrated by the billions that have been paid out to date, is astonishing.  Those who may seem paranoid about the financial markets have it right--way too often, the markets are rigged.

More Badness in the Bigness of Banks

The problems presented by gargantuan banks aren't limited to just too big to fail.  In recent months, we have seen government investigations and enforcement actions dealing with price fixing by big banks in interest rates (LIBOR), foreign currencies, oil and other commodities.  Cartels and oligopolies are antithetical to free enterprise.  To make things worse, the things that were the subject of the conspiracies--benchmark interest rates, petroleum, and the value of the medium of payment in various countries--affect the prices of numerous contracts, investments, products and other things.  Thus, the impact of the price rigging ripples through national and international economies, with the result that a lot of things aren't accurately priced.

The size of the mega banks allows them to dominate these markets.  The small number of players involved makes collusion easy.  It's hard to rig markets with dozens or hundreds of competitors.  But a few big dogs readily find it more profitable to stack the deck in their favor and reap monopolistic returns than compete with lower prices.

Collusion deprives consumers, investors and others of the benefits of competition and efficient markets.  The oligopolists are richer by their financial hooliganism.  The rest of us are poorer.  When banks are too big to fail, governments--and ultimately taxpayers--prop them up.  It would appear that the big banks return the favor by rigging prices.  It's getting harder and harder to see the societal benefits of really big banks.

LIBOR: Good Enough For Government

The Libor price fixing scandal keeps growing. Following Barclay's payment of $450 million in a settlement with regulators, word now comes of a U.S. Department of Justice criminal investigation into the morass. http://www.bloomberg.com/news/2012-07-15/libor-probe-may-yield-u-s-charges-by-sepetmeber.html. Indictments may come soon. Private civil lawsuits galore have been filed. The potential liabilities of the banks caught up in the scandal could run tens of billions, and maybe hundreds of billions if the price fixing is shown to have taken place over a sufficiently long period of time. If the latter were proven to be the case, many of the world's major banks would possibly be insolvent. Which would mean that the world's financial system could be at risk of collapse. Taxpayers on both sides of the Atlantic should brace themselves for yet another bailout of the major banks.

A crucial reason for the enormous potential liabilities is derivatives. (Yes, derivatives have done us in again.) The big banks that participated in setting Libor were often major dealers in the derivatives markets, and many of their products were based on Libor. That meant that they were exposed whether Libor was rising or falling. If they manipulated Libor up, one set of customers and/or counterparties would be injured (and therefore have a right to sue). If they manipulated Libor down, another set of customers and/or counterparties would be injured (and therefore have a right to sue). Since the price fixing could violate U.S. antitrust laws, the defendant banks may face liabilities for the treble damages permitted under the antitrust laws. Trebling the effect of the bad behavior could mean big, big money.

Vast legions of lawyers are now licking their chops at the prospect of suing or defending big banks with respect to the Libor mess. Their retirement accounts will reap rich harvests. Many will finance their childrens' higher educations with the fruits of their Libor engagements. And the modestly paid attorneys working on the government side of the cases can burnish their resumes with high profile cases.

If we want to reduce the likelihood of such windfalls for the legal profession--and, incidentally, enhance the integrity of the financial markets--we must find a better way to determine Libor. The British Bankers Association, a private organization that doesn't appear to be subject to direct government oversight, currently presides over the process of determining Libor. It's done a lousy job. Time to do a Trump and relieve BBA of this responsibility.

What's the best candidate for the job? The U.S. government. Not exactly the most obvious choice, but better than the alternatives. The private sector methodology for determining Libor was too easily infected with agendas and ulterior motives driven by the profit imperative. Government statisticians don't face such pressures. Admittedly, government statistics aren't perfect. But their methodologies are publicly known. We can praise or criticize those methodologies, and work to improve them. But we don't have to worry about price fixing.

One U.S. government statistic, the Consumer Price Index, plays a role in the economy comparable to Libor. Social Security benefits are adjusted when the CPI increases. Many public compensation schemes and private contracts adjust pay and/or benefits when the CPI increases. While numerous economists, statisticians, pundits, bloggers and other riff raff decry this or that about the CPI, no one has said it's secretly rigged. The Bureau of Labor Statistics is trusted to calculate and announce CPI figures.

Perhaps a group in the U.S. Commerce Department could be given the responsibility for determining Libor. (We should disregard America's special relationship with Britain and exclude the Brits from Libor calculations; they had their chance and blew it, big time.) The Commerce Department does not regulate any banks, nor does it have responsibility for monetary policy, nor does it finance the operations of the U.S. government. It has no vested interests, and could credibly determine Libor (preferably using actual market transactions, rather than the opinions of banks of the interest rate at which they could fund themselves, which is the formulation of Libor that has proven to be so problematic).

Having the U.S. government determine Libor would accomplish two important things. First, it would enhance the integrity and credibility of the announced rate. Since public confidence is, ultimately, the only thing that really matters in the financial markets, integrity and credibility are worthwhile. Second, a government determined rate wouldn't give rise to private liabilities the way that Libor has with each manipulated tick up and each manipulated tick down. The massive potential liabilities that major banks face, and the possible collapse of the financial system they could produce, would simply not arise. The cost of a handful of government statisticians putting out Libor might run a few million a year. The cost to taxpayers of bailing out the dodos at the big banks who have screwed up yet again could run billions and billions more and then billions more. At the risk of voicing a political heresy, there are some jobs government does better than the alternatives, and calculating Libor is one of them.