The rotten heart of finance | Hacker News Reader

The rotten heart of finance

economist.com

265 pointsbcn141 comments

I read things like this and by fixing LIBOR they're treating a symptom rather than addressing the cause.

My belief--and many seem to disagree with me on this whenever I've brought it up before--is that we erred in allowing investment banks to incorporate.

IMHO investment banks need to act like law firms: as partnerships with unlimited liability. Currently there is no incentive to not pervert the system and manage risk because:

- no one is going to jail for criminal acts committed in these financial crises (eg loan documentation fraud and illegal foreclosings in the subprime fallout);

- there is no financial incentive to act responsibly because if you go bankrupt this year last year's bonus is already banked;

- central banks have been perverted into being welfare for investment bankers as a so-called "lender of last resort". Ostensibly they are ensuring the function of the financial system. In practice they are giving investment banks an unhealthy appetite for risk. Banks and funds need to be allowed to fail; and

- governments are complicit in this.

I agree with every single point you've made except for the third (ie about central banks). Central banks need to act as the "lender of last resort" - however, what needs to be fixed is the transmission mechanism - so that the emergency loans reach the economy when it needs it and not be used up by intermediary banks trying to shore up their capital reserves when they've blown them up playing roulette.

But I think, if points 1 & 2 are addressed well enough, the transmission mechanism would work better and the banks would become what they ought to be - conduits for monetary policy and price discovery.

Point 4 - the reason Wall Street bankers get 10-100x the salary of a top-notch achiever in any other sector is because the government has created regulations which allow banks to have an oligopoly in this sector and pay its minions disproportionately high salaries - what saddens me is the same government which wants its best students to go into STEM ends up encouraging them to go into a non-productive profession.

Central bank as lenders of last reserve barricade against liquidity panics. They need to funnel capital directly into banks' reserves. They don't guard against insolvency (Treasury) nor "funnel money to the real economy" (Congress). One of the best bank rescues of all time, Sweden's, involved pumping capital into banks' equity.

Bankers earn less than traders and PE guys. For the same reason that Google has to pay exorbitantly for an engineer because he can walk out into a startup a bank has to keep pay competitive with hedge funds et al. Create/buy parity is maintained.

For measure on "non-productive professions" look at how hard emerging economies are working to build domestic fixed income and equity markets.

P.S. Anticipating a line of argument, no, the militant high-frequency guys aren't taking home even close to the lion's share of compensation.

Central banks do funnel money into the real economy via their monetary policy (Congress can only provide fiscal stimulus).

And lack of liquidity to the extent that it prevents current liabilities to be serviced causes insolvency - something which a Central Bank does guard against.

By "bankers", I meant to include the markets guys along with the IBD/M&A/ECM/DCM people. PE people come from the higher echelons of the latter category - which isn't too poorly paid. PE/HF people get the rewards for the risk they take, that's their business - this isn't true for bank-based traders who rely on cheap funding enabled by implicit guarantees from the taxpayer and non-transparent bid-ask spreads and collateral funding rates due to them always having more info than their clients about the market they trade in because, at the end of the day, they are the source for the bid-ask spread and they are the source for the collateral - there's no other conduit - in my book, it's called an oligopoly. They are not reaping returns commensurate to the value they actually provide.

Also, a top-notch Google/MS engineer isn't nearly as highly paid as a top HF/bank-prop(yes, the species still exists) trader unless they have equity upshot.

As for emerging markets - they aren't trying too hard. It's the western world which wants them to do that so that they can tap into returns more easily which isn't that easy to do with just off-shore/non-deliverable instruments. Emerging economies such as China and India often rely on capital controls for their competitiveness and continued ability to import commodities. Their domestic corporate funding still relies on bank loans.

Granted, having more capital markets leads to more transparent pricing and probably cheaper funding - but saying cheap funding is more valuable than the contribution of engineers and doctors and others who translate that funding into real, physical growth is naive, at best.

Sorry, I was speaking of central banks within their capacity as lenders of last resort. Monetary policy works through multiple financial intermediaries, not just the banks.

I agree that federally insured banks shouldn't have prop desks - but that probably means they won't be making markets, either.

The emerging markets are very ambitiously trying to develop capital markets. Singapore issues domestic debt explicitly for the purpose of nurturing a domestic bond market. Shenzen has dangled, in front of me and colleagues, heroic sums to build an equities market making operation. What is your source for saying EMs aren't pursuing a more sophisticated financial system?

Singapore is a different sort of "emerging-market", to be honest - it's economy has historically been far too open (and too small) to disallow that sort of thing from happening. A similar theme applies to South Korea - which probably has the most sophisticated bond market in Asia (ex-Japan). Even for Japan as well, the most sophisticated market in Asia, the keiretsu system drives most of the inter-corporate funding and credit.

The equity capital markets in both China and India are peanuts as compared to the bank-lending market for corporate funding and that's likely to remain the case for the foreseeable future - a crash in the HSI or the Sensex doesn't spell doom for the economy. The fact that we see China willing to allow RMB-trading in the London markets or to build an equity market-making operation implies a tactical funding alternative - not wholesale market "liberalization" as we perceive it.

As far as the debt-markets are concerned, these countries have been extremely wary of the implications - especially post the credit-crisis and the disastrous impact on high-yield names in the developed world. Non-performing corporate loans are a big problem as it is in both these nations and unsafe leverage is avoided at all costs. Foreign-currency bond issuances are strictly controlled by their respective central banks and domestic-currency corporate issuance is virtually non-existent. For a recent example of strict capital controls: to safeguard the Indian economy against commodity inflation and INR weakness on general growth concerns, the RBI imposed strict conditions on importers/exporters specifically and on FII transactions generally.

> Central banks need to act as the "lender of last resort"

Central banks act as lender of last resort because fractional reserve banking is broken by design. It's essentially very similar to a race condition in software. Bank runs are a very bad situation that happens only under "hypothetical", or "very rare" situations.

The central bank is trying to patch things after the fact. Imagine trying to resolve a race condition that corrupts memory by undoing the corruption after the fact. Insanity.

Rather than put a bandaid over the race condition, eliminate the race.

The race happens because customers put a large pile of money into the bank, and don't specify when they need it back. The bank assumes the customer will leave it in the bank for a certain amount of time. Then if customers get spooked because of something they hear on the news, they'll want to take all their money out. The result? Only 10% of it is liquid, and the rest is tied up in loans that won't be repaid for years. If the next customer wants to take their cash out, the bank is forced to sell short the loans it issued (which could be entirely legitimate and profitable). The bank now faces bankruptcy. In this situation, the bank run is rational, because the first N customers will get 100% of their money out, but the N+1th might only get 90% of their cash back.

It's worth pointing out this flaw is present, and exploitable in any fractional reserve bank at any time, regardless of how good its finances are. All you need is enough customers taking their money out at the same time.

The solution is really very simple. Require the customer to specify when they'll need their money back, and the bank is not allowed to loan out that money for shorter periods of time than the customer specified.

i.e. if I have an account at a bank, I'd say "I will always need access to $1000 in cash at any time of the day. Then I'll save $5000 for a vacation in six months, and won't need to touch the rest for 10 years." The bank then matches up the money you stored with available loans. i.e. your $5k in vacation money can only be loaned to other clients at terms of six months or shorter, so you and the bank have a clear understanding of when the money is available.

What this means is bank runs are not rational (nor possible, because you have a contractual obligation about when you get your money back). No central bank nor lender of last resort is necessary now.

Actually the solution is simpler: deposit insurance. Strikingly, economists thought about these things before Hacker News.

Restricting banks to time deposits pushes the liquidity problem onto the depositors (you need to break your time deposit for an emergency? Nope, can't do it). It is also similar to how post-war financial repression created the Eurodollar savings markets that produced much of the mess in the 1980s.

P.S. shadow banks try to do this by raising money wholesale at fixed maturities. Problem is nobody wants to lend to a bank unsecured for long tenors. Hence, one constricts the yield curve to the short, volatile end.

Deposit insurance can only safely and reliably be done by someone with access to a printing press. A central bank is hardly "simple".

> you need to break your time deposit for an emergency? Nope, can't do it

But you can. Just take a short sell on the asset.

> Strikingly, economists thought about these things before Hacker News.

That's a little snide. Economists discussed exactly what I just wrote 100 years ago.

I'm not saying this design doesn't have tradeoffs, but it's laughable to suggest that our current banking system is anywhere close to perfect.

There could still be runs on banks. If everyone takes their money out of banks, the money supply would collapse to 10x smaller. If you believed this was in the process of happening (rumors of a coming war, etc.), you'd want your money out as soon as possible, whether it had to be 6 months or 6 days, you'd still want out.

> Actually the solution is simpler: deposit insurance.

Canada didn't have deposit insurance until the late 1960s and has recently restricted its coverage. (It's now per depositor instead of per-account.)

Of course, Canada is populated by Canadians, who are demonstrably different than Americans. (One example - Canadians don't smuggle guns, much.)

> Strikingly, economists thought about these things before Hacker News.

Yes they've thought about this, but if they've asserted that deposit insurance is "the solution" they're more ignorant than I thought. Please tell me that you're just making this up.

Or just have a system where depositors lose their money if the bank goes bust. They will become a lot more interested in the activities of their bank. As I recall, few people lost their money in the wildcat banking days before the Civil War.

It seems to me that your proposed system exists right now, with CDs playing the role of "I don't need this money back until time X." The trouble is that people don't want to play games like that with their money, and banks don't want to be limited to holding onto 100% reserves for every deposit that could potentially be withdrawn right now.

Borrowing short and lending long is the very definition of a bank.

It's a service that people want, too - because there's a much larger number of people that want to lend short than borrow short, and conversely there's a much larger number of people that want to borrow long than lend long. If you instituted this then no-one would be able to afford to take out a mortgage - the cost of funds lend long would be far too high.

There are lots of services I would like to have. For example, I would love to buy $10 for $5. That doesn't mean someone can provide that to me, long term. The only way for fractional reserve banking to be practiced "safely" is if there is a central bank backstopping it. That introduces a lot of regulation, and still ends up being very expensive for the taxpayers.

What I'm proposing essentially separates "place to securely hold my cash, and provide ATM services" from "place to invest money long term".

Now, I agree that long term interest rates would rise, but it doesn't follow that mortgages would become unaffordable. What's more likely IMO is that houses become a lot cheaper. The main "anchor" to the price of a house is your ability to pay a fixed percentage of your income. Rather than paying 25% of your monthly income on a 30 year mortage at 5%, you'd probably end up paying 25% of your monthly income on a 10 year mortgage at 8%.

8%? There's no way the rates would be that low if you required your 10 year mortgage to be entirely backed by 10 year bonds. I do agree that house prices would necessarily fall, but the new point on the price/demand curve would see both lower prices and lower levels of home ownership. Much worse would be the effects on businesses that could no longer secure debt funding.

It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs.

Rather than a race-condition, a better way to look at it is as an unstable equilibrium. The bank isn't assuming it can keep your deposit for any length of time; instead, it's assuming that in aggregate over all its depositors a certain amount of money will be left on deposit at any given time. Obviously this assumption goes out the window if the depositors act together to remove their deposits - as long as they don't, the system is in equilibrium (it's not rational to withdraw your deposit and forego the interest). As soon as the equilibrium is disturbed and a run starts though, the risk increases sharply and it becomes rational to withdraw your deposit. Government-backed deposit insurance stabilises the equilibrium.

> It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs.

How is this possible? If the bank has to keep 100% of its deposits in reserve, how can it lend at any longer term than the deposits are borrowed for?

You're right, this is not possible. What caf may have been thinking of is that banks may borrow money subject to other conditions, such as by emitting bonds, to which the 100% reserve requirement doesn't apply.

Of course, such a system is also subject to bank runs, just via a different mechanism ("run on bonds" by lenders refusing to roll the bonds over instead of run on deposits).

I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.

I forget who Steven Keen is quoting in this manner but he points out an early opponent of the gold standard said "In the real world, banks loan money, create deposits in the process, and look for the reserves later."

As for your solution, suppose my kid has to go to the ER. I go to the bank to withdraw funds early because of unforeseen circumstances. Does the bank have to give them to me?

> suppose my kid has to go to the ER. I go to the bank to withdraw funds early because of unforeseen circumstances. Does the bank have to give them to me?

This sort of situation is what insurance is for.

So insurance pays for 100% of the cost? Where do I find such insurance?

Or suppose I need chemo and insurance will only cover 80% of the $100k cost?

Do I have to keep $20k under my pillow?

> So insurance pays for 100% of the cost? Where do I find such insurance?

Remember we're talking about a very different world from the one we actually live in, a world where banks aren't allowed to lend at longer terms than they borrow. In such a world health insurance would presumably also be very different from what we're used to, since it would only be expected to insure against things that should be insurable, i.e., unforeseen circumstances. What we now call "health insurance" is something like auto insurance that would also be expected to pay for oil changes, replacing tires, checking your air cleaner and wiper blades, etc., etc. If we had health insurance that worked more like the way our actual auto insurance works, we would cleanly separate predictable health expenses from unpredictable ones, and only expect insurance for the latter. That would change things a lot.

> Or suppose I need chemo and insurance will only cover 80% of the $100k cost?

The big question here is, why do you need chemo? We're probably getting off topic, but I can see at least three distinct possibilities:

(1) You need chemo because of something accidental and unforeseen that gave you cancer--say you were in an airplane that got irradiated with a burst of cosmic rays. This would be insurable, and these sorts of conditions are rare enough that I would expect an insurance company to pay the claim, with a reasonable deductible (you would trade off the deductible against the premiums, just as you do now with auto insurance--again, this is all in the light of the general comments I made above).

(2) You need chemo because someone else's deliberate act or negligence caused your cancer--say your city water was contaminated by a factory's effluent. In this case the party responsible should be paying for your chemo, just as if someone else hits your car they are responsible for paying to get it fixed.

(3) You need chemo because you didn't take care of yourself very well, didn't get regular checkups, and got a form of cancer that could have been diagnosed and prevented but wasn't. In this case your insurance company would still be obligated to pay, but your premiums would probably have been quite a bit higher, just as people with bad driving records have to pay more for auto insurance.

Of course I understand that this kind of analysis is a lot more unpalatable when applied to health insurance vs. auto insurance. Our bodies are much more important to us than our cars. But that doesn't change the economics involved.

I suppose building a different world is one way to solve the problems of the present. Maybe by version 7 or 8 we will get something liveable.....

> Remember we're talking about a very different world from the one we actually live in, a world where banks aren't allowed to lend at longer terms than they borrow. In such a world health insurance would presumably also be very different....

So that's your solution, throw away the world and start over again? This kind of thinking gets very unappealing when you realize that for all its flaws, the world seems to work fairly well as it is--and that empirically-based, stepwise improvement on the status quo is a safer and more reliable way to go than hoping some ideology is going to work better.

It's not my "solution", it's my description of what a hypothetical world might be like in which we didn't expect the difficulties of things like finance and health care to be hidden from us by schemes like banks borrowing short and lending long, and governments hiding from us the real costs of the health care we receive. I agree completely that the actual world we live in is nowhere near that hypothetical world, and that we aren't going to get to that hypothetical world in one giant transition.

However, I would also observe that what we are doing now is not a "stepwise improvement" towards that hypothetical world or anything like it. Instead we move in the other direction--more of the real costs of financial tricks and health care are hidden from us.

I said empirically based stepwise improvement, not stepwise transition towards some ideologically driven fantasy world.

Then how do you define "improvement"?

Empirically. Certainly not by comparison to some ideological ideal, but by analyzing the net results. If something "shouldn't" work, but appears to produce the correct result, I change my theory to match the new evidence.

For instance, empirically, lots of governments "hide the cost of health care" by setting up universal health care programs, and in every country that's economically, technologically, and culturally similar to the US, the result is improved health care metrics and lower costs per capita.

I could wave my hands around and say that's the wrong way to go, based on some crackpot ideology cooked up by a Russian novelist on speed. Believe me, I've tried that. But it's easier and saner to just use normal empiricism instead.

The problem with monetary policy is that it's nigh-impossible to do proper empiricism on it. What we can say is that we certainly aren't experiencing any major catastrophes that we didn't encounter with the gold standard, and in fact a lot of the problems we faced then are no longer possible.

I actually agree with your general methodology. I'm not sure I agree with all your factual claims.

Doesn't insurance hide the costs of health care?

What we currently call "health insurance" does, because it's actually more than just insurance; as I commented before, it's more like insurance plus an extended maintenance contract. Normal "insurance", like auto insurance or homeowner's insurance, only covers large, unforeseen expenses; it doesn't cover regular maintenance, and it doesn't cover things like buying new appliances when the old ones wear out.

2: So I'm lying in a hospital bed, bald and vomiting in a bucket and I'm supposed to go to court to continue to afford treatment?

Well, one alternative (in the hypothetical world I was describing--as I said in response to someone else, I'm well aware that the actual world is nowhere near like this) would be no-fault insurance--even if someone else's negligence or deliberate act caused you to need chemo, your insurance pays for it. Then you wouldn't have to go to court. The only drawback to that would be that, if the pattern seen with auto insurance is any indication, everyone's costs would be higher--auto insurance is significantly more expensive for everyone in states with no-fault insurance laws. But perhaps you would say that's worth it to ensure not having to go to court in circumstances like this.

It would make more sense to have insurance against the less likely risk, like a bank run.

What you're calling "insurance" against a bank run is a central bank printing money. For examples of how well that works out in practice, see the Great Depression and the economy right now.

A fair appraisal of fiat money would be the entire history of economic development since the 20th century, and on that standard it looks quite different. The world is far richer today than it was when the gold standard was abandoned.

> The world is far richer today

Agreed, but the relevant comparison is the way the world is now, compared to the way it would have been if the gold standard had not been abandoned. Unfortunately there is no way to re-run the experiment to see.

However, there is at least one interesting indication: the worst depression in history, the Great Depression, happened after we went off the gold standard and after we established the Fed to supposedly control the money supply so boom and bust cycles would be controlled.

The Fed's major mistake in the Depression was not printing enough money--the money supply contracted and started a deflationary spiral. Solution: go ahead and print more money when a big recession hits. Which is exactly the solution you people criticize.

The money supply has gone up considerably since 2008, hasn't it? Shouldn't that have led to an actual recovery, instead of the stagnant economy we've actually observed?

We didn't have another catastrophic depression, which is what not increasing the money supply might have done if we take the Great Depression as an example.

If we had a reliable way of triggering an actual recovery whenever we wanted, it wouldn't be worth arguing about; we'd just do it. Unfortunately, if such a thing exists, it's a mystery to everyone.

The penultimate paragraph sounds suspiciously like what Simple (formerly Bank Simple) is doing.

I agree with you. The partnership structure forces law firms to be run very conservatively, and prevents them from scaling to huge sizes, which has the advantage of limiting the amount of consolidation in the industry. I think for professions like banking, law, and accounting, these are good incentives.

I think it would also help to take more seriously the ethical responsibilities of bankers as fiduciaries' for peoples' money. A law firm cannot represent both sides of a merger, because that would involve a conflict of interest. So why can Goldman take positions where they stand to profit enormously if their clients lose money?

So why can Goldman take positions where they stand to profit enormously if their clients lose money?

Because Goldman's clients are grown-ups and allowed to have their own beliefs about the future of the market, as well as their own risk tolerance.

Goldman wasn't obligated to put up a shingle reading "We are losing our appetite for CDOs, and so can't take your money if you think they're still a great investment."

>Goldman wasn't obligated to put up a shingle reading "We are losing our appetite for CDOs, and so can't take your money if you think they're still a great investment."

This is the problem. They should be obligated. Being a professional carries ethical constraints. If your clients aren't getting your best advice you aren't a professional, you are a salesman. It's not okay for salesmen to pose as professionals.

>This is the problem. They should be obligated. Being a professional carries ethical constraints. If your clients aren't getting your best advice you aren't a professional, you are a salesman. It's not okay for salesmen to pose as professionals.

Now, modern usage of 'professional' aside,(I killed a long screed about how the only people putting effort into being seen as professionals anymore are salespeople, thus the word is losing it's previously positive connotations.) This idea that "professionals are trustworthy" comes from the outmoded idea that the upper classes are somehow more honest and trustworthy than the 'working man' - that because the lawyer has more education than the plumber, and probably comes from a higher-class background, he has a feeling of "Noblesse oblige" - and you can therefore trust the lawyer while you can not trust the plumber.

Professional ethics are based on the obligations that come with specialized knowledge and responsibility. Even professions that are solidly middle class are seen as having duties and obligations. Librarians are expected, for example, to resist censorship, and to protect the privacy of their patrons.

If professionalism seems less meaningful in modern society, it is because a distressingly large number of professionals in occupations like finance are acting dishonorably and unethically.

Fine, fine, I'll post the screed. My point is that the word "professional" is now all but synonymous with "slick salesman"

Personally, I doubt that "professionals" were any more trustworthy before I was old enough to notice, too... thus me poking fun at the very ideas underpinning it.

(as an aside, I don't know all that much about finance... but as far as I can tell, it's nothing but sales, so there really isn't any room for professionalism in the way you mean the word. They aren't doing anything but selling.)

My experience with people that claim to be 'professional' or who attempt to dress professionally - nearly all of those people I know are salespeople. If you want someone to show up on time and look good? sure, go with one of them. If you want the correct answers to your questions? if you want someone to give you truthful answers even when those truthful answers mean you go with a competitor? find someone who is actually into what you are trying to do.

That's the thing, at least in the part of Engineering where I work? sure, some good Engineers claim to be professionals, but almost none of them put any effort into the appearances of professionalism. Few put any effort into dressing or grooming, and many are habitually late.

The only people I know that put a lot of effort into appearing professional are the sales people.

I mean, sure, you and I can argue back and forth all day... "Words have meaning!" and, of course, a 'professional' is someone that does a job that requires a lot of training, and probably comes from an upper middle class background. But the thing is, that meaning changes over time, as how the word is used. Personally, I associate the word 'professional' along with the western style business suit, with fraud, mostly because the Engineers I know don't put much effort into claiming to be professional, while most sales people do. I think that more and more people have that opinion of the suit; even salespeople I meet rarely wear suits, (though, of course, they still loudly declare they are 'professionals' even though they have little knowledge of the product and are more than happy to make up ridiculous lies about their own product and the competition.)

Yea, I will refer you to this post that describes the fundamental flaws: http://news.ycombinator.com/item?id=3426201

"Professional always means power." Frank Herbert

Most specifically, the power to exclude competition, that is the sole real purpose of "professional licensing", whether medical, legal, engineering, or other. The "protecting the public" is fraudulent window dressing to impress the suckers.

Overly cynical. If doctors did not have a professional association their conduct would likely get worse, so there is a public interest being served when professions self-regulate for quality. There is also an anti-competitive factor, but corporate oligopolies do the exact same thing. Libertarians criticize professional bodies and unions while giving monopolies, oligopolies, and regulatory capture a free pass. This is plain stupid because it is those corporate monopolies that are stifling human progress, not the relatively powerless unions whether they're the white collar "association" variety or the blue collar "union" variety.

You're presupposing that the costs of decreased competition outweigh the benefits of regulation. I have yet to see convincing evidence in support of this proposition.

Your point, in short: non-professionals work really hard to present themselves as professionals, to the extent that actual professionals now shun the word.

The word has a strict technical definition, however, and that definition is all about trust. What makes a professional unique is that they are ethically and legally bound to do their best for the client. If they fail, they can be held responsible.

Stricter regulation over the word is obviously needed, because non-professionals have appropriated it.

>Your point, in short: non-professionals work really hard to present themselves as professionals, to the extent that actual professionals now shun the word.

Sure, you could put it that way. But being as I shun the word, I'm certainly not going to go about calling myself a professional. If you have the spare time to try to change the popular usage of a word, have fun. Sounds like a waste of time to me. Even if you succeed... well, salesmen are professionals; they'll find a way to adapt, just as they are adapting to the decline of formal dress and manners.

Meh, even as 'professionalism' has been defined during my lifetime, there are some positive aspects of the slick salesman. He is always on time, and always dresses presentably. He always gets you his bill on time. She knows how the system works to get in to the 'approved vendor' lists, and He knows who needs to get a kickback and how much of a kickback can be given without anyone getting in trouble. In some cases, that sort of thing is important. I know none of those things, and can't even properly accept a kickback of the generally accepted amount.

Oh man. I remember I was evaluating hardware for a client... the vendor took us all out to lunch and was handing out, you know, low dollar kickbacks. When he heard I was the tech doing the evaluation he gave me fifty bucks in gift cards. Right in front of the client, too. (there was a company policy about gifts, and apparently fifty bucks was the limit.) I was flabbergasted. I had no idea what to say. Everyone else thought it was completely acceptable, and the person I considered my customer was right there and approved so I didn't make a scene or anything, but yeah. I was shocked.

I mean, yeah, sometimes you are in a place where that sort of thing is just how it's done. And you really don't want me when that is what you need, because even if I was to stoop to that sort of thing, I'd fuck it up. It's more complicated than handing someone an envelope of cash. You want a Professional to handle that sort of thing.

No, it's based on the very real fact that a lawyer can get in serious trouble for violating a raft of nit-picky self-regulatory provisions. Law firms have entire departments dedicated to avoiding conflicts of interest, and lawyers can get in trouble even for failing to disclose unethical activity they know about. Not to mention the constant threat of malpractice suits, in which violation of the ethical rules are strongly probative of malpractice liability.

well, if the line between 'professional' and not is a legally defined one, you have a good point.

I don't know how deep it goes, but I do believe that you need some kind of government-issued licence to be a stockbroker, in which case, sure, maybe then you should be able to expect that they follow a certain set of rules. (I do note that even with tightly defined rules, it's /very hard/ for people that are essentially salespeople to act in someone else's best interest. Hell, it's hard for a honest person to at in another person's best interest.)

Financial licenses are issued by FINRA (Financial Regulatory Authority). A main focus of the general exam and the supervisory exam (the Series 7 and 24) is 'dealing with the public.' The industry relies on the idea that you can trust your financial advisor.

You still can't regulate ethics. Some people are just slimy; they will be slimy no matter what industry they are in.

> You still can't regulate ethics. Some people are just slimy; they will be slimy no matter what industry they are in.

I think this is a bit defeatist. Professions can and do regulate their own culture. It's a question of having the will to do so. I'm going through the process of being admitted to the bar right now, and I have to say it's instilled in me at least a healthy fear. It's incredibly invasive. The character & fitness committee not only digs into your public data (speeding tickets, etc), but reaches back into things like expunged juvenile convictions. And it starts from Day 1. I had professors who were on the C&F committee who told me horror stories of people with $200k of debt failing to be admitted. There is a honor code culture. If there was cheating going on at my law school, it was below my radar, while it was fairly common at my engineering school.

I feel medicine is the same way. I have family members who are surgeons who feel incredibly uncomfortable just when drug reps bring in lunch. Even in engineering, at least in the traditional disciplines like mechanicals, etc, (I was an aerospace major), there is a strong understanding that when you go into work, peoples' lives are on the line.

I'm sure there are a lot of slimly people in these professions, but the difference is that the strong cultural condemnation forces such behavior under the radar. Meanwhile, the financial sector seems to reject the idea of professional codes of conduct as outmoded.

Part of the problem is persistent allegations that firms were advertising certain investments as great, safe, wonderful money-making vehicles, while simultaneously knowing and privately acting on the knowledge that they were anything but.

That sure sounds like fraud to me.

Sales is sales. They were not doing this any more than than they would for any other product, and no financial investment is safe.

Blaming the banks who sold these seems totally crazy to me. The prospectus is available, and the contents are pretty well known in the industry anyway - it's in the name. Note that other banks were quite often counterparty, not the man on the street who feels overburdened by small print.

More likely the fraud & negligence for this specific part of the problem is committed by ratings agencies.

If a car dealer sells you a car he thinks will break down in six months, you definitely have a case against him.

Answering "caveat emptor" to everything is what's crazy. We're civilized people, we should abide by reasonable standards of business conduct. Especially when you're in a profession that holds itself out as representing the interests of its clients.

You wouldn't have a problem with your lawyer taking bets against your case? Or your accountant using the information he learns from auditing you to profit on the side? I think these things fall below the standard of reasonable business conduct. I think the excessive reliance on caveat emptor is the product of a failed economic ideology.

Those are terrible analogies. They did not hide bad loans in there and claim they were good. The products specifically consiste of a subprime tranch.

In the financial world you are always buying products with risk attached. The amount and nature of the risk varies with the product; remember lots of people made money on CDOs as they will continue to do, as they did and do on junk bonds, and every other product that has bankrupted someone in the past. Attempting to put some arbitrary limit on what can and cannot be sold seems rigid and counterproductive. You realise that you can still buy Greek government bonds, right?

Further, there is a reason caveat emptor is heavily restricted in the consumer domain: the overhead of people trying to assess and manage the risk of every single purchase they make far outweighs the cost of legislation and the onus on the company to deal with it instead. Note also that the strongest protections apply to new products. If you buy a used car without guarantee something can go wrong without any liability for the seller, so you are not even factually correct.

I cannot see a legitimate reason to downbote my parent unless considered to be factually incorrect. Probably better to state the inaccuracies, you know, kind of friendlier where they are non-trivial. Spent today upvoting similarly against-the-consensus comments; exceptionally disappointing that such discussion must be one-sided on HN.

Car analogy aside, I thought the other two were very apt.

>In the financial world you are always buying products with risk attached.

Which is why investors use ratings agencies to help them gauge the risk. Good job none of those AAA rated tranches were cut with toxic assets... Oh, they were? Woops.

I don't think anyone is arguing that financial products don't carry inherent risk. What would be nice is if the banks and investment houses worked hard to mitigate this risk for their clients rather than throwing them to the lions (or in many cases simply out and out lying) and profiting regardless. If they aren't capable of doing this themselves, then they should be regulated in to compliance. I don't expect my accountant to fuck me and the same goes for my financial advisor.

That was precisely the conclusion of my (heavily downvoted) reply. The ratings agencies are not the banks. What is unclear about this? I wouldn't even think it controversial.

The parent that I replied to stated that the instruments were marketed as safe when they were anything but. The implication in my view was that you should not be able to sell unsafe things (and the only other reply confirms this). Even if I misread this, it's simply not factually correct to say that they were marketed as safe. They will - like anything else - be marketed as a good product. Which means a good risk/reward ratio. Which means fuck all, if you don't trust ratings agencies. But again we are back to the same issue. Is it a good thing that ratings agencies make money from the companies selling the products they rate? Wow, you know what? That's an interesting point! Maybe it's easier just to click the down-arrow though - it's not as if the discussion is valuable. whatever, hating on bankers is more important than facts. apologies for the sarcasm.

Except it isn't just the ratings agencies is it? The banks have been mis-selling and over hyping virtually everything that goes across their desk. Dodgy prospectuses, mis-selling interest rate swaps (http://www.telegraph.co.uk/finance/rate-swap-scandal/9364019...), mis-selling payment protection insurance, rigging municipal bond auctions and the list goes on.

This is before we even wade in to the whole LIBOR scandal. How are you supposed to, as an investor, accurately gauge risk if the independent base rate used to calculate your interest has itself been compromised by the very banks you're buying the investment products from?

I think it would be more valuable to question your assumptions. You have changed the topic and conflated several different issues - it is not the case that doing one thing wrong means doing everything wrong. There's a lot rotten in banking, but selling a bundle of mortgages with varying quality - without misrepresentation of this, and to another financial institutoion - is not morally or legally questionable.

If you really want to talk about the other issues, I find it highly unlikely that 'mis-selling' in this sense means lying. That implication is yet another easy way to join the narratives to sell papers. Small and medium business are generally protected in the same style as consumer purchases - they are not sophisticated investors, and should not even be sold complex products. When they complain about the consequences not being explained to them, they were in fact quite plain in the contract, but they didn't bother to read it properly, or did not understand it. I can understand why we protect them like this, however - same reasoning consumer purchases.

LIBOR - trying to manipulate the market is a crime. Actual effect? Maybe none? Previous investigations and a couple of academic papers found no effect. The Economist also considers the more important thing the 'second type' of wrongdoing - where the ire directed at Barclays is that they initially didn't lie, and then later lied less than everyone else (possible at the suggestion of the government?).

At the stage of 'not lying as much as others', it's getting pretty silly in my view. Much like the financial crisis's beginnings, the public is sold nonsense and hyperbole and cartoon villains. So we focus so heavily on the bankers that we don't really look into mortgage brokers, ratings agencies, government monetary policy, regulators, etc. Conclusion is to velify one group - exactly what the other groups want - without fixing those that set the wrong incentives/hold them accountable. See you in 10 years for the same story.

All my replies have been in response to your "Blaming the banks who sold these seems totally crazy to me. " remark.

I'm afraid I don't find it crazy. I think they deserve an enormous amount of the blame (as I hope I illustrated in my earlier replies) and frankly, I find it vaguely irritating that anyone would try to defend their actions with arguments revolving around caveat emptor.

This by no means suggests I believe they are solely responsible. On this, we can both agree. As far as I'm concerned, the ratings agencies, regulators (pre-crisis at least), brokers, press and government also deserve a large amount of the blame. Irresponsible consumers don't get let off the hook either.

However, regulators (at least on the European side of the Atlantic), government in general and consumers have spent the last 5 years learning from their mistakes and are at least making efforts to correct the situation. The big banks on the other hand have continued to take the piss virtually un-fazed. I'm hoping the LIBOR scandal will now be their watergate moment.

Edit: and when I say "virtually un-fazed" that's charitable. Active denial would be a better choice of phrase. They have heavily lobbied against every single banking sector reform proposed since the crisis began. That takes some hubris. I mean christ, in London up until fairly recently the banks were effectively resorting to blackmail: "make these reforms and we'll have to quit the city and move our operations to a more 'enlightened' jurisdiction".

I think some further case history would help nail your case. Sadly I don't have it on hand but the assertion above that miss-selling isn't lying is invalid.

Miss selling is just a way to put it across creatively without getting decimated in the press.

Aside from that there are clear cases where the banks lied.

Frankly the only thing that saves them is the inability of other intelligent people to believe that this actually happened. "no it couldn't possibly be that! People are just grinding their axes."

Except every time you hear of the banks in the news they've managed to pull off yet another scam, which just got out in the open.

You know the one simple thing which we should stop offering banks? The option to just pay the fine and get out of a trial.

Barclays got fined - but it's not stood trial - they fessed up, and got off on good behavior.

Only Goldman recently was arrogant enough to believe that they could win a case in court.

Ah cases: the magnetar trade, and abacus. http://www.propublica.org/article/the-magnetar-trade-how-one...

Those are spot on analogies. I forget the name of the particular synthetic security case, but from the emails it was clear that the bank knew they were selling junk to their customers. From their sales materials / ppt / brochures its equally clear that they made no mention whatsoever that they thought it was useless/terrible/ and that they were shorting it.

When a bank shorts something, and then turns around and sells the counter position to a client while promising them that it will go long, what else would you call it?

Edit: I'm providing a reason only to why the Analogy is correct.

Finance discussions are always complex, and the rest of your points I have no real beef with. I am only pointing out that the banks are playing asymmetrically. In these cases it would not be possible for the customers to avail of the "informed / educated investor" clause.

First, there is the information asymmetry. Second, there is the incentive structure created by that conflict of interest, even in a situation where the clients had perfect information.

> Goldman wasn't obligated to put up a shingle reading "We are losing our appetite for CDOs, and so can't take your money if you think they're still a great investment."

They are obligated if they are fiduciaries.

I would qualify this. Note the recent implosion of the law firm Dewey Leboeuf. It grew very large through mergers and by luring lateral hires with multi-million dollar guarantees which it ultimately couldn't support. Many firms have become too bloated and have failed. More failures are expected. But you're right, the personal liability and ethical and other constraints on lawyers does induce risk aversion among law firms relative to bankers. However, the big catch is that the downside of lawyers and accountants being too conservative is not as acute as for investment banks where being too conservative has a very real and deep impact on markets, credit, liquidity, etc. So we (society, politicians, etc.) have tinkered with their regulations to try to improve markets, economy, etc. such as the repeal of Glass Steagall, etc. and we suffer the consequences.

Switzerland actually has a very interesting banking law: The directors and the board are personally liable if a bank goes bankrupt.

Not a lot of Swiss banks go bankrupt..

Our banks are private partnerships with unlimited liability for directors - this tends to increase the give-a-shit factor for reviewing assets and loans but also limits scale. Thus, we also have the incorporated UBS and Credit Suisse who, in proper fashion, proceed to blow up perennially.

Is "limits scale" a bug or a feature?

I expect that a lot of the success of the capitalist model stems from the fact that most actors in this model are not too big to fail. (See "internet": To make a resistent system, minimize the impact of any single node going down.)

The idea of a "market" is based on something like a bazaar, where no individual actor matters. When any single actor is large enough to matter on their own, you are leaving the the market model behind. There are terms like "monopoly" and "oligopoly" for that.

When the issue is "we can't let these actors fail, they are so big that it would destroy the market", it sounds like the solution should be a simple size limitation.

Where's the problem with that?

There are some efficiencies that come with scale. For example, it's preferable to have very large utility companies with heavy regulation. I tend to agree that scale is unnecessary for investment banking. If an entity needs capital in bulk it can go public.

The trade off then becomes efficiency of scale vs. tolerance to failure.

I would argue that certain sectors, like infrastructure for public utilities, would be negatively impacted by treatment as a free market - the cost of building that infrastructure presents a barrier to competition, so the market isn't terribly 'free' anyway - and gain much more from the efficiency of having a single pipe going to everyone's home which all suppliers use, with everyone paying for the maintenance of their own infrastructure.

If you're interested, this is called a natural monopoly: http://en.wikipedia.org/wiki/Natural_monopoly

Yes, the efficiency argument can be taken to justify anything. In truth, competition will always increase efficiency more than just scale alone.

The comparison with nodes is important and one which most people don't quite get. Banks should be limited in scale. If they need to undertaken large financings, then they can always form a syndicate that exists for a specific project, and is disbanded afterwards.

Everyone wants to sheet home the blame to the junk mortgages, or something else, but in reality any financial system is going to encounter shocks, whether they be man-made or perhaps natural disaster.

What is important is that the structure of the industry is robust enough so that one or two failures doesn't crater the industry.

Think of it like scaffolding - occasionally accidents happen on construction sites. But you don't want the entire scaffolding to collapse as a result. Any failure should be localised.

Warfare changed forever when the Generals couldn't sit in a bunker far from enemy fire and send cannon fodder in. It's time to have the finance generals out of the bunker. Ruin a bank, and you should be financially ruined as well.

Tyler Cowen has written about this before: http://www.nytimes.com/2012/02/12/business/making-shareholde...

According to Carolyn Sissoko (syntheticassets.wordpress.com) this is how English banks used to operate as well. Back in the days when draughts were accepted or not depending on the creditworthiness of the bank they were written by, it would have been laughable for a banker to not be super-wealthy, because how else would anyone recover their money in case of significantly correlated demand for liquidity? (This is long before the days of government guarantees preventing bank runs.)

So long as the primary leverage in an investment bank's business was people (skills, relationships), they were happy being partnerships.

In the 80's as investment banks discovered the joy of trading profits, they realised they could then leverage capital (pun intended). That therefore led to their finding more capital, in one of three ways, all which started to happen in the next 10-15 years : merging with commercial banks (which in turn allowed commercial banks to earn larger returns on their capital ... much better than lending to the neighbourhood convenience store); going public; and pressuring regulators to allow higher debt/capital ratios.

So, as with everything, a simple matter of incentives.

Really? "we erred" ? The most powerful people in the world asked for your permission?

This is a great idea, and I'd love to see some of these crooks who are literally ruining countries get locked up in prison. I bet the economy would recover REAL quick if we started throwing hedge fund managers in prison.

I agree that some of the crooks should be prosecuted and sent to prison (of course the Department of Justice has bigger fish to fry, like adulterer John Edwards), but that would have little or no effect on short-term economic recovery.

Warren Buffett and Charlie Munger think along similar lines, though I don't think they mentioned incorporation. But for the system to work, those playing with these huge sums definitely need to be on the hook for the downside, not just the upside.

I mean, shareholders of AIG or BAC or whatever got pretty wiped out, but a lot of bankers, as you said, get compensated more with cash bonuses than stock, and these don't get the downside.

Regarding this part of your statement:

there is no financial incentive to act responsibly because if you go bankrupt this year last year's bonus is already banked;

it should be noted that many bankers are terrible at saving; they simply scale up their spending rather than building a cushion for themselves. A large fraction of last year's bonus may already be gone or spoken for.

Source?

I'm sorry, I do not have quantitative data on the savings rates of finance professionals. This is just based on my personal observations.

>is that we erred in allowing investment banks to incorporate

Pardon my ignorance, but was there such a time in the past when investment banks weren't limited liability?

They used to be limited liability partnerships, but now are public corporations. For example, Goldman Sachs went public in 1999. Liability in a partnerships isn't unlimited as the GP suggests, but there is a higher level of personal responsibility.

I understand that as a partner in an LLC/WLL that even in a "limited liability" the liability is quite present. :-)

I'm too young to remember private banks as llc/wll though.

This reminds me of an anecdote told by my dad. He had bankers calling him quite often asking to "invest" his money instead of letting it sit in the account. For the first few times, as courtesy he'd politely decline. But when they really started getting to him, he coolly said something like this, "If you or anyone in your chain can PERSONALLY guarantee that you will NOT lose my money in the current scenario I will pull out every single cent I have and gladly hand it over to you". Needless to say, he stopped getting the calls.

This is why when you hear politicians bleating about de-regulation, you need to read between the lines to figure out what they are actually saying.

Conduct of markets so critical to our society need to be done in the open, in an publicly accessible exchange. Banks will not fix themselves, they need to be compelled to do so by strong regulation. For all of the hand-wringing over high-frequency trading of equities, at least you can ultimately figure out what is doing on.

Bankers used to be boring people whose primary job qualifications were looking distinguished and having the ability to follow instructions precisely. We need a regulatory environment that brings that kind of banker back to the mainstream.

They are regulated. The regulators are complicit. Regulation is not a magic bullet. Moreover, regulation is not homogenous. More regulation is not always better/worse, and less isn't always better/worse.

Leave the talking points at home.

Read parent again. He didn't say they any of the things you're trying to refute.

Poor and complicit regulation is not much better than no regulation at all. Deregulation does not necessarily mean that suddenly all rules and regulations are removed. It may also mean making the rules more and more lax, to the point that breaking the rule is no longer needed. On the other hand limiting resources of the regulator can also be very effective as a mean of deregulation.

The fact that there are some poor and rarely enforced rules does not constitute regulation. On paper things may look as they are regulated, but in practice it may be a whole different story.

The FCIC pretty much concluded that deregulation an self-regulation is what caused the financial crisis. So while it may not be a magic bullet, it's better than what we have.

It's better to describe regulators as captured rather than complicit.

Regulators have no chance when the people they are supposed to regulate have hundreds of times more power than the regulators. Allowing unlimited wealth concentration guarantees that the most powerful private interests are always more powerful than government regulators.

Power would matter a lot if regulators knew exactly what to do, but lacked power to enforce it. Unfortunately, most frequently regulators have very little idea about where the next crisis would come from (count how many times "unexpectedly" is featured in economical reporting) and what to do to prevent it, and there are many contradictory opinions on these subjects. Often they even have very little idea about what exactly major players are doing and why, and lack the ability to foresee all the risks. Moreover, since regulators are appointed by politicians (there's no other way to do it in democratic society) they of course would be heavily influenced by political considerations, which may be not to the best of the regulated industry - e.g., if politicians want more people have access to certain loans, regulators would force banks to accept more risk on such loans, even if it doesn't make financial sense to them. And then if such loans blow up, the bankers would have a valid claim to be bailed out - after all, didn't regulators ask them to accept such risks?

All of these are solvable problems.

1. Regulators lack visibility? Give them investigatory powers.

2. Regulators can't predict the next crisis? Maybe with bigger budgets they would have higher quality employees. All the talent works for the hedge funds who pay them literally hundreds of times more. If the person being regulated makes $1M/year the regulator needs more pay than that or there will be talent asymmetry. Obviously, the key issue here is that the financial sector gets paid way too much, way more than the value it produces. The profits are based on a rigged financial system.

3. Regulators appointed by politicians due to democracy? Cancel democracy and implement meritocracy. Require positions of power to be filled by civil servants with proven skill who have to pass tests, rather than politicians elected by the stupid hordes. If the masses are going to elect people that are provably useless, the masses should be stripped of their voting privileges for their own good. Democracy is not a panacea. Meritocracy is better.

4. Banks upset that the gov causes them to fail? Nationalize the fucking banks, duh. Banking is not high tech and should not be high tech. It should be a public utility that is the most conservatively run thing in the economy. Banks should be separated from investment entirely. Government should invest in high tech but only using the judgment of highly qualified meritocrats with proven knowledge elected by their specialist peers to oversee government investment within that specialty. Private investors should have no connection to banking.

The root of all social problems is the fact that the most qualified and knowledgable academics and technologists have zero political power, while Chrstian pseudo-preachers hold all of it. Intelligent people (e.g. Those on hacker news) should be pushing technocracy and meritocracy and disempowerment of the idiot hordes who don't even know how to act in their own self-interet.

1. They should know what to investigate. In most cases, they don't until it's too late. Amount of financial transactions in average bank is tremendous, and unless you know exactly what to look for it's beyond shadow of possibility to make sense of all of this data and see if there's any problem somewhere there. You'd need regulatory agencies with personnel 10 times more than whole personnel of all banks. Who'd pay for that?

2. It's not a question of budgets. Somehow some people got the idea money is all-powerful and enough money solves any problem. That's BS. Nobody knows that. And yes, bankers don't know that too - do you think they enjoy being nearly bankrupt? If they could properly predict such things, they would. They can't, however, so instead they do what they can - dance on the line as long as they can and cry for help when the time comes.

3. Yeah, right. And who will be determining "merits", you? No, thanks. I'd rathe take my chance with the stupid hordes - at least they are not so swollen with self-importance as to deny everybody who disagrees with them basic human rights of self-rule and control over their own destiny. All these arguments that some people should be slaves "for their own good" and have no rights except the right to be ruled by kind masters - we are way past that. Sorry, those times won't return, abandon that dream.

4. Nationalized industries work really great, duh. Of course, being controlled by the state gives people superpowers, so industry that was badly managed and corrupt as private, of course will become clean and well-managed as government enterprise. After all, government enterprises are universally known for their excellent management and total lack of corruption, especially when it comes to managing billions of dollars. Duh.

>> The root of all social problems is the fact that the most qualified and knowledgable academics and technologists have zero political power, while Chrstian pseudo-preachers hold all of it.

This is completely stupid and false. The social problems have multiple roots, and very little of them have anything to do with technologists and academics having little power. Academics, technologists and social engineers of all kids have huge powers and access to enormous budgets and overwhelming regulatory powers. Most of their social engineering enterprises, however, meet with disastrous results, exactly because every complex problem has cheap, obvious, easy to understand wrong solution. And people like you grab at it and yell "oh, that's simple, let's nationalize all banks and appoint more bureaucrats to run financial industry, that would guarantee us eternal prosperity". No, it won't, sorry.

The "idiots" are acting exactly in their self-interest when they are ignoring advice like yours - because what you are advising is a recipe for disaster and this was proven by history many times. Unfortunately, they don't always do that - sometimes the simple wrong solution is too tempting. They - we - always pay dearly for that.

Deregulation is a recipe for disaster. Using the scientific method, reason, and intelligence in government is the only way good governments have ever happened. You sound like one of those people who wants to abolish all government, meaning that corporations become the new government and we have feudalism. Bad idea.

Systems are never perfect but intelligent systems are still better than having NO system. Which is what extreme rightwingers and anarchists such as yourself are actually advocating. Deregulation caused the crisis and many people saw it coming. Bankers didn't lose money, it was the public who lost money. Bankers made record bonuses before and after the crisis and the top guys all had record golden parachutes. You're a clueless tea partier.

A stable, regulated banking regime was in place in the United States until the 1980's and 1990's. The 80's saw the results of "innovation" in the financial sector through the implosion of thousands of savings & loan institutions. We didn't adopt our current laissez faire regime of "bankers gone wild" until the late 90's.

My memory may be foggy, but I don't recall the period of 1945-1999 as some sort of socialist nightmare for the United States. Most people think of this era as a golden age.

Regulation doesn't mean nationalization. It means that you put rules in place to do things like eliminate practices the fundamentally place the bank at odds with their customers. Things like using the customer deposits to make multi-billion dollar gambles (JP Morgan Chase, MF Global). Or subject the firm to tend of billions of dollars worth of liability that the firm is unable to make good on (AIG). Or commit outright fraud (Countrywide, Washington Mutual, Barclays, etc).

I don't work in the financial industry, so the normal laws of business apply. If I systematically broke internal controls and rigged KPIs to achieve the maximum bonus compensation possible for me, I'd be investigated, terminated and likely prosecuted. Why shouldn't the guy managing my money have the same accountability?

If you call current situation in financial industry laissez faire you obviously have no idea what these words mean. Yes, there was some deregulation in 2000s, but there was still huge amount of regulation and government control over the financial industry. None of these controllers foresaw the crisis of 2008, none of them objected to subprime mortgage industry - actually, most of the politicians sung praise to raising home values, better access to homewonership for the poor, and upcoming prosperity for all, and pressed the banks into doing more to help the poor take the loans to get on the property train.

Check out this book, promising ever-rising home prises in 2005: http://www.amazon.com/gp/product/0385514344

Now check out the glowing reviews of this book, quoted on the same page, by no other than chiefs of Federal Reserve and Fannie Mae. You are telling me the problems happened because guys like these didn't have enough power? I've got a nice bridge for sale in Brooklin, are you interested?

>> Regulation doesn't mean nationalization.

For the guy on whose post I was responding it definitely does. Not only nationalization, but also removing democracy and rights of self-rule for everybody but people having enough of some "merit", which I suspect he assumes himself to possess in abundance. I am glad the problem with such suggestions is obvious for you.

Benford's law strikes! I was all set to read about crazy, complex data analysis that detected this, but instead check out the abstract below:

"With an eye to providing a methodology for tracking the dynamic integrity of prices for important market indicators, in this article we use Benford second digit (SD) reference distribution to track the daily London Interbank Offered Rate (Libor) over the period 2005 to 2008. This reference, known as Benford's law, is present in many naturally occurring numerical data sets as well as in several financial data sets. We find that in two recent periods, Libor rates depart significantly from the expected Benford reference distribution. This raises potential concerns relative to the unbiased nature of the signals coming from the 16 banks from which the Libor is computed and the usefulness of the Libor as a major economic indicator. "

Abrantes-Metz, R. M., Villas-Boas, S. B., & Judge, G. (2011). Tracking the Libor rate. Applied Economics Letters, 18(10), 893-899. doi:10.1080/13504851.2010.515197

I say this as an outsider to the industry, but the 'large' £290m penalty appears to be a joke and the media are either complicit or too thick to realise. Annual profits for Barclays were £5.9 billion to Q1 this year. May not be appropriate for comparison purposes, but if over a year the financial penalty Barclay's paid was the same basis as the penalty for dodging a £2 tube fare in central london - the fine for being caught would be just south of a whopping 10 pence! Simple incentive theory here. At that rate I'd dodge the fare every. single. day. The fine (reputation damage be damned as I'm not sure there is a honest broker to take my business to) is off by at least 2 orders of magnitude.

The philosophy is it isn't fair to penalise non-complicit employees, shareholders, and other stakeholders. Thus, when possible, the directors are decapitated and those responsible are charged personally.

Note that it wouldn't be productive for regulators to fine banks into needing to be rescued. I also suspect they're being cautious in light of the torrent of asymmetric lawsuits and contract unwindings about to hit these banks.

I appreciate that, but as far as incentives go, if you knew the chance you had of being caught was minimal and that even being caught and charged as criminal you'd have walked away with good amount of change - it's not much of a deterrent. And we're I a shareholder, I'm honest enough to say I (and I suspect many others) would probably turn a blind eye to it.

As to fining the banks into being rescued, totally agree that defeats the point. Think of it more as giving them a long term mortgage penalty. Say LIBOR + x basis points paid back over 20 years. :)

At some point, I think if you work for a corrupt company or government, you are complicit. Otherwise do you invoke the Nuremberg defense?

That line of reasoning is why we have so many problems.

The banks profited immensely from the manipulation, at the expense of other companies around the world (and their shareholders, employees, stakeholders).

If the directors knew about it, then they should be punished, as should the employees directly involved, but so should the bank itself.

If shareholders thought that companies they owned were immune from punishment, it would create an incentive for them to try pressure directors or employees of the company into doing morally or legally dubious things.

Sadly, this type of corruption looks to me to be far to deep for simple fines to fix. There is a rotten culture in London that needs to be removed.

It reminds me of the Enron recordings [0] ...

> "This is going to be a word-of-mouth kind of thing, We want you guys to get a little creative and come up with a reason to go down."

> "O.K., so we're just coming down for some maintenance, like a forced outage type of thing? And that's cool?"

> "Hopefully," Mr. Williams says, before both men laugh.

[0] http://www.nytimes.com/2005/02/04/national/04energy.html

Wouldn't penalizing the shareholders actually be a good free-market approach? Since the shareholders are ultimately the owners of the business, at least notionally, the free-market way to incentivize good behavior on the part of the business is to push those incentives onto the shareholders. If shareholders are penalized for bad behavior, they'll be motivated to control their board/executives/employees properly, instituting sufficient procedures and exercising sufficient oversight to avoid getting themselves in hot water.

>The philosophy is it isn't fair to penalise non-complicit employees, shareholders, and other stakeholders.

I thought capitalism wasn't supposed to be fair? Isn't that the whole point?

Can anyone guide me as to when the pursuit of fairness is essential and when it is moral degeneracy? It seems kinda arbitrary...

Wait for the lawsuits.

The article says $750 trillion of transactions are indexed to LIBOR each year. The short side of those were cheated out of money.

Hence "Banking's 'Tobacco Moment'".

What blows me away about this story is that, as far as I can tell, the entire financial world is built on this rate that is calculated by taking completely unverified estimates from a handful of enormous banks who have every incentive to manipulate those estimates. How on earth is such a conflict of interest allowed to parade around out in the open? And why should we have any reason to believe that there aren't other similarly absurd structural problems with the financial system? The whole thing sounds like a house of cards.

The world economy is a house of cards, propped up by ignorance. If the public at large knew how stupid much of this really was, there would be riots.

How many people do you know who /really / understand the world economy? It's the best act of "security through obscurity" combined with "security theatre" ever.

Must be the most robust house of cards in history, since this latest iteration seems to have managed to get us here all the way from the 18th century where capitalism originated to the present day where we have supermarkets, planes, the Internet, and a number of other wonders of the modern world.

Oh now, you're smarter than that. Capitalism existed well before the 18th century (where it would be more proper to say that it was first named and studied properly), and there have been plenty of temporary but drastic reversals before and since. I'm very much pro-market, but it's hardly immune to herding problems or irrational outcomes; and when markets fail, the burdens of that failure often fall upon those least equipped (intellectually or economically) to bear them.

The LIBOR is widely used, but there are others like the Fed's prime rate, and the consumer price index.

The entire entire financial world is built on insider manipulation. Too many examples to list.

I just don't understand why things are pegged to indexes at all instead of just letting prices be naturally determined by supply and demand. If prices are determined adversarially, then there is no room for manipulation or conflict of interest. Why have these indexes at all?

Put another way, who is willing to buy or sell according to prices that are open to manipulation (by being pegged to something like LIBOR), and why are they willing to do this? And why shouldn't competition favor produce better alternatives like financial instruments that aren't pegged to any artificial index?

why shouldn't competition produce ... financial instruments that aren't pegged to any artificial index?

There are those, too, but people want to hedge against the risk that "interest rates" move.

Then they must define "interest rate": is it mortgages in Peoria? Car loans in Manila? 30-year Treasurys? ... Well, how about we use LIBOR.

>> letting prices be naturally determined

This only works in economics textbooks. Economic actors never have perfect knowledge is another example.

I think most of these benchmarks are chosen out of expediency at the time, then they become entrenched. The use of the Dollar for oil transactions might be another example.

LIBOR is supposed to be determined adversarially; it theoretically represents the equilibrium of supply and demand for overnight liquidity. It's subject to manipulation because the number of participants in the market is necessarily small.

the entire financial world is built on this rate

The Epicurean Dealmaker (@epicureandeal) posted the standard response to your comment a few days ago ("Ready, Fire, Aim"). Prices are calculated as LIBOR + spread. You and I argue over the spread meaning that if I want 185 bp then I'll either ask LIBOR+165 or LIBOR+65 if the base rate went up by a whole 1%.

Check the people who responded to his twitter comments (e.g., @dsquareddigest) for more of the standard back-and-forth here. For example Eurodollar futures hedge the LIBOR so people short LIBOR during the period in question directly lost money.

Tangent: this is something I love about twitter. I imagine the meatspace equivalent would be eavesdropping on some Wall Street people in a bar, or hoping that a variety of voices get heard in the WSJ. But today, on twitter, I can read financial market participants' back & forth to each other about the scandal of the day, using their own terminology and reasoning. Very cool.

How on earth is such a conflict of interest allowed to parade around out in the open?

It's in no-one's interest to admit that systemically important banks have lost the confidence of their counterparties.

Imagine a slightly sweaty central banker dancing on stage:

  Transparency, transparency transparency, transparency ...

So much of the problems since 2008 arise because it was not known what others were borrowing or lending or from whom at what price.

The LIBOr rate is set by asking not what rates do you borrow at, but what rate would you like to borrow at!

Sorry folks, commercial confidentiality is a fig leaf too far now. Publish and be damned.

»"LIBOR is set [at]...what rate would you like to borrow at"

No, it's not. It's supposed to be what rate the bank estimates it could borrow at. You can't use actual transactions because there are very few actual uncollateralised interbank loans at each of the LIBOR tenors.

»"commercial confidentiality is a fig leaf too far now"

One of the issues with LIBOR is it discloses what rate each of the banks report. Thus banks and regulators have an incentive to under-report rates to prevent launching a feedback cycle.

But if we knew what they were actually borrowing at

1. LIBOR would be accurate and not open to manipulation

3. if a bank is weak it should find it harder to borrow. Feedback cycles can be beneficial, plus this sounds a lot like the old "the ratings agencies told me this sub prime mortgage was actually AAA". - if you are investing billions, do your own damn research. And your own damn research is a lot easier in a transparent market.

In the end I think the global finance industry is a threat as well as a benefit. We are happy to demand access to politicians finances, because it is their character that matters so much, a situation very similar to banks it seems.

"Banks, as presently constituted and managed, cannot be trusted to perform any publicly important function, against the perceived interests of their staff. Today’s banks represent the incarnation of profit-seeking behaviour taken to its logical limits, in which the only question asked by senior staff is not what is their duty or their responsibility, but what can they get away with."[1]

[1] http://blogs.ft.com/martin-wolf-exchange/2012/07/02/banking-...

This long-term fraud is one of the better cases for which there are likely to be thousands of individuals who should be held criminally and financially responsible. It is clear that many financial institutions will be held responsible.

If the thousands or even perhaps tens of thousands of individuals involved are forced to pay restitution damages in addition to punitive damages, would this further the cause of justice? I am of the mindset that it will. Do the world's prosecutors and politicians have the balls and/or resources to do it?

It may be all well and good to crucify ten thousand people, but unless there is a plan in place for the aftermath we'll still have a broken system ... and a lot of bodies, figuratively speaking.

unless there is a plan in place for the aftermath

Ooh! I know a good plan! How about we investigate and prosecute fraud? The idea is that this would create an incentive not to commit fraud in the future.

Former bank regulator William K. Black says that the agency he worked for during the 1980s S&L crisis made over 10000 criminal referrals to the Justice Department, producing over 1000 felony convictions. That crisis was 1/70th the size of this one. How many criminal referrals have been made in this one? Zero. How is that possible? The answer Black gives is: total gutting of the investigatory system. What you don't look for, you don't find.

That's a long runway for due process before anyone needs to dust off words like "crucify".

(I'm not giving a citation because although the above is easy to google, I don't know which of the websites are any good. I got it from watching interviews. Is Black credible? His experience in the field seems exemplary.)

If you change the law such that many behaviors which were once illegal are now legal (which some would argue was the upshot of repealing Glass-Steagall), then the negative consequences which may ensue aren't necessarily criminal.

According to Black and others, plenty of behaviors remain illegal that are simply not being investigated.

> It may be all well and good to crucify ten thousand people

There are millions working in worldwide finance. By "crucifying" (must you really be so hyperbolic here?) a small complicit fraction of these, you send the signal to the rest: there are conequences for malfeasance.

It's the same reason we have the concept pf prison in the first place - as a deterrent. The thousands of people who might be sent to jail are certainly replaceable. Justice dictates they should be, as well.

Robert Reich[1] in http://robertreich.org/post/26708840314:

  And it would amount to a rip-off of almost cosmic
  proportion – trillions of dollars that you and I and other
  average people would otherwise have received or saved on
  our lending and borrowing that have been going instead to
  the bankers. It would make the other abuses of trust we’ve
  witnessed look like child’s play by comparison.
  
  Sad to say, there’s reason to believe this has been going 
  on, or something very much like it. This is what the 
  emerging scandal over “Libor” (short for “London interbank 
  offered rate”) is all about.

[1] Chancellor’s Professor of Public Policy at the University of California at Berkeley, was Secretary of Labor in the Clinton administration.

Manipulation of the LIBOR would impact all the variable rate mortgages that are indexed to it. In California, home loans with a 0% interest rate for the first year and very low rate for next few years (negatively amortized) were very popular and pushed by Washington Mutual and other banks. But these loan's interest rates were tied to the LIBOR. A lot of foreclosures were do to these types of loans where the payment will increase 10 - 20%. How often does ones income increase 20% in a year or two?

The economist article is not exaggerating IMO.

How these banks are dealt with by our governments will illuminate the extent banks have corrupted our governments.

Public companies should just be forbidden to do speculative prop trading at all. If one does and is lucky for a couple of years, then all others need to follow suit to achieve compatible profit levels... And that gets everyone stuck in a stupid rat maze that benefits society just as much as ebola or scientology.

Just like any group, organization, family, company, establishment: A fish rots from the head down. The system has to be setup in such a way, that the heads of an organization are least likely to start "rotting": - checks and balances - personal liability - transparency

I wonder if the outrage at this particular practice will fuel politicians?

I'm sure it will. Will they fix anything, and if they do will the fixes be another produce better results, is another question.

"We have to pass the bill to find out what's in it."

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