Sunday, 1 July 2012

There's something very rotten in Finance

Can a whole industry be rotten ? Definitely not. As in any field, you should expect the good, the bad and the ugly. But increasingly it is difficult to spot anything good with the financial services industry. Consider the latest scandal to hit the headlines - the manipulation of LIBOR by Barclays and 20 other banks.

LIBOR (which stands for London inter bank offer rate) is one of the prime interest rate benchmarks in the world. Many interest rates are fixed at LIBOR plus a premium. LIBOR should therefore be an impartial market rate based on which a whole lot of other transactions revolve. But it now comes out that Barclays has been manipulating this rate for a while. A fine of $450m has been imposed on Barclays and a probe is on with 20 other banks.

I know greed is a universal vice and an industry that directly deals with money is especially vulnerable to an overdose of greed. Yet it would be difficult to find an industry that has so allowed its core to rot . One after another, examples of insane risk taking, outright fraud, manipulation and criminal behaviour is coming to light. Action by governments has been patchy at best.

There is almost no  financial player that has remained untouched. Mention banks and every bank of renown has been in trouble. Mention insurance and the likes of AIG and Marsh & McLennan come to mind. I don't even need to comment on the likes of hedge funds and other less savoury players. Even the most reputable names in the business (Barclays is one of them) have been caught in wrongdoing. How can this be - a whole industry cannot be bad ?

The best brains in the world go into finance. And this is the field that seems to have the deepest rot.  Says something about the value systems of bright people. The state of the industry has gone beyond outrageous levels and has to be stopped.

Draconian action has to be launched by governments against the industry. It has to be made the most boring business in the world - so much so that the best minds recoil from going there.  All the scare mongering that capital for business would dry up should be discarded - there is enough capital in the world and like water, it will find its way to the best businesses. If some forms of risk management become impossible - it doesn't matter; the plethora of so called hedging products have created more risk than provided insulation against them.

The Reserve Bank of India stands out , amongst global central banks, by being bulldogish and refusing to allow any form of sex appeal in Indian banking. They have tried their best to keep Indian banking a boring business. By and large Indian financial institutions have escaped from major disasters - we have the RBI to thank for this. 

I hate to say this, but even Ramamritham has his uses !


Appu said...

I think it is rotten because it gets the best brains! if it is really a best brain, i think possibly it is motivated cause of the fun and thrill in breaking the system rather than the greed for money! alas still it is nothing but crime

TMM said...

If you look at the Canadian banking system and the equivalent of the RBI in Canada that acts as the banking watchdog, you will notice that they have been relatively unscathed by the Global Financial Crisis and meltdown. Again, this is because of what is considered antiquated controls regime (read less cowboyism and fundamentally strong and conservative banking practices). Canadian banks never resorted to the NINJA loans (No income, no jobs or assets)to all and sundry who built up the huge property bubble in the US and other worthy European nations. Yes indeed, Ramamrithams have their utility.

Deepa said...

:D :D (at the last line).

About Ramamritham, he is unwittingly being usefully. If he understood that his conservatism is being helpful he might try to get innovative! :) Although, I have a little more respect for the RBI governors than Ramamrithams.

Shachi said...

A few years ago, I wanted to get an MBA in finance and join that industry....the more I started reading n researching, the more I ran away from it. I echo your feelings....

I too have a lot of respect for was a banker all his life and he provided me with a lot of insight on how things work in India...especially the loans. Things in US are so weird.....

Ramesh said...

@Zeno - I hope not. Bright brains and good values should not be mutually exclusive !

@kiwi - There's much to be said for ultra conservative central bankers. Canada may be a good role model to follow.

@Deepa - Oh yes; RBI Governors have done a sterling job for the country. A proof of their contribution comes from the fact that every banker worth his salt considers them nincompoops !

@Shachi - Oh yes - much is to be said for the RBI. Bakers everywhere display cowboyish tendencies. Indian bankers are no exception. The saving grace is that they are handcuffed and blindfolded by the RBI - so their ability to get into mischief is somewhat limited.

gils said...

guess ennoda browser has extra sensory perception..intha post enaku suthama puriathu sollitu thaan malware warning kuduthu meratti iruku nenakren!! :)

Ravi Rajagopalan said...

Ramesh, In all the crises and scandals that have hit banking, this one outraged me, and like you, I remarked on the contrast with India to my banker spouse. I know of at least one prominent foreign banker who was asked to "take a foreign posting (tsk tsk)" by the RBI for some less than compliant practices. Diamond should resign. Barclays is one of the four major "clearing banks" of old days. For them to do this is utterly reprehensible.

sriram khe said...

I suppose I have something to say even when I know nothing--what's new, eh!

From whatever little I have read, there seems to be quite a difference between the Canadian insulation from the financial craziness versus the Indian RBI protection. In India's case, it is more a result of old-fashioned "Ramamirtham" policies and procedures, while the Canadian is of an informed caution against the ponzi schemes.

But, hey, if we take a couple of steps back, we will notice that banking is merely yet another institution that we find to be rotten. Whether it is college football or religious institutions or the media or, well, the list is endless, we are slowly beginning to realize that there are very few "public individuals" and institutions we can trust.

The market system relies on trust. And when that trust begins to evaporate, transactions and life become way too cumbersome ...

For years now, in my classes, it has been a routine for me to tell students not to simply trust even their professors--including me--but to trust and verify. Of course, I make sure to point out the paradox here: what if they end up not trusting me when I tell them not to trust anybody? :)

Ramesh said...

@Gils - Ha Ha

@Ravi - And what did the fair lady say ?? What's the point in asking Diamond to go - the rot is just too widespread and he may actually be one of the better out of a bad lot.

@sriram - No No - RBI is not a dumb organisation. They have a pretty clear idea of what's happening. Their main advantage is that they do not face political pressure to be nice to banks. Banks are not major political donors and therefore governments don't care. The major problem in the US is that the financial sector is one of the heaviest political contributors. The watering down of the Glass Steagall Act and its subsequent abolishing by Clinton is one of the worst events in history and one that the whole world is paying for now.

And no; eduction or any other sector is nowhere near as rotten as the financial sector.

Hema said...

Rajalakshmi does not understnad the woes of Ramamritham.
I 'pass' this post without my comments.

Ramesh said...

@Hem - Ha Ha ha . Touche.

Appu said...

I am not sure how rotten the financial world is! Please do trust me when i say education is too rotten to an extent i really lose my sleep over it and literally the blood boils.
stories worth to fill novels

Ravi Rajagopalan said...

So Diamond did resign. And this is a salutary lesson. However, when I look at how the BBA sets LIBOR, it relies on essentially the honour system of predicting the rate at which the bank expects to borrow at certain maturities upto 11am the next day. In this day and age, these i-banking types who run commercial banks would laugh at this method. It worked before the Glass-Steagal Act and its British equivalent were repealed. Prior to the repeal, the overnight borrowing rate really depended on commercial banks covering fund positions based on retail deposit taking and commercial lending. Since any bank can do anything, this clearly does not work.

The only way out is to use technology and set up a Dutch auction system that will force the rates downwards as lenders respond to borrowers demands. It can be run by the Bank of England electronically every evening and the matching rates at which borrower and lenders do not find a lower rate would be LIBOR for that maturity.

What say you?

Ramesh said...

@Zeno - I am sure there are things wrong in the educational sector too, but trust me, they pale into comparison next to the rot in finance.

@Ravi - Yes Diamond has fallen on his sword. And yes, the system of fixing LIBOR seems to be antiquated to the 13th century. But these are symptoms of the problem - I believe the financial sector is simply rotten and now poses a menace to society.

My prescription is

- A version of Glass Steagall to be enacted by every government
- Drastic pruning of derivatives , even at the cost of losing hedging capabilities. Most derivatives other than very plain vanilla ones to be made illegal
- Draconian oversight of financial players; to the extent nobody wants to get into finance (let loose Ramamritham on steroids)

sriram khe said...

Way, way, back--the late 1990s, I think it was--I went to listen to Ralph Nader. For a few minutes in his typical flat monotone through which he somehow projected emotions, Nader went on and on about derivatives. This was a little before the Enron debacle. I was clueless, because the only derivative I knew was from calculus! So, after his talk, I had to read a few simply to get an idea of what Nader was ranting about.

Anyway, a wonderful line that I read today--one of the best openers I have come across recently:

"A liger is a cross between a lion and a tiger. Libor, on the other hand,..."

While the commentary itself falls flat after such an opener, if you are interested, the complete commentary is here

sriram khe said...

Old age and forgetting things!
I forgot to include a link to Nader's commentary from four years ago:

Sandhya Sriram said...

there was a prediction that world will end in 2012 as per Mayan's calendar.

maybe, this is the way it ends.

thatz how extinction starts. we are heading towards extinction of basic human values. the next world be barbarian (we already have shown all the necessary traits). and here we go beginning of the end - i guess.

Ramesh said...

@sriram - Interesting commentary actually - that is if you are interested in that sort of stuff. While calling Ralph Nader an "extremist", the powers that be have allowed extremists on the other side of the spectrum a free reign.

@Sandhya - The Mayan calendar booohaha is of course much nonsense, but what you say about degradation of values is very true and frighteningly a precursor to descent into barbarism. Thankfully for everything rotten, we also see incredible humanness - prime example being you yourself.

Vishal said...

\\The best brains in the world go into finance.\\

well, what to say, best brain choose to jump into finance for sheer power of money... after some point of time, money making seems to be prime agenda for one and all and in doing so, who cares about risk management... I do empathize with your words..

Ramesh said...

@Vishal - There's nothing wrong with the lure of money, but does anybody have to sacrifice values along the way ??

sriram khe said...

Perhaps you watched Colbert :)

In case you didn't, here:

Ramesh said...

@sriram - Don't watch Colbert very often. Missed this, but will see it. Loved his idea of raising a Super PAC - that was simply brilliant.

Sriram Khé said...

I didn't forget your post on this when I watched this WSJ video report:

"The brokerage industry’s efforts to woo traders escalated from taking them to fancy dinners to sometimes providing them with cocaine and prostitutes to allegedly helping them manipulate a key global interest rate."

Ramesh said...

Completely flattered that you remembered such an old post, but the video you link to makes very depressing viewing. When it comes to money, does man let go of everything that is supposed to make him human ?

Follow by Email

Blog Archive

Featured from the archives