Lies, Damn Lies and LIBOR Author: London Banker · July 10th, 2012 I’ve been hesitant to write about the LIBOR scandal because what I want to say goes so much further. We now know that Barclays and other major global banks have been manipulating the calculation of LIBOR through the quotation data they provided to the British Bankers Association. What I suspect is that this is not a flaw but a feature of modern financial markets. And if it was happening in LIBOR for between 5 and 15 years, then the business model has been profitably replicated to many other quotation-based reference prices. Price discovery is not a sexy function of markets, but it is critical to the efficient allocation of scarce capital and resources, and to the preservation of the long term wealth of investors and the economy as a whole. If price discovery is compromised by manipulation, then we will all be gradually impoverished and the economy will be imbalanced and unstable. Over the past 25 years the forces of regulatory liberalisation and demutualisation of markets have allowed the largest global banks to set the rules, processes and infrastructure of global markets to their own self-interested requirements. Regulatory complexity and harmonisation benefit the biggest banks disproportionately, eroding the competitive stance of smaller, local banks and market participants. This has led to a very high degree of concentration in a very few banks in most markets that determine global reference rates for interest rates, currencies, commodities and investments. If those few collude with each other – as Adam Smith warned was always the result – then they impoverish us all. We have allowed markets to evolve in ways that make supervision of markets almost impossible. Many instruments trade off-exchange or in multiple venues, making it nearly impossible for any single investor or regulator to supervise trading to prevent or detect manipulation or abuse. Many financial instruments are now synthetic compilations of underlying assets and derivatives, with multiple pricing components determined by reference to other prices or rates. Demutualisation and regualtory reforms stripped exchanges of the self-regulating interest in preventing manipulation and abuse by their members as mergers, profits and market share came to dominate governance objectives. Off-exchange trading has been allowed to proliferate, creating massive ill-transparent and largely illiquid markets in almost every sector of finance. Pricing in these markets is based around calculated reference rates which, like LIBOR, are open to abusive quotation and data input practices. Many OTC derivatives are priced and margined using reference rates calculated against quotations unrelated to actual reported transactions. Synthetic securities such as ETFs are another example of an instrument that prices off a reference rate rather than the actual contents of an underlying asset portfolio. These instruments are open to consistent abusive pricing as a means of incrementally impoverishing those market participants who are the krill on which the global banks thrive. How has it been possible for banks to grow from less than 4 per cent of the global economy to more than 12 per cent of the global economy without impoverishing others? How has it been possible for profits in the financial sector to be consistently higher than profits from other human endeavors with more tangible products or impacts on our daily lives – such as agriculture, transport, health care or utilities? How has it been possible that banks derive their profits not from the protected and regulated activities of deposit-taking and lending, but from the unsupervised and often unknowable escalation of off-balance sheet assets and liabilities? How has it been possible that pension savings have increased while pension returns have declined to the point where only bankers can expect a comfortable old age? Global banks have built the casinos and tilted the odds in the house’s favour by rigging the data that determines the outcomes of most of the bets on the table. Every one of us that sits at the table long enough – whether saver, investor, borrower, taxpayer or pensioner – will be a loser. It is not a flaw; it is feature. There is a reason that financial infrastructure used to be dominated by mutuals. Mutual gain and mutual liability created a natural discipline on excess and on rogue elements that would impoverish their peers. There is a reason why trading was restricted to exchanges, and exchanges and clearing houses used to be self-regulating, and even had responsibility for resolution and liquidation of their members. Direct responsibility, authority and financial control meant that they could exert very powerful and immediate consequences on those members identified as abusing the market or investors. The investigations into market rigging are just beginning. Paul Tucker opened the box yesterday when he admitted that he could not know whether the abuses discovered in setting LIBOR had spread to other synthetically calculated reference rates. As events unfold, it may be that we begin to appreciate just how deeply vulnerable we have become to predation by bankers with no stake in a local economy or in the local quality of life of the people they impoverish. A reckoning is needed, and then a rebalancing toward more local and mutual provision of essential services and market infrastructure that servers markets rather than those few bankers on the board. As a start, regulators should consider punitive restrictions on the sale of instruments which price on reference rates unrelated to reported market transactions or underlying asset portfolios. Pricing should reflect real market transactions rather than guesstimates talking the banker’s book. We need to rethink as a society what banks are for, what exchanges are for, and what clearing houses are for. If they are for the profit of the few at the expense of the many now, that is because it is the business model we have permitted. If banks, markets and clearing are protected because they have a social function, we should make certain that social function is adding value. If it isn’t, then we need some new models and some new rules. This post originally appeared at London Banker and is posted from EconoMonitor weblistigns.

The Death of Capital, by Michael Lewitt Michael E Lewitt is that rarest of birds, an honest and public spirited Wall Street fund manager, and this book is his attempt to make sense of what happened in the 2008 financial crisis, and outline some steps to prevent it happening again. The Death of Capital might seem like an ominous title, but Lewitt’s logic is that money is only worth anything if it is moving. In 2008 it stopped moving – those that needed it couldn’t get it, those that had it weren’t sharing. Despite poking it with the pointy stick of government intervention, capital did not respond. To all intents and purposes, it was dead. It died for two main reasons. First, because too much money was being pumped into speculation rather than productive enterprise; and second, because we insist on believing that markets are rational, despite all the evidence to the contrary. Add in a move towards ever greater secrecy, a relaxed attitude to debt, and stubbornly pro-cyclical government policy, and finance was a disaster waiting to happen. In some ways that disaster is a good thing, because it forces us to confront the underlying problems of the financial sector as it is currently configured. It gives us the opportunity to fix it.“The growth of finance has contributed to a deeply unfortunate trend in Western societies,” writes Lewitt, “in which an incalculable amount of brain power and economic power are devoted to activities that do not contribute to the productive capacity of the global economy or to the improvement of the human condition.” Finance was never meant to be an end in itself, it’s meant to resource business and development. To analyse where things have gone wrong, the book re-reads four important thinkers who understood how markets function. From Adam Smith we are reminded that all markets are made up of relationships. From Marx we see how capital is a process, not a thing – it is a moving, fluid process, inherently unstable. Important psychological lessons are drawn from Keynes, who understood the herd mentality and recognised that “the primary objective of investors is not to determine the fundamental value of an investment; rather, it is to determine what other investors think the value is.” Hyman Minsky is less well known, but has been rediscovered post-crash. His work shows that every bubble is essentially a ponzi scheme, and he unashamedly dismisses much modern banking as ‘ponzi finance’. On these foundations of the market as a network of human relationships, prone to emotional swings and far from rational, Lewitt offers some suggestions for making it more stable. These can be summarised in six headings, which bear repeating here: Taxing speculation Creating a unified regulator Addressing ‘too big to fail’ Improving capital adequacy Reforming monetary policy Improving transparency I won’t go into all the details of these, but it’s a compelling argument for common sense and honesty. There are excellent chapters on debt, and some useful explanations of how derivatives work, or rather why they don’t work. And there’s an underlying plea for socially productive and fair banking, an end to a system that “socializes risk and privatizes reward.” His honesty is also refreshing. The book discusses lobbyists and the huge obstacles to reform, and claims there are good reasons to tax speculation. “As someone who has worked in these markets for two decades, I can assure readers that Wall Street arguments to the contrary are both self-serving and false.” The book is not without its flaws. Lewiit admits the possibility of climate change and resource depletion, but only in passing, in a box entitled ‘future black swans?’ Since a black swan is a low-probability high-impact even, the answer to Lewitt’s question is no, these are not future black swans. They are high-probability, extremely obvious high-impact events, and sooner or later they will rock his investment business if he treats them as anything less. In that sense the book lacks the bigger picture thinking and would build a truly sustainable financial system. However, those oversights needn’t detract from what is an excellent book in its own field. We will need finance going forward, the productive kind that raises capital for business. We’ll need it to fund the radical changes that climate change and resource depletion demand. If it is run by people like Michael Lewitt, we’d be able to have a lot more confidence in its fairness and stability.

Half of SC/ST teaching posts unfilled in Central varsities Rahi Gaikwad From The Hindu.com July 2nd 2012 In the filled slots, SCs constitute just 12% against the stipulated 15% and STs 5% instead of 7.5% Among the ills that plague the Indian higher education system is the continued poor stake of the Scheduled Castes and Scheduled Tribes in it. Year on year, the huge backlog of vacancies in teaching positions in SC/ST categories remains a constant concern with little change in its position. Nearly half the teaching positions for SCs and STs in Central Universities are still unfilled. According to the data provided by the government of India in December 2011 to a Right to Information query by Lucknow-based activist Mahendra Pratap Singh, 48.5 per cent of posts in these two categories in 24 Central varsities were vacant during 2010-2011. The stipulated quota for SCs and STs in Central institutions is 15 per cent and 7.5 per cent respectively. For the year, 2010-211, the total backlog in SC category at the entry-level position of Lecturer was 341 out of 740 required posts. Thus, 46 per cent of these posts were unfilled. In the ST category, 197 or 53 per cent of posts were vacant out of the required posts of 369. Under-representation The huge gap points to the under-representation of these marginalised communities in educational institutions. The SCs constitute 12 per cent of the total filled positions in Central Universities and STs constitute five per cent of the filled posts. Climbing up to the prestigious ranks of Reader and Professor, their share gets alarmingly dismal. Over 84 per cent of posts for Readers in the SC-ST category were vacant in 2010-2011. And, over 92 per cent Professor’s positions in these categories are vacant. The Banaras Hindu University (BHU) has consistently had the poorest record of clearing the backlog. There was a whopping 59.7 per cent of SC and ST vacancies in lecturer positions itself in 2010-2011. A BHU source confirmed the situation remained the same in 2012 as well, since the University had not undertaken a recruitment drive in the past few months to clear this backlog. In fact, the current position is as bad if not worse, compared to previous years. As per the 2007-08 figures, obtained by The Hindu under RTI, SC-ST vacancy in BHU for the lecturer position was at 52 per cent. “The problem,” remarked Subhash Lakhotia, Professor Emeritus at BHU, “is that candidates are often not found suitable.” — a reason cited across the board for poor implementation of the reservation policy. “The university has to consider certain minimal requirement. Many teaching positions are for specialised candidates. The quality of degrees our education system gives is not [of a very high standard]. So, although candidates meet the eligibility criteria, they are not found suitable. A large number of open posts are also vacant,” Mr. Lakhotia told The Hindu on the phone. “The fallacy lies in the system. The graduates coming out today are unemployable,” he pointed out. The overall concerns over standards notwithstanding, the approach to implementation of reservation is complicated by a notional linking of the reservation policy with impoverishment of “quality” of education. “I would not like reservation anywhere. Higher education is about quality. The government says launch a special drive to fill posts; it is in their interest. But in the process you lose out on quality,” remarked Mr. Lakhotia. “Reservation has made things worse,” remarked a source from BHU. “You don’t get quality people. SC/ST candidates are competent. The ones from Maharashtra and the northeast are good. Tezpur University is doing very well. That’s because their graduates return to their native place.” Another reason cited by BHU was the increase in the retirement age to 65 years (as per 2006 UGC recommendations). “For some years, no one retired and then there were mass retirements creating a sudden vacancy. In Banaras, availability of housing and other facilities is a major problem. So no one wants to take up jobs here,” an official remarked. Making matters worse, the quota policy itself is looked upon as a benevolent act towards the lower sections, rather than an affirmative and necessary provision to ensure the fair share of SCs and STs in education, long denied due to the caste system. “Let me point out,” said a BHU professor in a letter to the BHU Vice-Chancellor, obtained through RTI by Mr. Singh, “that we are aware of our social responsibilities and compulsions which implies some reservation to be done for [the] weaker section.” Arguing for “phased reservation,” he wrote that the university must ensure that “the weaker sections get advantage at the entry level through phased reservation, but at the same time the academic profile/glamour/reputation of the university remains intact.” ‘Centre of excellence’ One argument put forth by the BHU is also that it is considered a “centre of excellence.” Therefore, it should be excluded from the reservation policy. Dr. Vikas Gupta from the Delhi University said that filling posts roster-wise would help ease the backlog. That entailed marking posts in departments as per each category and so on. “Roster implementation takes care of many of the [gaps] in filling reserved posts. Every department has to maintain a roster of posts to ensure full reservation and avoid manipulation. Rosters should be made public by all universities.” According to Mr. Gupta, earlier universities in their advertisements would mention only the number of reserved posts without specifying which post was for which community — SC/ST/OBC. So, a candidate did not know which post she/he was applying for. This way, universities “got the free ground to keep people confused.” Everyone is applying for everything. After the interview, the decision is made [on selection for a particular department post]. “This is unfair. This is how it is manipulated,” Mr. Gupta said. He remarked the situation was changing with universities going in for the roster system. Despite, repeated attempts, the University Grants Commission did not respond to The Hindu’s queries on the issue.