This past Wednesday was the five year anniversary of the arrest of Bernie Madoff; the disgraced financier who alone carried out the largest financial fraud in American history. The official numbers top out somewhere around the 50 billion dollar mark, with 11 federal felonies including: securities fraud, wire fraud, and money laundering.
Bernie Madoff's arrest in December of 2008 was perhaps the high, 'low' point of the financial collapse. After the late summer and fall of that year Americans were inundated with complicated explanations as to what had happened to their mortgages, 401ks and economic future. What they were left with were news outlets trying to explain credit default swaps, and collateralized debt obligations in the simplest of animated videos. The reality was that not even the CEO's of these banks really knew what was going on. So when Bernie Madoff was filmed being taken away in handcuffs because of a good old fashioned Ponzi scheme, the media felt like they really had something they could sink their teeth into.
The Ponzi scheme after all has a rather nostalgic feel to it, similar in vein to images of 'The Great Train Robbery', or the image of Edward G. Robinson as a street tough gangster. The Ponzi scheme resonates with the American public because of its episodic nature. Rather than diagraming out how your mortgage got packaged with other mortgages, and then valued on a derivatives market, which was then sold to a financial institution on the NIKKEI Exchange while you were sleeping. The historical context of the Ponzi scheme is of one gunslinger moving all his chips in and daring another to call his bluff.
Standing in stark contrast to the personalized human interest of a Ponzi Scheme is the massive 'to big to deal' Libor scandal. Ironically last week it was announced that six major banks agreed to pay out a total of $2.3 billion to the European Commission. Those banks include Deutsche Bank, Royal Bank of Scotland and Citigroup, among others; by paying out the penalties those banks essentially confess to collusion, and price fixing the borrowing rates. The ongoing investigation into this scandal does not seem to be going away as hearings are currently going on in Europe, Japan, and the United States. Yet the story itself remains couched nicely in the business section of the news, just out of the middle-class's radar. The reasons for this may be conspiratorial in nature, or may have more to do with human psychology than anything else. The reason being that the details of the Libor Scandal are so vast and overwhelming, it may be difficult to maintain viewer interest.
Consider for a second Tiananmen Square, located in the Chinese capital of Beijing, the square is the very heart of Communist China. After Communist leader Mao Zedong overthrew the KMT Party Tiananmen Square became the archetype for communism. It is by design that when someone goes there they can't help but be overwhelmed by the size of it as a reminder of the insignificance of the individual against the state. In some way this how the Libor scandal compared to Bernie Madoff and his Ponzi scheme.
One thing these two stories do share in common is that it is the collapse of 08' which led to both downfalls. In the case of Madoff it was simply a case of his clients needing to cash out their holding for actual liquidity. In case you haven't figured it out yet, a client cashing out is krypton to a Ponzie scheme, it's the one and only thing Madoff needed to be wary of. As for the banks involved with Libor, when the housing market was imploding, everyone was in a mad scramble to figure out what was going on. The people involved were not only the bankers, quants, and hedge fund managers, but also, the SEC, federal regulators, and congress attempting to untangle the toxic assets from the AAA rated assets. Without getting too complicated, regulators looked at the comparison of rates between what banks would charge for or against other banks on 'exotic' trading instruments (aka credit default swaps), what they found was a discrepancy that was too low to not have been manipulated.
So what does any of this mean, and why is this bad? The scandal itself boils down to the majority of the major world banks engaging in collusion to manipulate the borrowing rates. The reason for the manipulation was to compensate for toxic assets that were weakening banks' balance sheets, which in-turn discouraged investment. However, with artificially lowered rates, liquidity from investment would offset the difference.
So why is this scandal bigger than Bernie Madoff? Well first of all, as insane as it sounds, the $50 billion dollars Bernie came away with is nothing compared to the trillions that the world banking system has tied up in pension funds, local governmental agencies, municipalities, etc. So at a time when people literally were losing their houses, the banks were undercutting the rates in order to benefit themselves, but in turn costing middle class people all over the world billions of dollars in savings, pension funds and public services.
"So when Libor is lower than it should be, all these holding institutions, they earn less. So that means your town, your city, your pension, your union, all makes less money when these guys drive the cost of LIBOR down. For it to come out that the (Federal Government wanted that to happen is incredible). …They (the cities/municipalities) start cutting services, and that further impacts their general bottom line. When the balance sheets of these municipalities and town goes down, it further impacts their ability to borrow, which further increases their borrowing costs."
Authorities around the world have so far handed down a total of $3.7 billion in fines to UBS, RBS, Barclays, Rabobank and ICAP for manipulating rates, while seven individuals face criminal charges.
Although litigation in the Libor scandal is far from over, it remains to be seen whether any major players will face jail time. There have been many resignations including Rabobank chairman Piet Moerland, and Barclays CEO Bob Diamond. Bob Diamond remains an interesting piece to this whole puzzle because A. after resigning, he immediately got back into the banking game in Africa, and B. allegedly the Barclays CEO was reluctant to engage in the fraudulent practices, until he was coerced by the Bank of England (British Government). Which brings up a disturbing aspect to both of these stories. In the Bernie Madoff story there are multiple times when the SEC was alerted by former employee Harry Markopolos that he was running a Ponzi scheme, only to have the SEC turn the investigation around on him. In the case of Libor not only were the majority of banks colluding to fix the rates, but the British Government was encouraging this practice. The disturbing factor here is that both of these crimes come at the expense of the civilian tax payer, with little evidence that any government is in their corner until it's too late.