Mon, Jul 23, 2012 - Page 9 News List

Rise of the financial leviathan — megabanks fight off reform

By Simon Johnson

The recent departure of Robert Diamond from Barclays marks a watershed. To be sure, CEOs of major banks have been forced out before. Chuck Prince lost his job at Citigroup over excessive risk-taking in the run-up to the financial crisis of 2008 and, more recently, Oswald Grubel of UBS was pushed out for failing to prevent unauthorized trading to the tune of US$2.3 billion.

However, Diamond was a banker supposedly at the top of his game. Barclays, it was claimed, had come through the 2008 to 2009 crisis without benefiting from UK government support. Also, while his bank had been found in violation of various rules recently, including on products sold to consumers and on how it reported interest rates, Diamond had managed to distance himself from the damage.

Press reports indicate that regulators were willing to give Diamond a free pass — right up to the moment when a serious political backlash took hold. Diamond started to fight back, pointing an accusatory finger at the Bank of England. At that point, he had to go.

LESSONS

There are three broader lessons of Diamond’s demise at Barclays.

First, the political backlash was not from backbenchers in parliament or uninformed spectators on the margins of the mainstream. Top politicians from all parties in the UK were united in condemning Barclays’ actions, particularly with regard to its systemic cheating on the reporting of interest rates, exposed in the LIBOR scandal. (The London Interbank Offered Rate is a key benchmark for borrowing and lending around the world, including for the pricing of derivatives).

Indeed, British Chancellor of the Exchequer George Osborne went so far as to say: “Fraud is a crime in ordinary business; why shouldn’t it be so in banking?”

His clear implication is that fraud was committed at Barclays — a serious allegation from the UK’s finance minister.

After five years of global financial sector scandals on a grand scale, patience is wearing thin. As Eduardo Porter of the New York Times put it: “Bigger markets allow bigger frauds. Bigger companies, with more complex balance sheets, have more places to hide them. And banks, when they get big enough that no government will let them fail, have the biggest incentive of all.”

Second, Diamond apparently thought that he could take on the UK establishment. His staff leaked the contents of a conversation he claimed to have had with Paul Tucker, a senior Bank of England official, suggesting that the central bank had told Barclays to report inaccurate interest rate numbers.

Diamond apparently forgot that the continued existence of any bank with a balance sheet that is large relative to its home economy — and its ability to earn a return for shareholders — depends entirely on maintaining a good relationship with regulators. Barclays has total assets of around US$2.5 trillion — roughly the size of the UK’s annual GDP — and is either the fifth or eighth-largest bank in the world, depending on how one measures balance sheets. Banks at this scale benefit from huge implicit government guarantees; this is what it means to be “too big to fail.”

Diamond apparently believed his own rhetoric — that he and his bank are critical to economic prosperity in the UK. The regulators called his bluff and forced him to resign. Barclays’ stock price rose slightly on the news.

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