Phishing for Phools, LIBOR Scandal And More Begs The Question – Does Capitalism Lead To Fraud?

In David Enrich’s The Spider Network, an engaging chronicle of the London Interbank Offered Rate (LIBOR) interest rate-fixing scandal, employees of financial companies such as UBS, Citicorp, Deutsche Bank, HSBC, Rabobank, RBS, Barclays, and several brokerage firms conspire to move LIBOR and its offshoots by small amounts, for the sole purpose of benefiting derivatives traders who profited from the moves. The book implicitly raises a key question for the financial industry, indeed for the entirety of capitalism: Is there an ethical code that must be followed, apart from and beyond the requirements of the law; or is all that is necessary to be ethical merely to adhere to the law? The latter, many would agree, is a very dangerous idea – and therein lies the inescapable dilemma and challenge for capitalism.

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In Enrich’s book, attorneys for several of those accused of manipulating LIBOR make the following argument in their clients’ defense and against the prosecution’s case:

The crux of their defense was that the world the prosecution was describing to the jury – a world in which everyone was expected to play by the rules, where transparency mattered, where honesty and fair dealing were sacrosanct – was a fantasy. The financial industry was not a polite, rules-bound, ethical place; it was a no-holds-barred culture where brokers were actively encouraged to manipulate and lie to their clients.

Anyone familiar with the financial industry will know that at many, perhaps most financial institutions, indeed the most profitable ones, the no-holds-barred description of the culture fits better.

At firms like Goldman Sachs, products are designed with the sole purpose of increasing the information asymmetry between product sellers and clients – clients who were sometimes referred to as Muppets, that is, patsies, by Goldman Sachs employees. And the product designers and their sellers are richly rewarded for putting one over on their clients.

At Wells Fargo, pressure on employees to cross-sell new accounts to existing customers was so great that a subculture of employees who added new accounts and account features without customers’ knowledge – and charged them for it – became widespread and well-known within the bank.

At SAC, the hedge fund owned by Stephen A. Cohen, employees of which were convicted of insider trading, pressure to obtain special information about listed companies was so great that one employee could say that “he thought that trafficking in corporate secrets was part of his job description at SAC.”

And at UBS, Enrich says of Tom Hayes, the central character in his book:

He viewed his job as pushing things to the max to make money for his bank. That’s what good traders did – they ruthlessly hunted for tiny inefficiencies and loopholes they could exploit to gain a leg up on rivals or the broader market. Nobody ever told him it was inappropriate – legally, ethically, or otherwise – to lobby outsiders for help on LIBOR. What kept him up at night wasn’t that what he was doing was wrong. It was that he wasn’t doing it well enough.

…He viewed himself as operating within a closed system, facing off against other predatory professionals who were sufficiently sophisticated, and often avaricious, to deserve whatever they got. The perspective of the financial system as a playing field for these competitors, where amateurs were viewed as fair game if they were thought of at all, had been hammered into Hayes since he first set foot on a trading floor. It was a narrow, self-serving view, and its prevalence helped explain why the finance industry was heading for all sorts of trouble.

Two Nobelists in economics, George Akerlof and Robert Shiller, argue in their book “Phishing for Phools” that all of these results of capitalist competition should have been central to economic theory in the first place. In my review[i] of their book, I described their argument as “the exact same free-market process that Adam Smith lauded for doing a great job of satisfying mutual self-interests, also incentivizes scamming. It is not possible to separate the two; they must be part and parcel of the same economic theory.”

Read the full article here by Michael Edesess, Advisor Perspectives