We'll know we've hit dead bottom when there's no more surprise or shock. So, reactions to Libor revelations show we're nowhere near bottom yet.
The Libor scandal is unsurprising, in fact inevitable, resulting from four powerful causes: London, self-regulation, control by big banks and dream world "data." Let's defang all four of them.
First, London. According to Bloomberg News, banks have formed 10,000 subsidiaries in order to benefit, among other things, from laxer regulation. London is the preferred destination if you want less regulation. That's most likely why JPMorgan Chase's chief investment office is in London. Competition in regulatory laxity is another manifestation of the accelerating race to the bottom.
Let's subject everything owned or controlled by a U.S. bank or bank holding company, worldwide, to the full rigor of U.S. regulation — at the bank's expense. It beggars imagination to hear Treasury Secretary Timothy Geithner say that merely reporting Barclays to the Bank of England was enough.
Don't rely on foreign regulators. If you allowed a U.S. bank to have a Spanish subsidiary that was regulated by the Spanish and performed like a Spanish bank, it wouldn't survive. Ditto for a German subsidiary that German regulators encouraged to load up on Greek bonds.
Every U.S.-based entity's entire worldwide network should meet all U.S. requirements — as well as those of any foreign hosts.
A second reason Libor self-destructed is self-regulation — which has been a Swiss cheese of ineffectiveness since the '30s. That's what gave us the National Futures Association, supposedly policing Peregrine and 55,000 industry employees. How about the International Swaps and Derivatives Association? A "default" (like the Libor rate) is defined by polling of the heavy hitters — 80% required! — not by facts. Then, there is the British Bankers' Association, toothless guardian of Libor.
There's a better alternative. If we freed the CFTC from the congressional appropriations process, as we've done for the CFPB, then the CFTC could make the industry pay for its own regulation, which is only fair — and the agency could afford to regulate effectively without relying on subordinate self-regulators. Same for the SEC. Otherwise, blame Congress and ultimately the voters for preventing effective regulation by refusing to appropriate the necessary funds.
Self-regulatory organizations vindicate the interests of the regulated, not the public interest. How could the BBA be an exception?
Third, if big banks collectively provide all the inputs determining Libor, without independent verification or appeal, then these banks will collectively set Libor for their own best advantage. Does it take an MBA to figure that out? Or maybe a Ph.D. in statistics tuned to top and bottom 25 percentiles? A law degree?
Finally, and most important, the inputs from banks that entirely determine Libor aren't even supposed to be facts. They are nebulous fantasies, hopes or, if you're a Pollyanna, guesswork. We're pricing many trillions of dollars of real transactions on the basis of a few imagined transactions. A practice so obviously idiotic persists only because banks benefit from and impose it.
So the big banks control Libor absolutely — through supinely regulated London; through the BBA, their alter ego; through providing all the inputs and through the elastic, virtual-reality input definitions that give them so much latitude to optimize.