Amoral lessons from a Libor scandal

The Barclays scandal has again highlighted rife dishonesty among the globe's biggest banks and a closer look at the psychology behind stealing reveals its infectious nature.

Barclays was the first shoe to drop. So far, 20 banks have been named in investigations or lawsuits alleging that Libor was rigged, a total violation of trust and insider trading on a massive scale. As The Economist archly notes, the scandal corrodes "what little remains of public trust in banks and those who run them".

Now, you can bet that that Wall Street was doing the same thing. That includes the usual suspects – JPMorgan Chase, Goldman Sachs, Citigroup, and Bank of America. Every major bank participates in setting the Libor rate. Barclay's couldn't have manipulated it without their involvement. Not only that, the evidence suggests it had been going on for decades.

This raises the question of whether there is an infectious quality to cheating that can sweep through a sector. Did the dishonesty spread through the banking sector like a virus? The rule breaking seemed to become normalised for the participants. "Dude. I owe you big time!... I’m opening a bottle of Bollinger,” read the email from one Barclays trader to a colleague who had fiddled with the rate and improved the apparent profit of his derivatives book.

And is it just limited to banksters? Think of the wave of Wall street scandals at Enron, WorldCom, Tyco, Freddie Mac, Fannie Mae, Bristol Myers-Squibb, Halliburton and Bernard L Madoff Investment Securities.

Is the frequency of cheating increasing? Is the financial sector’s moral compass deteriorating? Or are improvements in compliance and detection of dishonest behaviour bringing the issue to light? And what do we do about it?

Some might suggest more jail sentences. Madoff was the only one in recent years who has received a significant jail sentence, 150 years. Maybe it’s because he stole from the one per cent. Still, harsher punishments and more stringent regulation might not be enough on its own to battle the irrational forces that drive dishonesty that we don’t yet fully understand.

A new book by social psychologist Dan Ariely, The (Honest) Truth About Dishonesty (Harper Collins, 2012) comes up with some alarming findings. The banking sector is not Robinson Crusoe. Most people are prone to cheating now and then. And there is an infectious quality to it, which explains why we are now seeing it in the banking sector.

Ariely contends that there are some rational forces which we think drive dishonest behaviour – doing a cost-benefit analysis of the benefit you get from the crime, the probability of getting caught and the expected punishment – which don’t. On the other hand, there are irrational forces which we think don’t drive it, but do. When you think about it, infidelity in a marriage or relationship would be the perfect example of cheating behaviour that does not emerge from a cost-benefit analysis and it often involves some level of lame self-justification.

Experiments conducted by Ariely, who teaches at Duke University’s Fuqua School of Business, found that people have this amazing cognitive flexibility to cheat only a little bit and come out viewing themselves as wonderful human beings. They convince themselves that if they only do it a bit, it’s not really cheating. Would it be legitimate to write off a portion of your car repair as business expense? If so, what amount would you feel comfortable with? What about that dinner? Where do you draw the line? Ariely calls it the "fudge factor”

This creates issues for managers who need to deal with dishonesty when it comes up every now and then. Isolating a few bad apples is not easy when there are so many around. Making sure people don’t have the right incentives to cheat does not help either. They don’t do it after doing a thorough cost benefit analysis and in any case, people always find ways to fudge.

Ariely found that dishonesty is indeed infectious. His experiments with students found that people are more likely to lie or steal if others in their group are doing it. If a member of another group, like someone from another university, is doing it, they won’t go along with it. "As long as we see other members of our own social groups behaving in ways that are outside the acceptable range, it’s likely that we too will recalibrate our own internal moral compass and adopt their behaviour as a model for own,’’ he writes. "And if the member of our in-group happens to be an authority figure – a parent, boss, teacher, or someone else we respect – chances are even higher that we’ll be dragged along.”

He says bankers are good examples of this when their peers and leaders start viewing fudging of the truth as appropriate behaviour. In one experiment, he found that students cheated more if they got paid not in cash but in tokens that could be redeemed for cash. Similarly, they were more likely to pinch six packs of Coca Cola than money placed on a plate. The fudge factor, he says, seems to increase when there is a psychological distance between a dishonest act and its consequences. As a result, it’s not drawing too long a bow to conclude that people are more likely to cheat when they use digital money rather than the folding stuff, or when they use financial instruments that few understand.

"From all the research I have done over the years, the idea that worries me the most is the more cashless society becomes, the more our moral compass slips,’’ Ariely writes. "If being one step removed from money can increase cheating to such a degree, just imagine what can become as we become as we become an increasingly cashless society. Could it be that stealing a credit card number is much less difficult from a moral perspective than stealing cash from someone’s wallet? … If being one step removed from money liberates people from moral shackles, what will happen as more and more banking is done online? What will happen to our personal and social morality as financial products become more obscure and less recognisably related to money (think, for example, about stock options, derivatives and credit default swaps).”

Ariely suggests a range of solutions, mostly about getting people to pull themselves into line if they find they are straying. Taking oaths and various secular versions of repentance might help bankers, corporate leaders, public servants and politicians control their behaviour but the problem remains that new technology and an increasingly cashless society will only exacerbate problems for the community and business people who have to manage dishonesty.

In that sense, the unfolding Libor scandal is only a reminder of what happens when stealing becomes an abstract activity, just quote a few wrong numbers and fake credit scores, and you can rip off institutions and people you’ve never met. That leaves plenty of scope for more research from the likes of Ariely.