Three decades of banking rot

The 1980s hailed a hedonistic decade of insider trading at investment banks, the 1990s were all about rogue trading, now we have rate rigging. At the root of all of these is a twisted culture of greed.

The Libor rate-rigging scandal has continued to shock and baffle onlookers as it develops in the public eye and threatens to bring more of the world’s largest and most well respected banks into the fold. It raises a number of questions, namely: How did the banking sector sink so low? And what can we do to get off this deplorable path of destruction?

There are many aspects of the banking sector that can be criticised as contributing to the current crisis of culture. But I would like to focus on the changes that took place in the sector from the 1980s onwards, and the effect these had on the corporate culture of investment banking.

Up until the 1970s, banks were limited in their scope by strict regulations and laws that curtailed their actions. In Australia, the interest rates charged on loans and deposits were tightly controlled, as were foreign exchange transactions. The various functions of the banking industry were also separated. According to the Reserve Bank, "trading banks lent to businesses; savings banks lent to households, almost entirely for housing; and finance companies lent for more risky property loans and consumer credit."

This changed radically in the 1980s, when banking enjoyed widespread deregulation. In the US, the the Depository Institutions Deregulation and Monetary Control Act of 1980 was signed into law by President Jimmy Carter, paving the way for the phasing out of interest rate ceilings. The Garn-St. Germain Act of 1982 gave traditional mortgage lending institutions powers that allowed them to act more like banks, resulting in increased risk.

During the same decade, banks also began to exploit loopholes in the Glass-Steagall Act of 1933. Originally put in place to prevent institutions that dealt primarily in traditional banking activities from dealing in securities, the Glass-Steagall Act played a diminishing role through the decade, allowing traditional banks to branch out into investment banking.

In the UK, the Big Bang of 1986 virtually deregulated the banking sector overnight. The previously separated functions of stockbrokers, advisers and intermediaries could suddenly be held under one roof, allowing for the rise of investment banking in the City. With the deregulation of the City, bankers began looking to the short-term, rather than long-term, benefits of an investment. The culture changed radically overnight, as greed took over from the traditional reserve and spirit of the old boys' club.

Greed is good

Gordon Gekko said in the hit film Wall Street, "greed is good”. This short phrase quickly became the mantra of investment bankers in the 1980s. In the US and UK, the decade became synonymous with greed, excess and corruption. Bankers in the major financial hubs played with exorbitant amounts of money that swelled their lust for the hedonistic lifestyle they had grown accustomed to. Sound familiar? We’re now three decades on, but in the City and on Wall Street, Gekko would still be lauded among bankers. Greed, it seems, is still good.

With this greed came the rise of dubious activities in investment banking. Insider trading was the buzz phrase of the 1980s. The stars of insider trading during the decade were financier Michael Milken, and arbitrage specialist Ivan Boesky.

Michael Milken, the ‘junk bond king’ was a financier operating as head of the junk bond trading department at doomed investment bank Drexel Burnham Lambert in the 1980s. During the decade, arbitrager Ivan Boesky became a client of Drexel. He was investigated by the SEC for insider trading and eventually agreed to a plea bargain that saw him fined $100 million and jailed for 3.5 years. The plea bargain also saw Boesky give up Milken to the authorities. Boesky is believed to have been the inspiration for Michael Douglas’ character in Wall Street.

In 1989, Milken was indicted on 98 counts of racketeering and fraud. He pleaded guilty to securities fraud and was sentenced to ten years in prison. He also paid a $600 million settlement to the authorities and investors of Drexel. The prison sentence was eventually reduced to just 22 months.

The rise of the rogue trader

In the 1990s, insider trading took a back seat to rogue trading, at least in the eye of the public. Notable figures involved in rogue trading in the decade include Nick Leeson and Toshihide Iguchi.

Nick Leeson was a derivatives trader working in the Singapore office of Barings Bank, London’s oldest merchant bank. From 1992 to 1995, he made illegal unauthorised trades that eventually cost the bank $1.4 billion. Despite trading on the derivatives desk for the bank, Leeson was also head of settlement operations. In essence, this enabled him to continue the fraud through the life-cycle of the trade, by settling his own trades. His reckless trading resulted in the collapse of the 230 year old bank after an unsuccessful bailout attempt by the Bank of England.

Toshihide Iguchi is another stand-out example of a rogue trader operating in the 1990s. Over an 11-year period, beginning in 1984, Iguchi concealed losses at Daiwa Bank on the US Treasury bond market. By the time of his arrest, the losses incurred were $1.1 billion. Iguchi was fined $2.6 million and sentenced to four years in jail. For attempting to cover up the losses, Daiwa Bank was fined $340 million and ordered to cease all operations in the US.

The fall of the fat cat

So, will the 2000s be known as the decade of rate-rigging? The attempt by Barclays to manipulate Libor is arguably the largest fraud the banking sector has ever seen. The scandal has placed a black mark on one of the biggest investment banks in the world and threatens the reputation of a number of other major banks, including JP Morgan, Citigroup, Deutsche Bank and HSBC. And the full facts of the Libor scandal aren’t even known. We have only begun to scratch the surface on this market abuse. The fine that Barclays received may yet pale in comparison to what other banks could be forced to pay.

Even before this latest scandal, the public had grown weary of bankers. Since the global financial crisis, bankers have been viewed with a mixture of wariness and disgust. Today’s banker is often viewed like a cagey, manipulative animal. Never to be trusted, the calculating banker must be kept at a distance at all times.

It’s the culture, stupid

The problem with the banking sector is the culture that has been allowed to develop since deregulation began. Across the three decades discussed in this piece, greed is the common thread. Walk onto a trading floor in any of the major investment banks and the greed is palpable. The ruthless, pressurised environment allows for only the strong to survive. The cut-throat culture breeds fear and greed simultaneously as traders compete with each other to make the biggest profits with the most risk.

A twisted atmosphere that revels in excess and gluttony is the root of the problem. While more regulation should be welcomed in the sector, the rate-rigging scandal highlights more than anything else the failing of corporate culture at investment banks. The culture inherent in the industry needs a radical overhaul, and this must come from the top brass.

This is exactly why someone like Bob Diamond is a terrible fit to lead a bank like Barclays. There is no doubt that Diamond was a successful banker and businessman. But he is yesterday’s banker, consumed by greed and excess. In the aftermath of the global financial crisis, the City and Wall Street need a new breed of banker.

In the search for a new chief executive, Barclays needs to forget the status quo and look for a leader who is willing to begin the hard slog of eradicating the rotten corporate culture inherent in investment banking. Only then will we be able to have confidence in the industry again.