The sequel to the financial crisis is under way, and there are no prizes for guessing who has been cast in the role of villain.
It has been a very bad few weeks for banking. The walk of shame has included employees tarred as rate-manipulators (Barclays PLC), money launderers (HSBC Holdings PLC), rogue traders (JPMorgan Chase & Co.), and outright fraudsters (Peregrine Financial Group Inc.).
The drumbeat of controversy is far more than an image problem for the banking industry. Four years after the financial crisis began, the pile-up of bad behaviour is feeding a sense that something remains deeply awry inside banks, despite efforts by governments to reform them.
The scandals are setting the stage for a new round of banker bashing, especially in the U.S. as the campaign for the presidency heats up.
Bankers fear that regulators will also turn up the heat, and if further misconduct emerges, push for deeper changes. in the industry. In particular, the outcome of the sprawling probes into a benchmark interest rate will speak volumes about how wrongdoing gets punished in the post-crisis era.
Even for a public hardened to revelations of Wall Street misdeeds, the recent spate of scandals is a lot to absorb. One sign of the times: Eliot Spitzer, the former governor of New York, recently compared the industry to Penn State, the university where a culture of impunity shielded a child molester.
But don't take the word of the one-time Sheriff of Wall Street, who of course has had his own very public ethical lapses. Even finance's top executives are acknowledging how low their reputation has sunk. The furor over the manipulation of a key global interest rate "is once more undermining the integrity of a system that is already undermined substantially," Lloyd Blankfein, chief executive officer of Goldman Sachs Group Inc., said on Wednesday. "There was this huge hole to dig out of in terms of getting the trust back, and now it's just that much deeper."
The more benign interpretation is that the latest instances of misconduct are simply the airing of dirty laundry accumulated during the financial crisis. Most of the problems now surfacing, experts note, didn't start in the past year or two. What's more, regulators and authorities are under pressure to adopt a more aggressive tack when faced with possible wrongdoing.
The negative view is that one of the issues that has emerged – the manipulation of a global benchmark interest rate – strikes at the very heart of the capitalist system, even if the behaviour in question is several years old. The evidence so far shows that traders falsified their submissions to the survey that generates the London interbank offered rate, or Libor, which is in turn used to price trillions of dollars of financial products, from derivatives to mortgages to credit card loans.
They did so not only to make their banks look healthier in the depths of the crisis, but also to goose the trading profits of their friends and colleagues. As one beneficiary wrote in a grateful e-mail, "Dude. I owe you big time! Come over one day after work and I'm opening a bottle of Bollinger."
On Bay Street, the view tends to be that the latest scandals are primarily a problem for New York and London. The one Canadian bank that submits estimates for the Libor survey – Royal Bank of Canada – has said it did nothing wrong. It is part of the investigation by British authorities. Canada's Competition Bureau is probing the activities of six foreign banks as part of the broader inquiry.
But if the Canadian banking industry thinks it can insulate itself from the backlash – think again, says Michael King, a former senior economist at the Bank of Canada and the Bank of International Settlements in Basel, Switzerland, and now an assistant finance professor at the Richard Ivey School of Business at the University of Western Ontario. Mr. King says the fallout will inevitably tarnish the many "decent and hard-working" people in the financial sector. "But at the same time, at the pace this is going, it is hard to believe that there is such a thing as an honest banker any more."
The latest revelations are widening the already considerable chasm between Main Street and Wall Street. With the U.S. election fast approaching, the banks remain an irresistible political target, particularly for Democrats. A Gallup poll conducted last month showed that public confidence in U.S. banks had slipped to a 40-year low, and down by more than half from pre-recession levels.
"We believe the industry is one more shoe to drop away from major regulatory aggressiveness against the banks," Michael Mayo, an analyst at Credit Agricole Securities, wrote in a recent note to clients, citing the trading blunder that cost JPMorgan billions – a fiasco that came just as the U.S. presidential election campaign began to heat up.
Banking scandals are not new, of course, nor is distrust of bankers. Charles Geisst, a professor at Manhattan College and the author of a history of Wall Street, notes that some of today's rhetoric – that financiers are manipulators, that institutions don't care about the little guy – wouldn't be out of place in the outcry that followed panics in the 1870s and in 1929.
The difference, he says, is that in the past, people tended to attribute the successes or failures of banks and markets to the actions of individuals (Jay Gould, the financier at the centre of the 1873 panic, was viewed as a hero before crowds began marching up New York's Fifth Avenue saying they wanted to hang him).
Today the outrage "is more directed at the markets themselves," Mr. Geisst says. "People are starting to realize that these markets are a little corrupt."
The source of the problem depends on your perspective. One school says the explanation is culture: Banks have become places where actions are disconnected from consequences in a headlong race for profits. Another asserts the problem is size. Banks have grown so big they can't police themselves. Still another faults the timidity of regulators, or human nature itself, which produces bad apples, no matter the institution or its size.
The root of the issues plaguing banks "is the drive to validate insane, no-downside compensation schemes," says Thomas Caldwell, chairman and CEO of Caldwell Securities Ltd. in Toronto. "It's a sick environment."
Wall Street is well aware of the perils of public criticism and the threat of increased regulation. Lawyers who work closely with the biggest Wall Street banks say there is an effort under way by boards of directors to make sure that compensation rewards good behaviour because they know it is critical to the success of their business.
"People are a lot more attuned to risk and are focusing a lot more on the tone from the top," says H. Rodgin Cohen, a partner at Sullivan & Cromwell LLP in New York, who is considered the dean of Wall Street lawyers. "Compliance is going to be more closely observed and failure more harshly punished."
The Libor scandal promises to be a critical test case. Because it touches every region of the world and almost every corner of finance, it has the potential to become a legal nightmare for banks, not to mention a major enforcement challenge for regulators, who are under pressure to prove that banks are not too big to punish.
Banks are already reportedly discussing the possibility of a joint settlement to the numerous probes under way. Central bankers, meanwhile, are set to examine proposals to fix Libor in the fall.
Regulators know their reputation is also on the line. Even as they race to crack down on Libor-related problems, they are under fire for failing to stop them earlier. Financial authorities on both sides of the Atlantic were aware that something was wrong with Libor back in 2008, but took no forceful steps to correct it.
While regulatory bodies in the U.S. were handed new powers in the wake of the financial crisis, it remains to be seen whether they will wield them effectively. Regulators "not having adequate resources is what really worries the life out of me today," says Harvey Goldschmid, a former commissioner at the Securities and Exchange Commission.
Ramy Elitzur, professor of financial analysis at the University of Toronto's Rotman School of Management, is equally pessimistic, saying regulators typically come up with rules that deal with the last crisis, not the next. "Whenever you try to close a loophole, you have people figuring out what loopholes are still open."
The latest scandals show that cleaning up the excesses from the financial crisis – and earlier – remains an ongoing project. And some experts who focus on white-collar crime say that accountability for the financial sector's misdeeds remains sorely lacking.
"The wheels came off the bus a long time ago," said William Black, a law professor at the University of Missouri and a former regulator. "This thing has been careening downhill, screeching, sparks flying, for years."
Mr. Black says Barclays' behaviour in the Libor mess shares something with the problems at HSBC, which failed to check money laundering despite internal warnings. Both are cases where "bad ethics drives good ethics out of the marketplace," he said.
If that is allowed to continue, Mr. Black and critics like him say, it will lead to only one place. "For us, it's the next crisis."