The Derivative Project

Material Conflicts, Lack of Training, Lack of Transparency Are at Heart of Financial Crisis

Material Conflicts, Lack of Training, Lack of Transparency Are at Heart of Financial Crisis

Floyd Norris of the New York Times has a piece today on the Barclay’s “Libor scandal”, Banks Ability to Rig Libor Shows a Change is Needed.  The premise of the piece is excellent, however, Mr. Norris and The New York Times, continue to rely on a circle of sources for their reporting that are conflicted and/or poorly trained in today’s global capital markets, which as we all know has been devastating for millions of Americans.  Education of the American public as to the past and future roles of our global financial markets has never been more essential to our democracy.

Mr. Norris quotes Mr. Cofsky of Bridgewater and Associates.  
As Bridgewater’s website indicates, “Bridgewater manages approximately $120 billion in global investments for a wide array of institutional clients, including foreign governments and central banks, corporate and public pension funds, university endowments and charitable foundations. Approximately 1,200 people work at Bridgewater, which is based in Westport, Connecticut.”
Perhaps Mr. Norris misquoted Mr. Cofsky of Bridgewater, but it is apparent that a fundamental understanding of off shore currency markets is lacking based on Mr. Norris’ piece.  It is this fundamental lack of understanding and/or material conflicts by today’s major money managers of derivatives, offshore currency markets, and counter party credit risk, that contributed to the severity of the 2008-2009 financial crisis.  The implications of this misquote is magnified by the fact that this firm manages over $120 billion in global investments.
The evolution of the offshore currency markets and eurodollars can be researched in The Derivative Project’s Blog’s last post, beginning with a 1971 article by Milton Friedman.
Mr. Norris quotes Bridgewater:
“The funding model that European banks have relied on since the adoption of the euro is largely broken,” a report by Larry Cofsky of Bridgewater Associates, a sponsor of hedge funds, said this week. “The unsecured bank market outside very short maturities” of up to a week, he added, “is now largely by appointment,” and even secured funding is harder to obtain.”
It appears Bridgewater Associates is equating eurodollars and eurodollar time deposit “funding” with the currency the “euro”.  Once again, eurodollars are U.S. dollars deposited outside the United State and have nothing to do with the currency, “euro”.  It is correct that funding for European banks is tight right now, but this has nothing to do with Mr. Norris article where the subject is Libor and needed changes.
The Economist, July 7th edition, has an excellent piece, “The Rotten Heart of Finance” on Libor and Barclay’s that deals with conflicts of interest and lack of transparency.
Material Conflict of Interest

As the July 7, 2012 Economist states: “First, it is based on banks’ estimates, rather than the actual prices at which banks have lent to or borrowed from one another. “There is no reporting of transactions, no one really knows what’s going on in the market,” says a former senior trader closely involved in setting LIBOR at a large bank. “You have this vast overhang of financial instruments that hang their own fixes off a rate that doesn’t actually exist.”
A second problem is that those involved in setting the rates have often had every incentive to lie, since their banks stood to profit or lose money depending on the level at which LIBOR was set each day. Worse still, transparency in the mechanism of setting rates may well have exacerbated the tendency to lie, rather than suppressed it.”
Here is another clear example of how self-regulation in over-the-counter markets and lack of transparency are harming those dependent on derivative markets. 
Asset International reported on the Department of Justice’s lawsuit against BNY Mellon on
“Abu Dhabi, Dutch Pensions, SWFs ‘Defrauded’ Out of Millions on BNY Mellon FX Trades, Lawsuit Alleges.”
“The US Department of Justice has brought a case against BNY Mellon alleging it cheated customers on foreign exchange services, leading to revenues of more than $1.5 billion from some of the largest institutional investors worldwide. “
Once again, the issues regulators must address are (1) material conflicts of interest, (2) lack of transparency, and (3) more extensive training of today’s money managers in global capital markets, the role of eurocurrencies, offshore currency markets,  and their intersection with derivatives and foreign exchange.  
As the Asset International article states:
“Industry sources note that the Justice Department’s latest lawsuit over FX represents, similar to the Bernie Madoff scandal and the subprime mortgage crisis, what happens when an industry becomes too trusting — when a lack of transparency fosters a system with inadequate checks and balances.”
Unfortunately this quote is equally applicable to the state of our retail retirement advice market, where there is a lack of transparency, material conflicts of interest, self-regulation (FINRA) and an industry that has falsely advertised the concept of a “trusted adviser”, who in reality cannot be trusted and has minimal to no training in today’s global capital markets.
With proper training and elimination of material conflicts,  institutional and retail money managers can do the proper due diligence and ask the questions, which will not always stop fraud, but can help deter the movement of money into anything they do not understand and cannot explain to either the institutional or retail investor.