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Finance’s Crisis of Legitimacy

From Project Syndicate by Simon Johnson:

The recent departure of Robert Diamond from Barclays marks a watershed. To be sure, CEOs of major banks have been forced out before. Chuck Prince lost his job at Citigroup over excessive risk-taking in the run-up to the financial crisis of 2008, and, more recently, Oswald Grübel of UBS was pushed out for failing to prevent unauthorized trading to the tune of $2.3 billion.

But Diamond was a banker supposedly at the top of his game. Barclays, it was claimed, had come through the 2008-2009 crisis without benefiting from government support. And, while his bank had been found in violation of various rules recently, including on products sold to consumers and on how it reported interest rates, Diamond had managed to distance himself from the damage.

Press reports indicate that regulators were willing to give Diamond a free pass – right up to the moment when a serious political backlash took hold. Diamond started to fight back, pointing an accusatory finger at the Bank of England. At that point, he had to go.

There are three broader lessons of Diamond’s demise at Barclays.

First, the political backlash was not from backbenchers or uninformed spectators on the margins of the mainstream. Top politicians from all parties in the United Kingdom were united in condemning Barclays’ actions, particularly with regard to its systemic cheating on the reporting of interest rates, exposed in the Libor scandal. (The London Interbank Offered Rate is a key benchmark for borrowing and lending around the world, including for the pricing of derivatives).

Indeed, Chancellor of the Exchequer George Osborne went so far as to say, “Fraud is a crime in ordinary business; why shouldn’t it be so in banking?” His clear implication is that fraud was committed at Barclays – a serious allegation from Britain’s finance minister.

After five years of global financial-sector scandals on a grand scale, patience is wearing thin. As Eduardo Porter of The New York Times put it,

“Bigger markets allow bigger frauds. Bigger companies, with more complex balance sheets, have more places to hide them. And banks, when they get big enough that no government will let them fail, have the biggest incentive of all.”

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