Have a Sabra Liqueur on Us, Big Boy

Last week Barclays was fined $93 million, the largest fine ever levied on a British bank, for "deceitful manipulation" of financial rates. If it's happening in London, you can be sure it's happening in Tel Aviv too.

What is the interest rate today? How about the dollar-shekel exchange rate? What's Teva trading at? How about Check Point?

The answers to these questions are as precise and absolute as the temperature in this room. Right?

Think again.

When Yossi Average borrows money, makes a deposit or signs a contract, he assumes the figures are clearly defined and accepted by all parties to the deal. Yossi assumes that there is an underlying system that has some form of oversight and that the interest rate and the official dollar exchange rate are the true market values.

Yossi assumes that the numbers that were provided to him by the bank or a government body, like the Bank of Israel, are the correct ones. He doesn't doubt the veracity of these figures for a second.

But Yossi could be wrong, as we learned last week in the City of London, that center of global finance.

An investigation of market events dating from 2006 has revealed that at least one bank, Barclays, regularly provided the markets with false interest-rate quotes. These inaccurate rates were rigged by bank employees to suit market positions held by its trading operations and major clients.

Here is what happened.

The London Inter Bank Offered Rate of Interest is the most important interest rate used in the world's financial markets. LIBOR is written into almost every financial or commercial contract, and is set every day by calculating the average interest rate quotes offered by London's largest banks.

This is the interest rate banks use when they lend each other money, and for all intents and purposes it is the price of money, or roughly speaking, "the zero-risk rate of return," that is familiar to all economics and finance students.

The basic assumption underlying the widespread use of the LIBOR in commercial contracts was that British banks maintained a Chinese wall between the bank departments that supply "real" interest rate figures to the market and the banks' trading desk operations that make speculative gambles in the markets. This assumes great trust in the British banks.

Have a free one. On us

But it turns out that an email request and a promise of free drinks is sufficient to breach the Chinese wall. That is what was revealed in an investigation by British and American financial regulators who examined Barclays' employee email correspondence.

After sifting through the hundreds of emails that passed back and forth between major bank clients and Barclays employees, investigators found one in which the banker setting the LIBOR rate verified that the rate complied with the request of one of the bank's clients. "Done... for you, big boy," the email reads.

And what was the quid pro quo? It sounds like something taken out of a Wall Street movie. A half a year after the previously mentioned email and in the middle of another deal, the same client wrote to a Barclays banker who sets the dollar exchange rate that "If it comes in unchanged, I'm a dead man."

The banker responded by promising "to have a chat" with the necessary people and the subsequently published exchange rate was in fact lower than the previous day's rate. The client wrote back in response, "Dude. I owe you big time! Come over one day after work and I'm opening a bottle of Bollinger."

Following the findings, the British Financial Services Authority decided to levy a $93 million fine on Barclays, and that was 30 percent lower than the original fine because the bank had cooperated with the investigators. This was the largest fine ever paid in the United Kingdom.

Barclay stock, it bears noting, actually rose after the fine was announced: investors rejoiced that the cloud shadowing the bank had finally dissipated, and that the fine wasn't large enough to cause a serious dent in the bank's business.

Still, at the time this specific investigation concluded, the British public's rage had still only begun to boil.

The head of the opposition Labor Party, Ed Miliband, said at the end of last week that the banks are being led by a "corrupt elite" and suffer from "institutional corruption." He added that a real change in the culture of the City was necessary, including the passage of new legislation and prison sentences for illegal behavior.

"What has happened at Barclays is the unacceptable face of capitalism," said Miliband. He proceeded to demand the establishment of a committee to conduct a wide-ranging investigation into the culture and accepted practices in the British banking establishment.

These weren't just the fiery words of an opposition leader seeking to garner headlines. The criticism of Bank of England Governor Sir Mervyn King was just as scathing.

Barclays' behavior was nothing but "deceitful manipulation" that demands real "change in the culture" in the banking industry, said King.

The real deal: The bonus

Meanwhile, a technical but interesting discussion has begun to determine how best to set the global interest rate. One suggestion is to shift from a rate based on bank interest rate quotes to one based on the bank interest rates actually used in completed transactions so that there will be some kind of "market oversight" with respect to the rates offered by the banks.

There at least two lessons the Israeli public can learn from the Barclays banking scandal. The first is that asset prices and market rates aren't set in stone. They are numbers set by people with their own personal interests at stake. These bankers aren't thinking about justice or fairness when they set the published rates, just their own profits, bonuses and promotions.

This applies well beyond British bankers.

Israel's official dollar-shekel exchange rate, for example, is set in a manner very similar to the LIBOR. Although it is published by the Bank of Israel, a public body - the official exchange rate is actually calculated based on an average of the dollar-shekel exchange rate quotes offered by Israel's major banks.

On any given day each of these banks holds market positions that rise or fall as a result of the exchange rate published by the Bank of Israel.

Be not proud, Israel

In Israel, too, there have already been more than a few trading days when the rate quotes the banks forward to the Bank of Israel didn't accurately reflect the dollar's value in the foreign exchange market (the rates at which actual foreign exchange transactions were concluded between the banks and their clients).

Manipulation also happens in international interest rates, currency exchange rates in Israel and abroad, and certainly in equities. There isn't a day that asset prices aren't being manipulated toward the closing on the Tel Aviv Stock Exchange.

On the TASE, you don't even need to buy anyone a bottle of champagne. Stock buy orders worth tens of thousands of shekels, and sometimes even smaller amounts, issued during the last moments of trading cause a spike in a stock or corporate bond. The upshot is a share price with the most tenuous of links to its true value.

The upshot is that plenty of price quotes are routinely distorted because someone benefits from it greatly.

If we were to adopt the choice phrasing of the British Labor Party leader, the price of various financial assets is often deliberately chosen because it suits the needs of a "corrupt elite."

The second conclusion is that if conservative Great Britain is raising the alarm, calling for an in-depth examination of the culture, ethos, interests and salaries of its own banking establishment, one can only assume that such an investigation is necessary in Israel as well.

Why? Because the Israeli financial system always gazes longingly both in admiration and in envy of its sister banking establishments in London and New York and almost always attempts to adopt their business practices and culture.

Blessed incompetence

However, the Israeli financial system doesn't always succeed in its efforts to emulate more veteran establishments.

On one hand, Israeli banks did not rush headlong into adopting the creative and aggressive trading practices employed at major world financial centers, which spared the local banks the massive losses and writeoffs that hit the world's big banks.

On the flip side, Israel's banks never adopted the flexible employment practices or operational efficiency that characterizes their peers abroad. Now the banks are bloated with staff, costing a fortune to maintain.

What they did emulate are the sky-high high salaries and more or less the fundamental assumption that banks belong to their owners and a handful of senior bank executives – and, therefore, almost anything goes for the sake of profit.

This is a false premise. For in addition to their controlling shareholders and senior executives, banks have a fiduciary duty towards their depositors and clientele, service providers, the state, the surrounding business ecosystem and towards the markets and the wider public. For today it is clear that negligence on the part of one bank can bring the entire financial and economic system to the brink of collapse.

These are the questions that needed to be asked in Israel. This should be the focus of a local inquiry, needed not only because of Israeli domestic concerns, but also in response to the scandals and crashes that have engulfed Wall Street, the City of London and Europe's financial centers that we so long to emulate.