World View: Libor-Rigging Scandal, Lying on Wall Street

This morning’s key headlines from

  • Dept. of Justice announces civil lawsuit against S&P ratings
  • Royal Bank of Scotland fined $612 million for Libor-rigging
  • The moral bankruptcy of Libor-rigging traders
  • Ron Baron, Baron Capital, doubles down on lying about stock valuations

Dept. of Justice announces civil lawsuit against S&P ratings

Results of investment-grade subprime mortgage-backed securities issued in 2005-2007 (Bloomberg)

Results of investment-grade subprime mortgage-backed securities issued in 2005-2007 (Bloomberg)

As we’ve been saying for a long time, the Obama administration has
adamantly refused to even investigate, let alone prosecute, American
bankers for the financial crisis, even where there’s massive evidence
of fraud. (See “Financial Crisis Inquiry hearings provide ‘smoking gun’ evidence of widespread criminal fraud” from 2010.) I’ve described two reasons for
this: One is that Generation-Xers, having had bad experiences with the
criminal justice system in the 1980s, are unwilling to prosecute other
Gen-Xers; the second is that the Obama administration benefited
greatly through criminal activities of bankers because of campaign

Now the tide seems to be turning. It’s becoming overwhelmingly clear
that the crimes of Gen-Xers were so egregious that blaming Boomers no
longer makes sense in many cases. And the presidential campaign is
over, so there’ll be no more political contributions for a while

On Wednesday, the Justice Dept. filed a civil lawsuit charging
Standard & Poors Financial Services with effectively colluding with
banks to give invalid AAA ratings to synthetic securities backed by
subprime mortgages. According to e-mail messages, S&P knew as early
as 2004 that their models were wrong, but they kept the invalid models
anyway so that they could continue issuing AAA ratings. (See
“A primer on financial engineering and structured finance” from 2008.)

The result of this fraud was disastrous, as shown by the chart above,
which shows the default rate of investment grade subprime
mortgage-backed securities issued in 2005-2007. AAA rated securities
were downgraded (equivalent to a default) 80% of the time, even though
the ratings models assume that an AAA default rate of less than 0.1%.
Even BBB rated securities are supposed to downgrade or default only 1%
of the time, but 100% of them failed. USA Today and Dept. of Justice and Text of lawsuit (PDF)

Royal Bank of Scotland fined $612 million for Libor-rigging

Libor (London Interbank Offered Rate) is the benchmark interest rate
used in the pricing of some 1/3 of $1 quadrillion in financial
instruments worldwide, so even a small change in the Libor rate can
affect trillion of dollars in securities. There are about 20 banks in
Europe and N. America that compare rates every day to come up with the
Libor index for that day. What was revealed last year was that
bankers at Barclays were purposely rigging Libor rates in order to
control the values of securities that they bought and sold, in order
to make vast profits. The bankers setting Libor rates at the 20 banks
knew each other and did favors for each other — raising or lowering
Libor rates by small amounts so that they could all profit — in
what is being called the biggest financial fraud of all time.

For example, an e-mail message from one UBS to a trader in 2008

“I need you to keep it [Libor] as low as possible. If
you do that … I’ll pay you, you know, $50,000, $100,000 …
whatever you want … I’m a man of my word.”

According to former Fed Chairman Alan Greenspan:

“Through all of my experience, what I never
contemplated was that there were bankers who would purposely
misrepresent facts to banking authorities. You were honor bound
to report accurately, and it never entered my mind that, aside
from a fringe element, it would be otherwise. I was

Greenspan is part of the Silent generation that survived the Great
Depression and World War II. The reason that he was wrong is because
he never dreamed that Generation-X would be so much more lacking
in ethics and morals than his own generation.

On Wednesday, the Royal Bank of Scotland (RBS) was fined $612 million
for “widespread misconduct” in the same Libor scandal. One RBS
employee jokingly texted: “I’m like a whores’ drawers. I’ll send
lunch around for everybody.” The RBS traders were so stupid that they
continued rigging Libor even after the investigation had started.
Guardian (London) and Bloomberg

The moral bankruptcy of Libor-rigging traders

The stupidity, depravity and debauchery of the Libor-rigging traders
is so egregious, that the public may actually be catching on to what
happened. According to the Economist:

“They were said to be among the most talented of their
generation, recruited after exhaustive interviews and grueling
internships. They worked at firms prepared to spend small fortunes
to attract and retain them lest they take their skills
elsewhere. Yet the moral bankruptcy of traders implicated in the
rigging of the London Interbank Offered Rate (LIBOR), one of the
world’s most important interest rates, is matched only by the
incompetence with which they covered their tracks.

Take traders at the Royal Bank of Scotland (RBS), who left a trail
of evidence in a trove of e-mails and audio recordings detailing
how they set about trying to manipulate LIBOR, even after they
knew investigators were looking into the issue. “We’re just not
allowed to have those conversations over Bloomberg anymore,” said
one trader, laughingly, in a call to another who a little earlier
had asked in writing for a rigged rate. “Its [sic] just amazing
how libor fixing can make you that much money,” was the verdict of
another trader. …

The scandal has also hardened the views of regulators and

If the views of regulators and politicians are really becoming
“hardened,” then we can expect to see a lot more investigations and
prosecutions. The Economist

Ron Baron, Baron Capital, doubles down on lying about stock valuations

Ron Baron, Baron Capital (CNBC)

Ron Baron, Baron Capital (CNBC)

The Libor-rigging scandal is only a small part of the sickness that’s
controlling Washington and Wall Street. Lying and fraud are the norm.
I’ve repeated named names of so-called “experts” who lie openly about
stock valuations. (See, for example, “14-Apr-12 World View — Wharton School’s Jeremy Siegel is lying about stock valuations” from earlier this year.) In today’s
world, respectable people are gangsters, and gangsters are treated as
respectable people. One of those people whom I quoted lying was Ron Baron, chairman and CEO of
Baron Capital. That was about a year ago.

Well, this week Baron was back on CNBC leaving me breathless
as he blurted one ridiculous statement after another. Here’s
what he said (my transcription):

“14,000 is where we were in the Dow Jones [Industrial
Average] in 2007, so it’s been flat for five years. If you go
back further than that to 1999, you’ll see that for the last 13
years, it happens to be the worst period in the financial history
of the united states. The market is up 20-30%, companies have
gone up in earnings 2 1/2 times. the reason that has happened was
because we started off in 1999 at 32 times earnings, we’re now at
13 times earnings. So if you go back 100 years, 200 years, 50
years, the stock market normally trades between 10 and 20 times
[earnings], and the median is 15 1/2. You’re now 13, it was 32 –
that’s the highest it’s ever been. So the market is now at an
attractive level, compared to its median for a very long period of
time. …

We’ve been through civil wars, we’ve been through world wars,
we’ve been through depressions, deflations, inflations, and yet
the stock market has grown 7% a year for 100 years, 200 years, and
so do I think it’s gonna change over the next 20 years or 30
years, no. And just every now and then you go through these
periods of time where not much happens it happened – I started my
career in 1970, between 1966 and 1982, the stock market traded
between 1000 and 600, and then in March of 1982, we started Baron
Capital, the Dow is 880, and in August of that year, went to 1000,
and went on the way to 14000. What I think is the same sorta
thing is gonna happen in the next 10 years maybe 20 years.
Everyone who works in my firm and they’re gonna have the same
opportunities that I had in the 1980s and 1990s – they’re about to
have it.”

This is absolutely breathtaking in its erroneousness, since many
of the figures are lies.

  • He says that the P/E ratio in 1999 was 32. That’s absolutely
    right, and by quoting that figure, he’s proving that he’s using the
    standard definition of the S&P 500 Price/Earnings ratio (using “one
    year reported earnings,” not “future forward fantasy earnings.”)
  • He says that the P/E ratio is now 13. That’s a lie. According to
    the Wall Street Journal last week, the current P/E ratio is 17.92.

    WSJ P/E ratio, Friday, February 1, 2013

    WSJ P/E ratio, Friday, February 1, 2013

  • He says that it was 32 in 1999 and that was the “highest it’s
    ever been.” No, the highest it’s ever been was in 2008, when it
    went over 100.
  • He says that the historical median P/E ratio is 15 1/2. No,
    that’s a lie. It’s 14.
  • He says that the market grows by 7% per year. No, that’s another
    lie. I did that computation on my Dow Jones historical page, and the market grows by 4.5% per year, including
  • He says that the current P/E ratio is 13, and concludes that
    the market is underpriced, same as in 1982. No, that’s another
    lie. In 1982, it was at 6.79, which is very low. Today it’s
    at 17.92, which is far above the historical average.
  • So he says that stock market will grow in the next 10 years the
    way it did in the years after 1982. That’s a calamitous
    miscalculation. As I’ve written many times, the P/E ratio has been
    well above average continuously since 1995, and by the Law of Mean
    Reversion, the market will crash to below Dow 3000, as the P/E ratio
    returns to its 1982 level. (See “1-Jan-13 World View — 2013 Forecast: Financial Crisis and China Threat”)

So what should we make of this breathtaking display of stupidity? Is
Ron Baron just another debauched Libor-rigging crook who thinks it’s
fun to defraud anyone for his own personal gain? Or is he so stupid
that he’s unable to do long division, and is unable to figure out how
to divide price by earnings to get the P/E ratio? Well, Dear Reader,
whether it’s crook or stupidity, this is not a person you should trust
your money with.

You have to remember, Dear Reader, that the Libor-rigging scandal was
not some unique circumstance. It’s characteristic of the entire
financial and political culture today, in Washington and on Wall
Street, where massive fraud and screwing people is perfectly OK if you
can get away with it. And we’ve all barely begun to pay the price.

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