The recent revelations that Barclays bank lied about the rate at which it could borrow money from other banks, “the LIBOR scandal,” raises interesting questions about executive decision making and the political imagination. The Bank of England (BOE) asked Barclays’ CEO, Robert Diamond to resign, several days after Great Britain’s Financial Services Authority (FSA) had agreed to settle the charges against the Bank. While the FSA had fined Barclays some $450 million dollars, it had expressed support for Diamond to remain in his role.
The Wall Street Journal describes the details of Diamond’s firing. On July 2, the Bank of England's governor, Sir Mervyn King, “summoned Mr. Agius, [Barclay’s board chair] and Mr. Rake, [a board member], to a meeting that evening. The two directors didn't know why. At 6 p.m., Messrs. Agius and Rake sat down with Mr. King in a private reception room at the central bank's headquarters. ‘Bob [Diamond] has lost the confidence of regulators,’ Mr. King told them. He said Mr. Diamond should be gone within 24 hours and told them that the U.K. Treasury chief, Mr. Osborne, also agreed, according to a person familiar with the meeting.
Messrs. Agius and Rake were taken aback by the extraordinary dictate from the central bank's governor. They protested that the FSA hadn't objected to Mr. Diamond keeping his job and that his removal would be destabilizing to the bank, given Mr. Agius's [prior] decision to step down [as chair]. Mr. King said the matter wasn't up for discussion. The meeting was over in less than 30 minutes, the person familiar with the meeting said.
Outside the Bank of England building, Mr. Agius's Mercedes was waiting. He and Mr. Rake drove to a Barclays' office in London's Mayfair district and convened a conference call of the bank's non-executive directors. The board decided to ask for Mr. Diamond's resignation.
Then Messrs. Agius and Rake drove the few miles to Mr. Diamond's rented town house in the posh Chelsea neighborhood. They arrived after 10 p.m. Mr. Diamond was alone; his wife and children were in the U.S. for the Fourth of July holiday. Mr. Agius told Mr. Diamond about Mr. King's demand and the board's decision. Mr. Diamond responded with "stunned silence," according to a person familiar with the meeting. He told the two directors that he needed time to think and talk with his wife. He promised to call them later that night.
The directors left after about 15 minutes. Within hours, Mr. Diamond's lawyers had negotiated the terms of his exit, which included deferred bonuses that could be worth more than $30 million. Days later, he relinquished the payout amid a continued public uproar that shows no signs of abating.”
Three questions are; why was Agius taken aback; why was Diamond stunned; and why did the Bank of England (BOE) make such an extraordinary request? The reporter’s text gives one obvious answer to the first two questions. Both the chair and the CEO believed that the bank and its CEO had the full support of the FSA. What upended that understanding, and might the answer to this question help explain the BOE’s extraordinary request?
I want to suggest that Diamond and Agius were stunned because they lacked what we can call a “political imagination.” They believed quite reasonably that their explanation of the Bank’s malfeasance was entirely sensible and put to rest charges that the bank’s senior management had been reckless, unethical or self-serving. And from a logical point of view they are entirely right.
In a report the Bank published the day before Diamond was scheduled to testify before a parliamentary committee, but one day after his surprised firing, Barclays highlights the following.
There were two separate incidents of LIBOR manipulation, one in 2005 and one in 2008, during the financial crisis. In the first, lower level traders asked their peers, who submitted the bank’s rate to the LIBOR committee, to increase or decrease their submission a bit, so that particular traders’ financial positions would be enhanced. For example, if the bank paid a counterparty LIBOR plus 2%, a lower LIBOR could reduce the trader’s obligations. It should be noted however, that no bank can significantly distort the final reported LIBOR rate, since the latter is calculated as a “trimmed average” of the rates submitted by 16 banks. Banks, whose submitted rates fall within either the top or bottom quartiles, are simply excluded from the calculation. The traders and submitters at Barclays thus had limited influence on the outcome.
In October of 2008 during the financial crisis, the situation was entirely different. Bank runs threatened many banks, and a bank’s reported LIBOR became a measure of its solvency. If other banks would lend money to a particular bank at only high rates, then how sound could the bank itself be? Indeed, while Barclays reported higher LIBOR rates than most of its peers, its senior executives believed that other banks were under-reporting their rates to look good. Since Barclays never needed a bailout, this interpretation seems reasonable.
Indeed, in that same month, in 2008, the Wall Street Journal estimated that of the 16 banks in the LIBOR panel, Citigroup, Germany's WestLB, the United Kingdom's HBOS, J.P. Morgan Chase & Co. and Switzerland's UBS, were most likely to be under-reporting. Moreover, Barclay’s concern, that its reported rates could lead to unwarranted concerns about its solvency, was sound. For example, Bloomberg published an article entitled “Barclays takes a money market beating” on September 3, 2007. It noted that Barclays’ LIBOR submissions in three-month sterling, euro and US dollars were the highest of all banks contributing LIBOR submissions. The article posed the question, “What the hell is happening at Barclays and its Barclays Capital securities unit that is prompting its peers to charge it premium interest rates in the money market?”
Finally, Barclays raised the issue of under-reporting to the FSA, the Bank of England and the Federal Reserve Bank. Indeed, as the New York Times reports, in 2008 Barclays informed the New York Fed that it was submitting artificially low rates! “The concerns were passed on to Timothy F. Geithner, then the chief executive of the regulatory body. But the New York Fed did not tell other authorities in the United States or Europe about the specific problems at Barclays. Instead, it proposed changes to the rate-setting process.”
So what forced Diamond’s firing?
Barclays report reproduces a note Diamond wrote after a call he had with Paul Tucker, the Bank of England’s executive director for markets. The call was on October 29th 2008. “By Diamond's account, Mr. Tucker told him that he had "received calls from a number of senior figures within Whitehall to question why Barclays was always toward the top end of the LIBOR pricing."
After Mr. Diamond explained the bank's pricing, he says, Mr. Tucker reiterated that the calls he was receiving from the government were ‘senior’ and added that ‘while [Mr. Tucker] was certain that we did not need advice, that it did not always need to be the case that we appeared as high as we have recently.’”
When Diamond reported this call to his subordinate, Mr. Jerry del Missier, the latter interpreted the call as an instruction from the bank of England to lower its LIBOR submissions. And he complied. Diamond later denied that this was the note’s meaning.
Diamond’s transmission of his note and its subsequent impact highlights a familiar process. Senior executives and government leaders in politically delicate situations often speak in coded terms. By convention, the higher ups need protection, they represent the franchise, so that it is up to those lower down to interpret the code, in ways that protect the higher ups and the organization. This also reflects a fundamental survival principle in any organizational hierarchy; “make your boss look good.” Misseir’s interpretation and subsequent action in this sense appears entirely reasonable, even if unethical. He believed he was receiving an instruction from the Bank of England. Diamond’s later denial of the note’s meaning is consistent with the idea that the purpose of coded language is in fact to facilitate deniability.
However the note’s inclusion in Barclays report raises a more fundamental issue. If the note had no salient meaning, as Diamond later argued, why was Barclays including it in the report? One obvious explanation is that the bank was protecting its reputation by declaring that it rigged its LIBOR submission in response to a request from the Bank of England! While the report was published the day after Diamond’s resignation, it clearly had been in preparation for some time and in all likelihood, the BOE governor, Sir Mervyn King had advance notice of the report’s content. It seems reasonable to conclude that this is what triggered the BOE’s decision to make its extraordinary request that Diamond be fired. Indeed, a former director at the FSA, Lindsay Thomas, noted that “suggestions that the Bank of England had condoned the rate-rigging practice would have been 'a Rubicon' that would have led Sir Mervyn to demand Mr. Diamond be forced to quit. He told BBC Radio 4's World at One: 'They would have been livid. I would think that the Governor would have called up Barclays and made it plain that that's what they expected to happen.’”
One question is why Diamond and his peers had been so obtuse as to include the note in the report? Indeed, as the Wall street Journal reports, while some of Diamond’s subordinates believed the note underlined Barclays’ innocence, others worried that it would launch a war against the regulators. Moreover, in 2007, “Mr. King delivered a series of speeches attacking what he described as overpaid London bankers, an apparent reference to Mr. Diamond, who was one of London's highest paid.” The regulators had declared war 5 years ago!
One hypothesis is that Diamond’s decision to include the note in the report reflected a profound lack of political imagination. The political imagination is based on two frames of reference; understanding the role of symbols and their relationship to emotions in shaping reasoning, and understanding the “games” of self-interest in which for example, “the enemy of my enemy is my friend.”
These frames of reference make contradictions look reasonable. For example, because Barclays cooperated extensively with the authorities in Britain and the U.S.- in the words of the Department of Justice, “the nature and value of Barclays cooperation has exceeded what other entities have provided in the course of this investigation,” --it was the first to settle and therefore the first to be exposed. But as the first, it then became the ready symbol of the “bad bank” responsible for the financial crisis a reprise of Sir Mervyn King’s earlier attack on overpaid bankers. Similarly, Ed Milliband, the head of the Labor party called for a criminal investigation of bankers who broke the law by rigging the LIBOR rates. In effect, he was siding with the Bank of England, an institution on the other side of the class divide, because the former opposed Barclays, a symbol of the “bad bank.”
Both of these understandings point to the limits of what some call “technical rationality,” that is, the logical delineation of the relationships between means and ends based on facts and data. It is likely that Diamond, a man schooled in technical rationality by virtue of his expertise in finance, was seduced by the reasonableness of his own case. He could not see beyond the logic of cause and effect which rules out contradictions, to contradiction’s reasonableness when seen through the prism of the political imagination. In addition, a person of Diamond’s stature and standing may lose site of his political vulnerability. After all, as the story of the call from the Bank of England suggests, Diamond’s subordinates protected him. His experience of being protected may have weakened his ability to exercise his political imagination. This may ultimately be why he was stunned when asked to resign. It was simply not logical.