July 19, 2012
Simon Johnson has an interesting column discussing the Fed’s response to the rigging of the LIBOR rate. He refers to the memo that Treasury Secretary Timothy Geithner (then the head of the New York Fed) sent to the Bank of England in 2008 and notes evidence that the Fed knew of rigging as early as 2005. Johnson then cites comments from Fed Chairman Ben Bernanke that the Fed couldn’t do anything more than it did in calling the Bank of England’s attention to the problem.
This is known as the Incredible Hulk theory of public policy. Comic book fans everywhere know the story of the Incredible Hulk. He is the alter ego of mild-mannered scientist Bruce Banner. While ordinarily Dr. Banner is meek and retiring, when he gets angry he turns into the gigantic and powerful Incredible Hulk.
The United States government can be the Incredible Hulk at important moments. Certainly it was the Incredible Hulk that invaded Iraq. It is also the Incredible Hulk that engages in drone strikes around the world with little regard for the wishes of the governments of the countries in which the strikes take place.
The United States government as the Incredible Hulk also can also show up in the world of finance. After the September 11th attacks the United States demanded that European governments change their rules on bank secrecy in order to allow it to better track the financing of terrorist networks. The European governments quickly complied.
However the United States government can also be mild-mannered Bruce Banner, as was apparently the case with the LIBOR scandal. As noted, Federal Reserve Board Chairman Ben Bernanke told a congressional committee that the Fed had sent a memo to the appropriate officials at the Bank of England, and that was all it could do.
While Johnson sketches out how this was an enormous failure of the Fed in its responsibility to regulate U.S. banks and protect U.S. financial markets, it is also interesting to ask how the Incredible Hulk might have dealt with this problem. While it is unlikely that an invasion of the U.K. or drone strikes against the Bank of England would be necessary, there were some simple steps that Fed could have taken that would almost certainly have quickly brought an end to the rigging.
For example, if a month or two passed following the Geithner memo with no action, there could have been a follow up memo. This one would explain that the LIBOR is of fundamental importance to the U.S. since so many loans are tied to it. It would then demand action and explain that if no action is taken by a date certain (tough guy language), then the Fed would hold a press conference in which it would publicly disclose both its evidence of LIBOR rigging and its unsuccessful effort to get the Bank of England to clean up the cesspool.
I could be mistaken, but my guess is that such a memo would have prompted Mervyn King (the head of the Bank of England) to move very quickly to stop the rigging rather than risk public humiliation and dismissal from his position. Unfortunately, we had Bruce Banner at the Fed, so we will never know exactly what the response to stronger measures would have been.
Comments