Another Banking Scandal

As financial investigations go, it literally can’t get any bigger than this: The world’s biggest banks are now being investigated for rigging the world’s biggest market.

In a widening inquiry, as many as 15 banks — among them, Barclays, Citigroup, Deutsche Bank, Goldman Sachs, JPMorgan Chase and UBS — are under scrutiny by international officials for alleged manipulation of the $5.3-trillion-a-day foreign exchange market.

The allegations involve collusion among the banks’ traders to fix benchmark exchange rates in their favor, resulting in higher costs for pension funds, mutual funds, multinational corporations and other bank clients that routinely buy and sell currencies.

Also in harm’s way would be those clients’ customers, including investors and consumers, who would face lower returns or higher prices as inflated transaction costs are passed on to them. In a market as vast as foreign exchange, a scheme that skimmed even a minuscule fraction from each dollar could translate into millions or even billions siphoned daily into bank profits and trader bonuses.

In the United States, both the criminal and antitrust divisions of the Justice Department are investigating the banks’ foreign exchange activities, a hopeful sign that the department may be bringing more depth and creativity to its investigations of major banks. The Commodity Futures Trading Commission, which emerged from the financial crisis as the most aggressive market regulator, has also opened an investigation, as have authorities in Britain, the European Union, Switzerland and Hong Kong.

For now, the evidence of wrongdoing seems to be from online chats among traders who referred to themselves as “the cartel,” “the bandits club” and “the mafia.” The Financial Times has reported that regulators were alerted to the chat rooms by a whistle-blower.

However, the traders — whatever their culpability turns out to be — are not the real problem. The real problem is that foreign exchange is one of the most opaque and least policed of all financial markets. There is no exchange where all currency trades and prices can be tracked; much of the trading is still done by phone. The Obama administration foolishly added to the opacity last year when it exempted certain foreign exchange derivatives from new rules under the Dodd-Frank financial reform law, despite research and analyses showing considerable risks in the exempted instruments.

Making matters worse, traders’ bonuses are based on how much profit they generate from currency trades, which gives traders an incentive to collude and manipulate, all the more so in the absence of strong oversight from senior management.

Policy makers, regulators and prosecutors know what is needed to bring transparency to opaque markets: exchange trading, clear benchmarks, and fee-based rather than bonus-driven pay. It also takes aggressive use of legal tools to prosecute misconduct, including admissions of wrongdoing, clawbacks of ill-gotten pay, sanctions for management failure to supervise, nondeductible penalties and criminal prosecutions, where warranted. It is possible to have fair and robust markets, but not without wise laws and tough enforcement.


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