Barclays' Bid-Rigging Deja Vu

NEW YORK (TheStreet) -- We're in the middle of what I would call an "uncomfortable anniversary" -- the anniversary of an event that the so-called financial-services industry would like to forget, and usually does so without any difficulty.

In 1991 and '92, Wall Street was rocked by a tawdry scandal at Salomon Brothers, in which bond traders rigged the auctions for two-year Treasury notes.

In commemoration, Barclays is staging a lavish re-enactment.

The bid-rigging scandal that has rocked Barclays, involving manipulation of the benchmark LIBOR interest rate, has stunning parallels with the scandal that eventually brought down Salomon. Probably the most significant is the moral dimension, or lack thereof. Both demonstrate that, in their heart of hearts, some of the most august investment houses have the morals of a $20 hooker. Deregulatory propaganda notwithstanding, major corporations are only too willing to flush their "reputations" down the commode if it means squeezing out an illicit buck.

Also remarkable is the parallel lessons that they teach us about systemic risk. The only solution to that perennial issue is to prevent banks from growing so large that they can wreak havoc with the financial system. Because if they are big enough to do so, they inevitably will.

In the Salomon Brothers scandal, a trader named Paul W. Mozer -- under the noses of eminent super-trader John Meriwether and the much-hyped CEO John Gutfreund -- placed illegal bids for two-year notes. The purpose was to squeeze out some illicit bucks by cornering the market and exerting a short-squeeze on traders who were short the note.

Well, as you can imagine, people who knew Mozer were shocked -- shocked! -- that he would do such a thing. He was portrayed in the media as a "soft-spoken" fellow who had the milk of human kindness coursing through his veins. Much the same was said about Meriwether, who swiftly landed on his feet, founding a hedge fund called Long-Term Capital Management that performed so dreadfully that in 1998 it almost brought down the entire financial system. I'm sure that when we find whoever was responsible for the Barclays mess, we'll find that he or she is a soft-spoken, kind person.

Gutfreund (who no one ever described as "kind") was axed, stripped of compensation, and agreed to a fine and to never run a Wall Street firm again. Warren Buffett stepped in as a white knight, Citigroup took over Salomon and then ... well, basically, nothing. The whole thing was pretty much forgotten. That's probably the most important aspect of the outcome -- that everybody forgot about it.

We haven't quite gotten to the point that Barclays is about to be swallowed up by anybody, and that is the crux of the problem. It may be too big to be swallowed up by anybody. It is certainly amply big enough -- and trusted enough by the British authorities -- that with the cooperation of other major banks, it was able to rig the LIBOR.

At Barclays, the MacGuffin of the scheme was a benchmark rate, not a Treasury instrument. Instead of the two-year note, the traders at Barclays manipulated the London interbank offered rate. That is far more consequential to the markets than the two-year note, because it is the benchmark in setting the price of gazillion bucks worth of derivatives and financial products, ranging from toxic-waste financial sludge to adjustable-rate mortgages. In the Salomon scandal, the only people directly hurt were a handful of traders and hedge funds who were short two-year Treasuries. At Barclays, the list of victims spans the globe. Already the lawsuits are flying.

Financial scandals follow a kind of implicit script, and all is going according to that elaborate kabuki so far -- in both the things that are going to happen and, more importantly, the things that aren't going to happen. After a few weeks of initial legal wrangling -- the lawsuits and investigations commenced on both sides of the Atlantic, which was Stage One of the scandal, on Monday and Tuesday we had Stage Two, the Ceremonial Head-Choppings. First there was the resignation of Barclays PLC Chairman Marcus Agius and, a day later, CEO Bob Diamond.

Stage Three, Real Consequences, is not yet in the cards. No, the $453 million fine that Barclays agreed to pay U.S. and British regulators doesn't come anywhere near to being a Real Consequence. The impression one gets is that regulators want to put this mess behind them. It's an election year in the U.S., after all, and Obama is having a hard enough time raising money on Wall Street as it is. While there's talk of criminal prosecutions of specific executives at Barclays and other banks that may have participated in the rate-fixing scheme, I think we have to be realistic. The Obama administration just doesn't prosecute major bankers. Period. It ain't happening, unless the British do something. In other words, forget about it.

Even if it did happen, it wouldn't be a permanent solution to the perennial messes created by the banking industry.

The recurrent scandals at the New York Stock Exchange point to the solution. For decades through the 1990s, the NYSE was beset by scandals involving self-dealing and frontrunning by brokers and traders working on the floor of the Big Board. It's been a good many years since we've heard about any such thing, and for a simple reason: Most trading simply doesn't take place on the NYSE floor anymore. Instead it takes place off the floor, in electronic networks, and that makes it much harder to front-run orders. It wasn't regulation or law enforcement but a structural change in the nature of the NYSE that wiped out trading floor scandals. There's still a trading floor, but it mainly serves as a backdrop for cable-TV talking heads.

Preventing future banking and trading scandals requires a similarly radical approach. It has to be in the interests of the largest banks to shrink to manageable size, just as it was in the economic interests of the NYSE to go electronic, as it did under the hard-eyed John Thain. Perhaps the largest banks can be incentivized to break up?

Anyway, that's just a fantasy right now. We're in the middle of a rip-roaring new banking scandal, so let's sit back and watch this one as it wreaks havoc. We're going to have these every few years, so I guess we might as well get used to them.

Gary Weiss's most recent book is AYN RAND NATION: The Hidden Struggle for America's Soul, published by St. Martin's Press.

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