Lurking somewhere in the sordid recesses of dim light and flickering shadow that comprise finem respice's checkered past is the memory of a sporadic (and obviously memorable) visit to a private collection of gambling instruments owned by a certain friend of finem respice (also, as it happens, an accomplished fund manager). Among the items on display was a rigged roulette wheel, purportedly counting a Meyer Lansky casino (perhaps in New Orleans?) among the torrid entries in its ignoble provenance. On first blush this is curious, as Lansky establishments were widely reputed to be among the most honest purveyors of wagering entertainment and games of chance- the Lansky straw having been not so delicately inserted into the milkshake quite a bit further downstream from the players- in the counting rooms to be exact- where it sucked dairy product rather more directly from the teats of the casino's shareholders. But one does not lightly cast aspersions on property of the "Mob's Accountant," even almost three decades after his passing. And, after all, it is entirely possible that this particular instrument of probability skew predated Lansky's revelation that honest casinos tend to pay more in the long run. Or, perhaps, it simply resided in one of Lansky's smaller, and therefore less scrupulous, establishments.

Wherever the binary call-writing table hailed from, its connection to Lansky, the tension created between structural and artificial bias in Lansky gambling havens that the table's very existence highlights, and observations on the design of "fair" systems all come together in the green 00 pocket. It is this nexus- and certain recent examples of artificial, systemic bias- that occasion finem respice's instant prose.

No less a powerhouse of investigative journalism than Life Magazine introduced the general public to the casino skim antics that would eventually drive the narrative in Martin Scorsese's 1995 production of "Casino." Back in 1967 Life ran a series of explorations into the Mafia that included one of the most colorful crime syndicate diagrams in modern print. By this time Lansky was rumored to own (either directly or by proxy- but probably though bank President and Albanian diplomatic passport holder Tibor Rosenbaum- you can't make this stuff up) a controlling interest in Banque du Credit International, a Geneva based institution that in turn spawned Atlas Bank in the Bahamas as a subsidiary. Atlas, along with fellow Bahamian institution the Bank of World Commerce (apparently La Cosa Nostra was nothing if not creative when naming their captive financial subsidiaries) received cash directly from Lansky's bagmen and loaned it back to its owners at 6%.1 In and around 1967 the resulting loan from a Swiss bank appeared pure as the driven snow. Times have, obviously, changed.

Harvard alum, Lansky Associate, and Swiss Citizen, Sylvain Ferdmann boards a
TWA flight bound for Switzerland from Philadelphia with a bag stuffed with cash.

On March 19, 1965 Lansky bagman Sylvain Ferdmann made a critical error. A parking attendant in Miami picked up a receipt he had dropped on Banque du Credit International letterhead:

This is to acknowledge this 28th day of December 1964, the receipt of Three Hundred and Fifty Thousand ($350,000) Dollars, in American bank notes for deposit to the account of Maral 2812 with the International Credit Bank, Geneva, the said sum being turned over to me in the presence of the named signed below.

/s/
Sylvain Ferdmann

The above is subject to the notes being genuine American banknotes.

/s/
John Pullman
Witness

The parking attendant turned the note over to the police.

One is caused to wonder what Ferdmann was doing with a receipt bearing his name, Pullman's name, and the numbered account details in his pocket for nearly three months.

Oops.

Still, for nearly two years Ferdmann hauled cash overseas on a nearly monthly schedule. Realizing that $350,000 in 1965 dollars approaches $2.5 million today, one gets a sense of the scale of his courier route, and Ferdmann was at least the third in a series of porters for Lansky.

The FBI was convinced Lansky had over $300 million socked away in various places, but if so it was never recovered. Lansky died of lung cancer in Miami beach in 1983. He was eighty years old.

You never quite know if a casino is honest, but it is entirely possible to be certain one is crooked. Lansky's insight (if he can indeed be credited with it), that one should take the skim at the choke points, not the mouth of the funnel, is in a sense timeless. A crooked roulette wheel has to escape the notice of thousands of players who have direct and immediate contact with it. A secret, forbidden and crooked counting room has only to escape the notice of a few distant shareholders who aren't allowed admittance in any event.

Of course, the choke points in a system have to be corruptible to be vulnerable to the Lanskys of the world. This would seem to complicate matters significantly for the would be manipulator as choke points are also easier to secure than, say, tens or even hundreds of thousands of points of sale. What could possibly induce systems designers to forgo architecting a robust system with these factors in mind?

Simple hubris, or (decidedly less simple) malfeasance- and sometimes both. Consider:

A flood of wailing and rending of garments has accompanied the apparent revelations that the London Interbank Offered Rate (LIBOR) seems to have been manipulated for many years. Still other commenters are shocked, shocked to learn that this has been an open secret for going on a decade and a half. The always astute finem respice reader will not exhibit such rank (or affected) financial melodrama. In fact, as a close student of system structures, the astute finem respice reader has been suspicious of Queen LIBOR and all of her ilk that populate the Court of Lending for some time. It was not so long ago, in fact, and though under another guise, that finem respice had cause to comment on the absurdity of the LIBOR recipe.

More simply, and as one friend of finem respice expressed it recently:

"The LIBOR fix is fixed. Duh."

For the uninitiated, the "LIBOR Fix" is cooked up in London from among the submissions of a panel of banks hand picked by the British Bankers' Association (hereinafter the "BBA"). The BBA provides an interesting perspective on the rationale that created LIBOR:

At the beginning of the 1980s it became apparent that an increasing number of banks in the London market were actively trading new instruments such as Forward Rate Agreements, whilst at the same time London was also emerging as a centre for loan syndication. Many banks considered these new instruments as attractive; however, they were inhibited by the nature of the underlying rates that had to be agreed before entering into a contract.

The BBA was asked by the banks it represents to bring a measure of uniformity into the market and to devise a benchmark to act as a reference for these new instruments. Rather than negotiating the underlying rate or forming rates by taking averages of ad-hoc panels, banks could now use a standard rate. This facilitated the operation of markets and made benchmarking more transparent and objective.2

The clever finem respice reader will have already identified the hubris that is the beginning of the end in this sentence:

Rather than negotiating the underlying rate or forming rates by taking averages of ad-hoc panels, banks could now use a standard rate. (Emphasis added).

Of course, in the mid-1980s the reporting of individually negotiated rates might have been technically complex, but that isn't remotely true today, nor has it been for almost 15 years.

At first banks on the panel answered the following question to make their LIBOR submissions:

At what rate do you think interbank term deposits will be offered by one prime bank to another prime bank for a reasonable market size today at 11am?3

Readers can be forgiven for already finding the process arbitrary and flawed and the question unduly vague. Which prime bank? What's a reasonable size? Does "you think" refer to the bank answering the question (and how is the bank's collective mind taken on this point?) or the clerk punching in the number? Readers can be forgiven their skepticism because the question in that format would not survive after 1998 when it was revised to:

At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?4

Readers can be forgiven again for wondering how it took thirteen years to make a change, and, again, how that change in method could be so abysmally weak.

The answers of the panel banks are collected and, as in gymnastics, the highest and lowest scores are thrown out to make sure the scores from the French and German judges don't count (actually in LIBOR the top and bottom 25% are tossed to keep Société Générale and Deutsche Bank out of the mix) and the remaining rates averaged up and published. If this is sounding awfully arbitrary and subject to mischief that is most likely because it is.

The entries are tallied and the calculations done by clerks in a secret room in an "undisclosed location" in the Thomson Reuters offices in London. If that sounds a little like the counting room in a Lansky casino to you, you are catching on.

It has emerged that two kinds of manipulation seem to have plagued LIBOR fixes in recent (or not so recent years). First, in the form of unofficial favor calling in between LIBOR fixers (so to speak) to benefit certain derivative positions held by the panel banks. The second appears to have been occasioned by the fact that the individual rates submitted by panel banks to answer the "At what rate could you borrow funds, were you to do so..." question are published. Obviously, the answer to this question would (or at least should) tell the reader something about the health of the institution answering. Obviously, a bank under stress compared to its peers would stand out with one of the higher borrowing rates- these borrowing rates being important pricing signals to the market. And, of course you realize, we simply cannot suffer to endure those sorts of goings on.

When a broken and arbitrary system (and that is quite the oxymoron in the world of finance) endures for so long it is almost always because the interests of the most influential members within the system are served by its continuing imperfections. It would be far more difficult to game a system that reports (with appropriate sanitization, of course) every negotiated rate on loans a bank makes with its peers than to game a panel of 18 peers where fully half of them have no influence on the final rate at all.5 This, as it were, is the choke point.

The Bank of England is kind enough to help us understand this dynamic with a real world example. It would be fair to say that Barclays Bank is at the center of the LIBOR whirlwind, but it is also probably the best insulated in some cases. This is because Barclays primary regulator, the Bank of England, at the urging of Whitehall, appears to have given its tacit approval to engage in fixing shenanigans during the recent credit crisis so as to conceal the degree to which Barclays was in distress. Of course, this is in keeping with the time honored goal of regulators and the executives who command them to promote transparency and the free flow of information about the health of financial institutions to the general public.

In this scenario an email in October of 2008 from Sir Jermey Heywood (the private secretary of savior of the free market and then British Prime Minister Gordon Brown) to Paul Tucker, at the time the head of markets at the Bank of England, asks why Barclays is paying "ABOVE [GBP] LIBOR."6

One is forced to wonder what the private secretary to Gordon Brown is doing leaving email trails with names of involved parties that would tend to suggest Whitehall was seeking to influence LIBOR rates from on high. But, then, maybe he's related to Sylvain Ferdmann?

Oops.

One can argue about the likelihood that junior Barclay's execs did or did not perceive subsequent communications with Barclay's CEO Bob Diamond as an order to lower Barclay's GBP LIBOR submission artificially, but that misses the point. The operative issue is, rather, how such manipulation could even be possible in a system that purports to convey pricing and risk information except by at least tacit approval (if not by outright design).

In a way it is this recognition that makes the current bout of anti-capitalist epilepsy in the British Parliament (and elsewhere) occasioned by the "LIBOR scandal" something of a joke. That is not to say that the Bank of England (even if understandably corrupted and cowed by the overwhelming and scintillating force of Gordon Brown's financial acumen) didn't act improperly, but rather that the fact that no one who used LIBOR over the last 15 years (and this is a rather large population) was actually exposed to real price and risk signaling by the market is the least of the market's problems.

After all- and not to be too much of an Austrian about it- if the offense here is the manipulation of a key rate tied to $500 trillion in transactions in order to lower the cost of borrowing for and to conceal the degree of stress impacting a distressed entity, why are pundits not focusing on the market for United States Treasuries?

Every reader who believes that the risk of the United States defaulting is at the historically low rates hinted at by the rock bottom yields of United States Treasuries please raise your hand.

Anyone? No, no, sit down Mr. Lansky. You're disqualified.

1. 1. Smith, Sandy, "Mobsters in the Marketplace," Life Magazine (September 8, 1976).
2. 2. British Bankers' Association, "Historical Perspective."
3. 3. Ibid.
4. 4. Ibid.
5. 5. For the record, for the USD LIBOR fix as of May 2012 those 18 are: Bank of America, Bank of Tokyo-Mitsubishi UFJ Ltd, Barclays Bank plc, BNP Paribas, Citibank NA, Credit Agricole CIB, Credit Suisse, Deutsche Bank AG, HSBC, JP Morgan Chase, Lloyds Banking Group, Rabobank, Royal Bank of Canada, Société Générale, Sumitomo Mitsui Banking Corporation, The Norinchukin Bank, The Royal Bank of Scotland Group, and UBS AG. For British Pounds they are: Abbey National plc, Bank of Tokyo-Mitsubishi UFJ Ltd, Barclays Bank plc, BNP Paribas, Citibank NA, Credit Agricole CIB, Deutsche Bank AG, HSBC, JP Morgan Chase, Lloyds Banking Group, Mizuho Corporate Bank, Rabobank, Royal Bank of Canada, The Royal Bank of Scotland Group, Société Générale, and UBS AG. (British Bankers' Association).
6. 6. Wilson, Harry "Email Cache Shows Depth of Whitehall Fears Over Barclays LIBOR Submissions," The Telegraph (July 9, 2012).

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