There was a hit song in the forties (made popular more recently by the Muppets) called "Ain't Nobody Here But Us Chickens."
One night a farmer hears noises from his henhouse and investigates with gun in hand.
"When he shouted, 'Who's There?'
This is what he heard
There ain't nobody here but us chickens,
There ain't nobody here at all
So calm yourself, stop that fuss,
Ain't nobody here but us"
The song is a joke. I never thought that needed explanation, but maybe it does. Chicken don't talk. So if a voice from the henhouse said, "ain't nobody here but us chickens," it probably wasn't really a chicken. It was probably a human being, because people, unlike chickens, talk. More specifically, it was probably a chicken thief who was in the henhouse to steal the farmer's chickens. Farmers object to the theft of their chickens, so the chicken thief lied. Claiming to be a chicken just trying to get a good night's sleep was not a very credible lie, but was still an improvement on saying "I'm a chicken thief here stealing your chickens." The thief's lie was comically implausible not just because chicken don't talk, but also because the thief had an obvious motive to lie.
What makes me wonder if everyone gets the joke is that government agencies continue to rely on internal investigations by financial institutions of evidence of wrongdoing.
This week the Justice Department announced a settlement between bank regulators in Britain and Switzerland, the Commodities Futures Trading Commission in the United States and UBS, an international bank based in Switzerland, over charges that UBS falsely reported interest rates used to calculate the London Interbank Offered Rate, or LIBOR. LIBOR is a benchmark interest rate used in hundreds of trillions of dollars of outstanding loans and other contracts, including interest rate derivatives. LIBOR and related rates are based on reports of what the biggest banks have to pay in interest for borrowing for different periods in different currencies. Interest rate derivatives originally had the legitimate purpose of letting businesses manage the risk of a change in interest rates. A business vulnerable to an increase in interest rates could enter into a derivative contract that would pay them if interest rates went up, offsetting their losses. Far more often now, however, interest rate derivatives are just pure bets on whether interest rates will go up or down. The banks that report interest rates used to calculate LIBOR also actively trade in interest rate derivatives based on LIBOR.
In the settlement, UBS agreed to pay fines of $1.5 billion, about a third of their 2011 profits, for filing false interest rate reports to make money on interest rate derivatives. The analogy to betting on a game by players and coaches is obvious.
The regulators described the criminal conduct as "epic in scale," involving at least 40 employees, including managers, and at least another 70 UBS employees knew of the rate rigging, including senior managers. There were hundreds, maybe thousands, of requests for false reports, and a stunningly incriminating email trail. The criminal conduct included bribes of employees of other LIBOR-reporting banks to provide false reports as well, and UBS employees promised the employees of the other banks that they would "return the favor." Since investigations of other LIBOR-reporting banks are still pending (UBS began cooperating early in the investigation), the promise to "return the favor" is intriguing.
There were rumors in the markets of LIBOR fixing, of course. After a flurry of press stories about the rumors in 2008, UBS conducted an internal review and concluded that their LIBOR reports were clean. The British banking regulator found that the 2008 review was "inadequately performed." The central flaw was that the UBS employees who conducted the review were the ones involved in false reporting. UBS filed a number of interest rate reports for borrowing in different currencies for periods ranging from overnight to one year. The report looked at a sample of reports and found that the reported rate was the same as the actual rate. The samples were not random. The samples were of reports the UBS employees knew had not been altered. Also, the UBS employees just lied rather than admit to hundreds or thousands of separate felonies.
Maybe the Department of Justice and our financial regulators should not rely on internal investigations performed by the financial institutions suspected of misconduct.
"Unfortunately," Willem Buiter, a prominent economist, wrote, "self-regulation stands in relation to regulation the way self-importance stands in relation to importance and self-righteousness to righteousness. It just isn't the same thing."
People who have been involved in pervasive felonious conduct cannot be trusted to report themselves voluntarily, and even when asked directly they have a motive to lie. And regulators should not rely on the institutions to act against their own interests, even when there is less at stake than a possible prison sentence. Regulators rely on financial institutions to grade their own "stress tests," to propose their own "living wills," and to conduct "independent foreclosure reviews" with consultants and law firms of their own choosing. A dose of skepticism by regulators is in order where financial institutions have an interest in what they report.