L ondon I s B etter O ff R eformed (LIBOR)

Poor London. They may have the Olympics, but the recent LIBOR scandal appears to be strike three in a ballgame full of regulatory gaffes that have left the city's reputation for governance tarnished in the eyes of the world's financial elite.

Strike one, the story goes, was AIG. In 2008, the London-based arm of the insurance conglomerate had sold off credit protection (through unregulated credit default swaps) for mortgage-related products that broke the bank, and for that matter the wallets of U.S. taxpayers, to the tune that year of $85 billion.

Strike two was the JP Morgan trading fiasco. There, unbeknownst to even Jamie Dimon, supposedly the most savvy CEO on Wall Street, Bruno Iksil (aka the "London whale" ) botched and then allegedly mismarked derivatives trades that will cost the firm an estimated $5.8 billion in losses.

And now there's the LIBOR scandal. Barclays (and likely other banks) misreported borrowing cost for purpose of hiding their own weaknesses and affecting the London Interbank Offered Rate, an ultra-important benchmark used in the financial markets to determine a range of interest rates, including U.S. mortgages.

There's no doubt that the city's reputation is now in tatters, and that it needs to undertake significant regulatory reform to reclaim its place among the leading financial centers. The pity, however, is that at least in the first two cases, London's regulators probably don't deserve most of blame. AIG was for the most part regulated by the now-defunct Office of Thrift Supervision. Meanwhile, because JP Morgan's operations in the city were conducted through "branches," and not UK "subsidiaries," responsibility rested with U.S. watchdogs located thousands of miles away.

This leaves only the LIBOR scandal squarely at the feet of UK regulators, who for decades left the industry group that sets LIBOR, the British Bankers' Association, essentially unregulated.

That said, the post-crisis years collectively reveal that we've entered an age where the new risk to a financial center's reputation isn't necessarily its own regulation anymore. (Pay attention New York, London, Hong Kong and Singapore!) It's the regulation governing foreign financial institutions that operate in your own backyard. If a foreign bank fails or commits massive fraud because its regulators back home don't do their jobs right, the blame will primarily fall in the lap of the country hosting the foreign firm. The home regulator won't get off scot-free, but it will escape a lot of the scrutiny.

The downside is that this state of affairs will undoubtedly create plenty of pressure for more unilateral oversight in the world's leading financial centers. Don't get me wrong; to some extent, limited duplicative regulatory efforts can help stymie some of the worse instances of one country's regulatory breakdowns creating systemic risks in others. Yet there are good reasons why we have regulatory cooperation. Without it, the rules of home and host regulators might conflict, and in the process create various regulatory arbitrage opportunities. (Indeed, LIBOR is itself the consequence of banks trying to respond to the arbitrage of U.S. banking rules on deposits by coordinating lending rates.) Plus deference can have positive outcomes where home regulators have greater expertise and understanding of a bank's operations than hosts.

But for international regulatory cooperation to work, you need two key ingredients. First, any regulator seeking to rely on another has to ensure that its presumed partner is going to do a good job and is committed to tough oversight and surveillance. If it isn't, cooperation won't work, and you have to intervene yourself with regards questionable practices needing regulatory attention. Simply shooting over a memo to a counterpart suggesting oversight isn't enough, even where the regulator has proved itself in the past in some ways just as responsible as yourself, if not more so.

Second, and equally important, you have to make sure that where regulatory gaps and letdowns do arise, blame is allocated to the regulator who fell short. If reports are correct, the U.S. Treasury Department didn't do everything it should have to push stronger UK regulation since U.S. banks themselves appeared to teeter on the brink in 2008. This has naturally generated plenty of speculation that Tim Geithner is to blame in some way for the scandal. And the US Justice department is looking to haul off some of the local bad guys in hand cuffs, elevating the sense of U.S. responsibility.

But ultimately the LIBOR scandal is an instance where the UK appears to be the most responsible authority since the British Bankers' Association, a local organization, provided the unique product in question -- an internationally accepted and relied upon interest rate -- even as some aspects of the process were outsourced to other firms. London's Financial Services Authority was not a host, but was instead, for all practical purposes, the home regulator.

Of course, there's plenty of blame to go around, but only by allocating the rightful amount of responsibility are you going to get the reforms that the international system needs. International financial regulation isn't perfect; it can only be improved in a world of at times second-best options. Knowing whom to trust and, just as important, whom to blame and to what degree when things go wrong, are vital starting points for reform. In this case, reform must begin, above all else, on the other side of the pond.