Barclays scandal shows flaws at heart of accounting

THE RECENTLY deposed chief of Barclays, Bob Diamond, told a treasury select committee investigating the Libor scandal how he became physically ill when he discovered that Barclays, a bank he loved, employed traders who abused a position of trust by telling lies to inflate their bonuses.

One wonders how Diamond would have felt if a Barclays employee misled the committee in its attempts to restore the reputation of London’s square mile.

Libor is the name given to the average interest rate that banks pay to borrow money. Like government debt, the markets pay close attention to this rate to see how healthy a bank is. Healthy profitable banks are treated like the German government and are offered low rates, while banks hiding losses are given the Greek treatment, paying a high rate that is potentially unsustainable.

The Libor scandal has two strands. First, derivative traders take bets on which way Libor interest rates are going to go. Wins are guaranteed if they are able to lie about their borrowing rates and encourage other banks to do the same. For instance, betting that Libor falls from say 6 per cent to 5 per cent is lucrative if you encourage your own and other banks to say that they borrow at 5 per cent even if the actual rate is different. Traders routinely took bets knowing they could eventually fix the rate they wanted – a form of insider trading and market manipulation.

A second strand of Libor fixing is to conceal how much trouble you are in. It is now well-known that banks produced annual reports that failed to reveal the losses they suffered from toxic structured products.

As with Greece, the markets ignored what the banks were saying and took the view that if the cost of borrowing was high, the bank had a high chance of going into default. So, banks like Barclays effectively told lies about their true borrowing rate.

Some regard Diamond as solely responsible for Barclays’s growth and success. He found and rewarded the brightest bankers who produced huge profits. Even corporate governance expert Tim Bush of PIRC, the UK investor consulting group, and a critic of Barclays’s accounting practices, believes Barclays was not the biggest Libor-rigger.

It is well-known that the UK’s Financial Services Authority is very concerned about the aggressive bonus culture. Evidence that Diamond submitted to a previous sitting of the Treasury Select Committee in January 2011 would almost certainly have raised concerns. Barclays engaged in the questionable practice of “off-balance sheet” accounting, not too dissimilar to that practised by Enron a decade ago – through an offshore company known as Protium.

Like Enron, Barclays used the transaction to delay recognising losses on toxic illiquid assets – Barclays created an artificial sale of these assets so that it could remove them from its balance sheet out of shareholder view. The transaction was similar to the famous Lehmans pretend sale of $50 billion of assets. In Barclays’s case, the transaction size was $12.3 billion.

When asked about the deal, Diamond told the committee that Barclays had problems selling certain illiquid assets but they were now sold, off-balance sheet vehicle Protium was not part of Barclays, the controversial deal did not affect his personal remuneration and that regulators were aware of it.

It has since emerged that Barclays simply arranged an artificial sale and paid ex-Barclays employees a substantial fee for arranging it. Although Barclays did not own any of the shares in Protium, they financed it through generous loans, making them de facto owners – and while the regulators were aware of the transaction they did not approve.

According to the Financial Times, the deal was designed simply to delay revealing large losses. After pressure, Barclays later reversed the “supposed sale” and is now once again the owner of the troubled assets.

In Britain, as in Ireland, dealing with the banking crises has become a very delicate balancing act. Everyone knows things can’t continue as they are. In 2005, the accounting standard-setters placed the accounting profession into a damaging straightjacket, by dropping the requirement to tell shareholders instantly of loss-making or troubled loans. The leaders of the profession have let down their members and the public. They could become the next target of the regulators.

Cormac Butler is author of Accounting for Financial Instruments. ctkbutler@aol.com