More Great Reasons Not to Buy Banks

Earlier this year, Barclays (NYSE: BCS  ) was ordered to pay a $450 million fine for attempting to manipulate the London Interbank Offered Rate (LIBOR). Yesterday, The New York Times reported that UBS (NYSE: UBS  ) is close to reaching a deal with regulators that would see it paying a similar fine, for a similar crime. The news comes quick on the heels of another fine, in which UBS was ordered to pay $47 million for failing to catch one of its traders "going rouge."

It would be lovely to say that this new fine is going to cap off a horrible year for banks, but that's optimistic. A month ago, Citigroup (NYSE: C  ) issued a statement saying that "Citigroup subsidiaries [had] received additional requests for information and documents from various domestic and overseas regulators and enforcement agencies, including the Monetary Authority of Singapore and a consortium of state Attorneys General." Why did they get those requests? Potential Libor rigging charges. While no one would argue that the past few years have been stellar for banks, 2012 may go down as one of the worst.

Get your [darn] hands off [the LIBOR]!
The problem big banks have had in 2012 is that all their sins have been exposed, and like pulling back the gauze on a festering wound, the resulting sight has been shocking. Barclays was one of the first to take a big hit, as it was revealed that employees submitted false LIBOR rates in an attempt to earn more from investments and to make the bank seem stronger than it was.

The revelation came with heavy-handed rhetoric, especially from regulators who were supposed to be managing the process. But in a Shyamalan-ian twist, Barclays' CEO Bob Diamond alleged that he was encouraged to submit some of the false information by the regulators themselves. Suddenly, there was no one that the public could seemingly trust. Every gamekeeper was a retired poacher, and no one could be sure how deep the problems ran. Even before the announcement from Citi last month, everyone knew something was coming. In late July, a study from Nomura found that Citi had underestimated borrowing costs by 42%. But even that was old news. You can go back to a UCLA study from 2010 that illustrates a similar point.

The problems with LIBOR are easy to see, in hindsight. The odd thing is that those problems were easy to see even without the benefit of history. The rate is based on self-reported rates, the banks reporting their own rates are in a position to make money off of the aggregate rate, and the rate acts as a public statement of a bank's financial stability. The final piece of the puzzle is that there was absolutely no system in place to punish banks for submitting false rates, or even for detecting false rates. Everyone saw this coming.

Why the new case is new
But the scandal was like a tidal wave -- too large to ignore and too large to outrun. UBS might be the newest casualty in the LIBOR scandal, but it's not going to be the last. I would be surprised if it was the last case to come out in 2012, and there are only a handful of working days left this year.

The case against UBS is important for two big reasons. First, it will be the first meaningful blow UBS has had to sustain this year. The trading loss fine was relatively small, and as analyst Andrew Lim said, "The fine is immaterial and the steps on the capital front are also immaterial because they are so well capitalised." While The New York Times reported a $450 million estimate for the fine, the Wall Street Journal has claimed that it could be much larger, which would add to the woes of other banks that might come under investigation.

Which bring us to the second important point. According to insiders, regulators are claiming that UBS colluded with other banks. That's very different from the Barclays allegations, and it means that other banks are potentially going to be pulled into the LIBOR scandal in a more direct way -- by being named.

The fragile future
The laundry list of problems in the banking sector needs to be heavily trimmed in 2013. The biggest problem is forcing a cultural shift on employees and managers. That can only come with new blood, and the closest we've gotten recently has come from Canada. The U.K. recently named Mark Carney as the next governor of the Bank of England, but even his breath of fresh air comes with years spent at Goldman Sachs  (NYSE: GS  ) in London.

Investors need to realize that even as more of the iceberg's tip is revealed, it's still just the tip of the iceberg. Barclays was the first out of the gate, and it's the first to be sued for LIBOR manipulation in the private sector as well. As the scandal unfolds, there's no telling where it will stop, or who will be implicated.

Until things are all sorted out, investors would be better off keeping a watchful eye on more responsible banks. The Motley Fool has a new report on Wells Fargo (NYSE: WFC  ) , which has been clean so far. Readers can get all the details on what to watch for, and what the bank has lined up for the future. Get your copy today.


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