- Five banks — JP Morgan Chase, Citigroup, UBS, Barclays, and the Royal Bank of Scotland — were hit Wednesday with $5.4 billion in fines for attempting to rig foreign exchange markets.
- Unlike in previous bank regulatory cases, the Justice Department insisted that the banks in question actually plead guilty.
- Despite this unprecedented regulatory action, the banks -- and their executives and shareholders -- will continue to prosper.
So what did the banks actually do? And how consequential will this regulatory action be?
1) What's a foreign exchange market?
International markets in foreign exchange (you can also call it forex or FX to sound hip and in the know) are where people trade currencies. Dollars turn into euros, pounds, yen, or francs and vice versa. To an extent, people need foreign exchanges to conduct international commerce. If you're an American on vacation in Spain, you are going to end up with some euro-denominated charges on your credit card or ATM card. To settle those charges, your bank is going to need some euros. On a larger scale, big international enterprises need lots of foreign exchange to conduct their business.
A McDonald's or a BMW has both revenue and expenses in various currencies around the world, and they don't always balance. You might have a lot of suppliers in Malaysia but few customers, and a lot of customers in Canada but few suppliers, so you'll need to sell Canadian dollars and buy ringitt to make your cash flow add up.
But this kind of buying and selling for commercial purposes is a minority of the FX market. Most of the trades are simply speculative. By performing fundamentals-based analysis of macroeconomic trends, "technical" analysis of market fluctuations, or algorithmic trading, people buy and sell large volumes of currency, hoping to make some quick money. The existence of a large and deep speculative market complements the commercial market by ensuring that there are usually ready buyers and sellers for whatever it is people want to do. But it can also be a source of macroeconomic instability, especially for small countries, which can suffer the real-world consequences of speculative booms and busts.
2) What did the banks do wrong?
The conduct alleged is essentially what's known as front-running. The way front-running works in the stock market is that if you know a client has placed a large order to buy shares in Apple, you can buy a few shares for yourself before executing the trade. Since your client's Apple buy will push up the price of Apple stock, you make a little profit for yourself. In stock markets in the United States and other major countries, this is illegal. But it's not illegal in the foreign exchange market — which is generally not regulated as stringently — which adds a little nuance to the allegation.
The ostensible reasons for the light regulation of forex markets are twofold. One is that unlike the stock market, ordinary consumers don't really do speculative forex trading. The other is that the forex market is supposedly so enormous that there are no real profits to be made front-running it.
The core of the charges was that traders at major banks found a loophole in this "too big" theory — you can collude. By using various online chat services to cooperate, traders were able to coordinate the timing and scale of front-running actions enough to make money. No one trade is big enough to cut through the news, but collaborating in groups with nicknames like "the cartel" and "the bandits' club" traders were able to put together big enough pools to move prices at key times. It's mostly the collusion here rather than the front-running that was illegal, though since the front-running involves ripping off the banks' own clients, the PR hit comes both ways.
3) Didn't this whole rigging/collusion thing settle already?
No. You are thinking of a different scandal that also involved bank trading desks colluding with one another to rig a financial market. That was about the London Interbank Offer Rate and has no formal relationship with the FX market issues. The fact that it's possible to become confused about exactly which market-rigging scheme we're talking about, of course, is a problem all on its own right.
4) What did regulators do about this?
Due to the inherently international nature of foreign exchange trading, plus the way the case involves the intersection of securities fraud and anti-trust violations, a staggering array of regulators are involved in investigating this matter. British and Swiss authorities were involved on their end. And in the United States, the Federal Reserve levied some fines.
But most importantly, Attorney General Eric Holder seems to have viewed the case as an effort to cement a missing piece of his legacy. Liberals generally hold Holder in high esteem for his work on racial justice and LGBT rights, but criticize him for failing to mount any major criminal prosecutions on Wall Street.
That's why the DOJ decided that in this case there would be no cash settlement without an admission of guilt. Banks were forced to enter actual guilty pleas, allowing the Justice Department to say that, yes, there have been criminal charges brought related to bank misconduct.
5) So someone's finally being held accountable for the financial crisis?
No. The financial crisis and its bitter aftermath have substantially raised the salience of all kinds of bank regulation issues, but many of them have nothing in particular to do with the crisis. Front-running in foreign exchange markets did not cause the property bubble of 2005-2006 or the real estate slump of 2007 or the financial panic of the summer of 2008 or the massive economic slump in the winter of 2008 and 2009. It is just something that happened that is illegal and that also involves some of the same institutions whose practices in the aughts contributed to some of those things.
On the other hand, one can make the case that an overall culture of laxity on the part of regulators and impunity on the part of bankers was a major contributing factor to the crisis. In that sense, any tough prosecution for anything helps.
In this case, however, there is a bit less than meets the eye to the criminal convictions. Market regulators have the authority to bar criminal banks from managing mutual funds, corporate pension plans, or other regulated financial entities. But in this case not only has the Securities and Exchange Commission issued waivers to avoid that from happening, the DOJ worked with the banks and regulators to ensure that the criminal case was not officially settled until the waivers were in place.
In other words, the very same Justice Department that proudly insisted a fine wasn't good enough to settle the case also acted to ensure that there would be no practical consequences beyond the fine.