Introduction
In the aftermath of the 2008 financial crisis, the world was hungry for justice. People wanted to see wealthy bankers face consequences for their reckless behavior that had brought the global economy to its knees. But is it fair to blame individual bankers, or should we look at the system that enabled and encouraged their actions?
"The Spider Network" by David Enrich delves into this question by telling the story of Tom Hayes, a mathematical genius who became the fall guy for the banking industry's widespread manipulation of interest rates. This book takes us on a journey from Hayes's childhood dealings to his rise as a star trader and eventual conviction as the mastermind behind the "Spider Network."
Through Hayes's story, we get an inside look at how the most common benchmark interest rate index in the world – Libor – was manipulated, and what happens when traders, brokers, and bank executives operate without proper oversight. It's a tale of greed, corruption, and a system that rewards unethical behavior.
Tom Hayes: A Mathematical Prodigy with Social Struggles
Even as a teenager, Tom Hayes showed a remarkable aptitude for numbers and financial dealings. At just 15 years old, he was already making a profit by lending lunch money to his friends with a 50% interest rate. His fascination with patterns and numbers extended to slot machines in local pubs, where he would study their behavior to maximize his chances of winning.
However, Hayes's mathematical brilliance came at a cost. He struggled with social interactions and making friends throughout his life. Bullied in school for his neat appearance and lacking a positive male role model due to his father's early departure, Hayes found comfort in the reliable logic of mathematics.
It's likely that Hayes had an undiagnosed mild form of Asperger's syndrome. He exhibited classic symptoms: intense focus on complex mathematical problems, difficulty making eye contact, and occasional fits of rage when upset. These traits would later play a significant role in his career and legal troubles.
Drawn to the stock market's mathematical nature, Hayes interned at UBS, a Swiss bank, while studying at the University of Nottingham. This experience ignited his passion for finance, leading him to secure a permanent position at the Royal Bank of Scotland in 2001.
Understanding Libor: The Backbone of Global Finance
During his time at the Royal Bank of Scotland, Hayes was introduced to the complex world of Libor (London Interbank Offered Rate). Libor is a crucial benchmark used worldwide to determine interest rates for various financial products, from mortgages to complex derivatives.
The process of setting Libor seems simple on the surface: certain banks in London regularly submit the average rate at which they can borrow money from other banks. These submissions are then averaged to create the current Libor rate. This rate is used as a benchmark for countless financial transactions globally.
However, there was a significant flaw in this system: there was no mechanism to verify the accuracy of the banks' submissions. For years, financial institutions were simply trusted to provide honest figures. This lack of oversight would prove to be a critical weakness in the global financial system.
By the time Hayes entered the finance world, Libor had become the go-to benchmark for banks worldwide. It was referenced in the fine print of loans, credit card payments, and countless other financial products. More importantly, Libor played a crucial role in the rapidly growing derivatives market.
Derivatives are essentially contracts that banks use to insure themselves against various risks. For example, a bank might buy a derivative to protect itself if a client defaults on a mortgage. As banks created derivatives for almost every deal they made, Libor's influence on the value of these financial instruments became increasingly significant.
The Rise of Tom Hayes and the Birth of Libor Manipulation
Hayes's exceptional mathematical skills quickly propelled him to success in the finance world. In 2006, after making millions for the Royal Bank of Scotland, he accepted an offer to work for UBS in Japan. It was here that Hayes first realized the potential for manipulating Libor to his advantage.
The process was relatively straightforward: Hayes would buy derivatives whose values would increase or decrease based on Libor's movements. He would then reach out to his brokers, who would convince the people responsible for submitting their bank's Libor information to adjust the numbers in his favor.
This system quickly became a regular procedure:
- Hayes would purchase derivatives that would benefit from specific Libor movements.
- He would contact his brokers, instructing them on whether Libor needed to go up or down.
- The brokers would then reach out to Libor submitters, often offering rewards for their cooperation.
- Most submitters would comply, resulting in profits for everyone involved, especially UBS.
Unknown to Hayes, his brokers had found an even more efficient way to manipulate Libor. One broker, Darrell Read, knew Colin Goodman, who created a popular spreadsheet shared with bankers every morning. This spreadsheet included a suggested Libor rate for submitters to enter. By convincing Goodman to adjust his suggested rate, Read could influence Libor submissions without directly contacting each submitter.
The Complicity of Banks and the Rewards of Manipulation
Hayes's Libor manipulation scheme was not a solo operation. It required the cooperation of numerous individuals across various institutions, and importantly, it was tacitly approved by bank executives who benefited from the enormous profits it generated.
To compensate the brokers who assisted in his scheme, Hayes employed various tactics. One common method was the "switch trade," where two traders would set up a million-dollar trade through a broker, only to reverse it shortly after. This allowed the broker to collect hefty commissions without any real change in the traders' positions. Hayes also used more traditional methods of reward, such as expensive dinners and entertainment.
It's crucial to understand that Libor manipulation was not just tolerated but encouraged by bank executives. Mike Pieri, Hayes's boss at UBS, was fully aware of the Libor manipulation but never made any effort to stop it. The reason was simple: Hayes was making UBS obscene amounts of money.
In 2007, Hayes was generating as much as $10 million a day for UBS. In 2009 alone, he brought in well over $100 million. The executives at UBS were thrilled with his performance and tried to keep him happy with promises of substantial year-end bonuses.
However, UBS wasn't the only bank interested in Hayes's talents. Citibank, aware of his ability to generate massive profits, successfully lured Hayes away from UBS with a $3 million signing bonus. At Citibank, Hayes found the same eagerness to support his Libor manipulation tactics. His new boss, Chris Cecere, and even Citibank CEO Brian McCappin, were willing to do whatever it took to help Hayes continue his lucrative operations.
The Toxic Environment and the Beginning of the End
While Hayes's financial success was undeniable, his personal life and work relationships were far from ideal. His struggles with social interaction, likely due to his undiagnosed Asperger's syndrome, made it difficult for him to fit into the aggressive, macho culture of investment banking.
The banking environment was filled with crude language, offensive nicknames, and aggressive behavior. Hayes tried to adapt by mimicking this behavior, often screaming obscenities when things didn't go his way. However, his colleagues found his intensity overwhelming, and many were relieved when he left UBS for Citibank in 2009.
One person who wasn't happy about Hayes's departure was his former boss at UBS, Mike Pieri. Feeling betrayed by Hayes's move to a competitor, Pieri harbored a desire for revenge. This desire would soon find an outlet as investigations into Libor manipulation began to take shape.
Following the 2008 financial crisis, there was significant public pressure to hold bankers accountable for their role in the economic meltdown. It was during this time that irregularities in Libor rates began to attract attention.
Carrick Mollenkamp, a Wall Street Journal reporter, was one of the first to notice that Libor rates weren't reflecting the financial turmoil that banks were experiencing. This observation led to formal inquiries from regulatory bodies such as the US Commodity Futures Trading Commission (CFTC), the Justice Department, and Britain's Serious Fraud Office.
As these investigations progressed, Hayes found himself increasingly isolated and under scrutiny. His former colleagues, including his vengeful ex-boss Pieri, were all too willing to provide information that implicated Hayes as the mastermind behind the Libor manipulation scheme.
The Unraveling of the Spider Network
The turning point in the Libor investigation came when Barclays bank, hoping for leniency, provided direct evidence of their involvement in Libor manipulation. This included a recording of Barclays employees discussing executive orders to manipulate Libor rates.
As more evidence emerged, it became clear that Libor manipulation was a systemic issue within the banking industry. However, Hayes was increasingly singled out as the primary culprit, the "bad apple" responsible for orchestrating the entire scheme.
The testimonies of Hayes's former colleagues, particularly those from UBS, proved especially damaging. Armed with this information, investigators arrested Hayes on December 11, 2012.
By this time, Hayes was married to Sarah Tighe and had a young son. The stress of the case against him took a severe toll on his mental health, leading him to contemplate suicide at one point. However, he eventually found the strength to fight back, pleading "not guilty" when formally charged.
Hayes's defense team portrayed him as a product of a corrupt system, arguing that Libor manipulation was common practice long before Hayes became involved. They also highlighted how Hayes's Asperger's syndrome made him particularly susceptible to the influence of his superiors, who had encouraged and rewarded his behavior.
Despite these efforts, Hayes was ultimately convicted and sentenced to 14 years in prison, a verdict that left his wife in tears and his young son without a father.
The Scapegoat of a Broken System
The Libor scandal revealed deep-rooted problems within the global financial system. While Tom Hayes played a significant role in the manipulation of Libor rates, it's clear that he was far from the only culprit. The scandal required the cooperation and coordination of numerous individuals across multiple institutions.
Yet, when it came time for accountability, Hayes was the only one to receive a severe punishment. His 14-year prison sentence stood in stark contrast to the outcomes for others involved in the scandal.
Six other brokers, including Hayes's longtime associate Darryl Read, were put on trial in England but were acquitted. They all pointed the finger at Hayes, characterizing him as the mastermind behind the scheme.
The fact that Hayes was socially awkward and often difficult to work with made it easy for his former colleagues to paint him as a villain. Many were willing to lie or exaggerate Hayes's role to protect themselves from blame.
This outcome raises important questions about justice and accountability in the financial sector. While Hayes certainly bears responsibility for his actions, the focus on him as the primary culprit obscures the systemic issues that allowed and encouraged such behavior in the first place.
Attempts at Reform and the Persistence of the Problem
In the wake of the Libor scandal, some individuals have attempted to address the root causes of the problem. One such person is Alex Stenfors, a former trader who was fired from Merrill Lynch for his involvement in Libor manipulation.
Stenfors used his experience as motivation to pursue a PhD at the University of London, writing a thesis that detailed the realities of the Libor scandal. Now, as a professor at the University of Southampton, he teaches a class that includes a presentation called "Risk Takers, Rogue Traders and Rotten Apples." This course examines the sociology behind the cutthroat and ethically corrupt financial system.
However, despite Stenfors's efforts to expose the ugly realities of high finance, he still encounters young men eager to enter this world, attracted by the prospect of quick wealth. This persistence of attraction to the financial sector, even in the face of its known ethical issues, highlights the ongoing challenge of reforming the system.
The Broader Implications of the Libor Scandal
The Libor scandal and Tom Hayes's story reveal several important truths about the global financial system:
Systemic Corruption: The scandal showed that unethical behavior was not limited to a few "bad apples" but was endemic to the system itself. Banks, brokers, and traders across the industry were involved in or aware of the manipulation.
Lack of Oversight: The ease with which Libor was manipulated for years highlights the severe lack of oversight in crucial areas of the financial system. Regulators and industry leaders had placed too much trust in banks to self-report accurate information.
Misaligned Incentives: The financial rewards for unethical behavior far outweighed the perceived risks. Traders like Hayes were incentivized to make money by any means necessary, with little regard for the broader consequences of their actions.
Scapegoating: When the scandal came to light, the industry was quick to pin the blame on individuals like Hayes, deflecting attention from the systemic issues and the role of senior executives in fostering a culture of manipulation.
The Human Cost: While the financial impact of the Libor scandal was enormous, the human cost is often overlooked. Hayes's story, from his childhood struggles to his imprisonment, illustrates the personal tragedies that can result from a corrupt system.
Challenges of Reform: The continued allure of the financial sector to young professionals, even after the exposure of its ethical failings, shows the difficulty of implementing meaningful reform.
Conclusion: The Need for Systemic Change
The story of Tom Hayes and the Libor scandal serves as a stark reminder of the deep-rooted issues within the global financial system. While it's easy to vilify individuals like Hayes, the reality is far more complex. He was a product of a system that not only allowed but encouraged and rewarded unethical behavior in the pursuit of profit.
The aftermath of the 2008 financial crisis created a public demand for accountability, and Hayes became a convenient scapegoat. However, focusing solely on punishing individuals like Hayes misses the larger point. To prevent future scandals and protect the global economy, we need to address the systemic issues that allow such manipulation to occur.
This means implementing stronger oversight mechanisms, realigning incentives to promote ethical behavior, and fostering a culture of accountability at all levels of financial institutions. It also requires a shift in how we educate and train future finance professionals, emphasizing ethical considerations alongside technical skills.
Furthermore, the public and policymakers need to maintain pressure for reform, even years after the initial scandal. The allure of quick wealth in finance remains strong, and without constant vigilance, old patterns of behavior can easily reemerge.
Ultimately, the Libor scandal and Tom Hayes's story should serve as a cautionary tale. It reminds us that in a system where money is the primary measure of success, ethical considerations can quickly fall by the wayside. Only by addressing these fundamental issues can we hope to create a financial system that serves the broader economy rather than putting it at risk for the benefit of a few.
As we move forward, it's crucial to remember that while individuals must be held accountable for their actions, true change can only come from reforming the system itself. The story of the Spider Network is not just about Tom Hayes or Libor; it's about the need for a fundamental reevaluation of how our global financial system operates and the values it promotes.