LIBOR, rogue traders and the supply of motivated offenders

A brief trawl of media comment on the banking industry over the last few years suggests that the industry is awash with criminals and fraudsters. The picture of traders, often presented in the press, is of amoral risk-takers with bosses who are always ready to turn a blind eye if profits are being made. There has been a public parade of rogue traders from Nick Leeson to Kweku Adoboli and the LIBOR and EURIBOR scandals are setting new records in terms of the number of people implicated. So, is this picture fair, or is something more complex going on?

English: The City of London skyline as viewed ...
The City of London  (Photo credit: Wikipedia)

Criminologists Peter Grabosky and Grace Duffield suggest that fraud is the product of three factors: a supply of motivated offenders; the availability of suitable targets; and, the absence of capable guardians.

The Wheatley review of LIBOR focuses in its prescriptions on the second and third factors. Recommendations concentrate on reducing the opportunities for fraudulent manipulation of LIBOR and on strengthening oversight both through external audit and internal improvements in governance. The first factor, the supply of motivated offenders, is not addressed by Wheatley. It is to this issue that I turn below.

Unpicking the myths

I have been researching and observing the work and behaviour of financial traders since the mid-nineties; interviewing and studying large numbers of traders and their managers, collecting data on their personalities, risk-taking behaviour, performance and more recently on their physiological and emotional reactions to stress and market volatility. The findings do not reflect the press stereotype. To unpick a few myths:

There is not a particular trader personality type. On average traders are slightly more conservative and introverted than the population average but among their ranks you can find the full range of personality types.

Traders are not especially risk-takers: on average traders actually seem more risk averse in their everyday lives than the population mean. Generally traders don’t seek risks for their own sake. They bear risks and learn to manage them in pursuit of other goals.

Traders are not especially dishonest. In many cases we were struck by the emphasis placed by traders on rigorous honesty, with themselves and others.

English: BNP_Paribas_London_Trading_Floor
English: BNP_Paribas_London_Trading_Floor (Photo credit: Wikipedia)

In truth traders are not extraordinary, they are ordinary human beings with ordinary human failings and problems; perhaps somewhat at the more intelligent end of the spectrum, but not universally so.

So what are the factors that may lead these ordinary people to lie, cheat, and commit fraud? What are the factors that ensure a supply of motivated offenders?

Skill and performance are loosely coupled

Trading is skilled work, but good traders often lose money and poor traders can get lucky. There is a lot of noise in the relationship between skill and performance. Trader managers often found it hard to articulate to us what makes a good trader; falling back on phrases like ‘a certain flair’ or ‘a nose for markets’. However, most agreed that it can take a couple of years to establish if someone is any good; that good managers play down early successes and understand that even top traders have periods when everything seems to go wrong.

This can be a source of enormous performance anxiety for traders. The trader who gets lucky early on and develops an undeserved reputation (and bonus) for good judgement will feel under great pressure to maintain a level of performance that is beyond them. The good trader who is having a period of bad luck and diminished confidence can see earnings and reputation suffer. But traders build up financial commitments that reflect their earnings and faced with an inability to sustain performance (and status) can feel under tremendous pressure to take unreasonable risks or bend the rules. For example, in one of our studies we wired traders up with sensors to measure stress and emotional reactions. Overall the results showed traders struggled to manage their emotions in volatile markets. But one very experienced trader exhibited high stress when markets were quietest. He told us that he was seriously below target and when markets were quiet he had little opportunity to make money; the stress was the “difficulty of resisting the temptation to do something stupid”.

Performance related pay motivates effort not thinking

Recent research suggests that one of the important limitations of performance related pay is that competitive incentives induce people to work harder but not smarter. Excessively high rewards can lead to a ‘choking under pressure’ effect, which can create inverse relationship between incentives and cognitive performance. Whilst some thrive on pressure, others react by increasing effort at the expense of performance. To shortcut the relationship between performance and reward, some may become increasingly willing to bypass controls or expose the organisation to unacceptable and hidden risks.

Fraud is easiest when the victims are faceless

Most of us find it hard to lie to someone’s face in a way that harms them. For this reason successful con artists are rare and often have a degree of sociopathy. However, the more the victim can be distanced, the easier it is to avoid feelings of guilt. That is one of the reasons why internet fraud has become so common. The move to abbreviated forms of electronic communication in the banking industry may also bring about this distancing effect. Further, a culture in some investment banks of seeing customers as ‘marks’ to be exploited and of ‘revenue at any cost’ may encourage what criminologists call ‘neutralisation strategies’ where potential victims are disparaged and described in terms that make them seem unimportant or unworthy of respect. In the case of LIBOR manipulation it may have been easy for traders to tell themselves that for every loser there was a winner, so their manipulation was morally neutral.

Given the right incentive we are very good at fooling ourselves

Any good con artist knows that they don’t need a watertight story; given the right motivation victims will fool themselves and clever people have the most brainpower to devote to their own self-deception. Similarly in banking, if you want to know why clever people sometimes seem blind, look to the incentives. In the recent financial crisis a lot of senior bankers had been noticing unusually high levels of profits in the sub-prime market, yet seemingly failed to ask,” if we are making unusual profits, what are the unusual risks that underpin those profits”. Humans are good at ignoring information that makes them feel bad and often privilege information that shows them in a good light. The same process probably underpins why some managers failed to notice the illegal activity under their noses. While the courts will judge who was complicit in the LIBOR deception, banks also need to ask themselves whether some managers may have been unconsciously complicit.

Rules and systems don’t preclude the need for effective line management

Reflecting on several years of research in investment banks we concluded that “in a combined 70 years of experience, the authors have never encountered so little management development in sophisticated organisations of vast resource” [2: 209]. Many of the issues I outline above are tractable to good line management. There are certainly some good line managers in investment banks but since the route to management is primarily through trading, management skills are variable and there is often insufficient attention paid to selecting for or training the skill-set that trader managers really need. As is common in large organisations the gap in management capability is often filled by complex rules and systems that are difficult to police; both of which may have unintended consequences.

The Wheatley review does perhaps present part of the answer, but without improvements in skilled line management and attention to the role of perverse incentives, the conditions which ensure a continuing supply of motivated offenders are likely to continue.

1.    Duffield, G.M. and P.N. Grabosky, The psychology of fraud. 2001: Australian Institute of Criminology.

2.    Fenton-O’Creevy, M., et al., Traders: Risks, decisions and management in financial markets.2005, Oxford: Oxford University Press.

3.    Fenton-O’Creevy, M., et al., Emotion regulation and trader expertise: heart rate variability on the trading floor. Journal of Neuroscience, Psychology and Economics, 2012. 5(4): p. 227-237.

4.    Bracha, A. and C. Fershtman, Competitive incentives: working harder or working smarter? Management Science, 2012.

5.     Wheatley, M. 2012. The Wheatley Review of Libor: Final Report. HM Treasury.

A version of this article was originally published by Thomson Reuters GRC. ©Thomson Reuters 2013

10 thoughts on “LIBOR, rogue traders and the supply of motivated offenders”

  1. […] There are important parallels between the traits that make many of us easily deceived by fraud and those that make traders in financial markets easily deceived by market movements. In my own research on the behaviour of traders in investment banks, I found these well educated, intelligent and highly trained professionals to be often prone to illusions about the extent to which they were in control and able to make unbiased financial judgements. Fear, greed and the need to maintain self-esteem may make many of us more easily trapped by a telephone or internet scam, but they also account for some major mishaps in financial markets. In another blog post I discuss some of the reasons traders may turn to fraud themselves. […]


  2. Hi Steven, thanks for your feedback and for the really interesting comments.

    I do know some remarkably effective and thoughtful managers in trading rooms, but I agree that this is by no means the norm. It is certainly the case that technical skill does not by any means always translate into effective management.

    I wonder if sometimes the levels at which traders are being paid mean that there is a mutual interest between them and the bank in maintaining the illusion that they have no further development needs. Of course the more rational approach might be to ensure that trader managers have all the support they need to deliver the performance from themselves and their team that their pay justifies.


    1. It is very interesting point you make. – I think part of the problem is that traders live in a bubble, many of them get paid well in excess of what managers in other parts of the bank get paid, their pay structure means that their P&L and any other contributing factors to their pay (such a rating from clients and sales) are paramount. – In a sense this is conditioning, they have no obligation to the organisation or wider business, and do not think in terms of business or strategically. I think this is understandable in this context.

      I had a conversation recently with the global head of trading at a major investment bank, he told me that the previous year they planned to put a number of trading managers on a two day management course, the reaction was derision from those who were selected. – They did not see the relevance, nor I guess wanted to be away from the business of trading. – I think this highlights the point well.

      Until banks start aligning their incentive structures, encourage a more corporate culture within trading businesses, and providing support and training, then this is likely to contribute.


  3. Hi Mark

    Wonderful piece as usual.

    Having worked in trading departments of banks as a trader, I can vouch for the dreadful quality of bank management. This is not to say that these individuals are not well meaning individuals with high moral values, most of them in my opinion are. It is just that few if any have any management trading, or a sufficiently developed and full understanding of the big picture. Often they are grounded in the technical aspects of the job, and even then their experience will gravitate to their own particular field of expertise. I have seen the disastrous levels this has had at a micro level let alone from the macro perspective which fosters the situation which lead to examples such as the Libor fiasco.

    Hans’s comment above illustrate this nicely. However, I will echo an example which affected a good friend and ex-colleague of mine at a major bank. The incident happened a few years ago before the GFC. The trader was involved in relative value trading across fx and interest rate spot and derivative products in a number of Asian currencies. He maintained a relatively flat book with regard to outright rate and fx exposure, however he maintained a high level of basis ‘cross market and product’ risk. This meant the bank managing his risk across various different systems, where end of day valuations and risk metrics varied. As such his P&L and Risk assessment was open to a variation, and would differ significantly with his own records, maintained via spreadsheet. – The risk managers did not really understand his approach/method, the head of trading, also did not really understand his approach/method, which differed significantly from his own experience. The traders attempts to explain his approach typically fell upon deaf ears, as this would mean exposing potential ‘knowledge gaps’ of senior managers, plus over time his own numbers would prove correct (pretty much), hence he was given the necessary lattitude, ‘but’ was never really trusted.

    One year the trader was on vacation, and out of touch. – There was a ‘short-term’ dislocation in the market, and his end of day P&L showed a large discrepancy, equivalent to the traders P&L for the first 6 months of that year. – This is where the risk managers and head of trading’s ‘lack of knowledge’ and ‘distrust’ became an issue. The Head of Trading, when presented with this from took a decision to liquidate the portfolio, a horrendous decision, as the portfolio unwind, cost more than 3 times the original loss. – In actual fact the dislocation merely exposed the mis-pricing between two different systems, and the traders portfolio would have been unaffected. – The trader was dismissed soon after his return.

    The an example I have witnessed too many times over the years. – I now work as an executive and performance coach in the financial markets. – I am seeing these problems from the other sides. – MDs are often promoted from within the trading division, often though not always they are given 1 to 2 days rudimentary management training, in some cases a week. – They are completely ill-equipped for the task, and many of them become swamped. – These individuals are often technically skilled, but have little or no management expertise, and rarely any real ‘Strategic’ experience beyond their own trading experience. – There are exceptions, some make the leap superbly, but these are few and far between, and even then they are rarely given the necessary support and training to turn this to the businesses advantage. – Steep hierarchies, and rapidly changes in management with people bringing in their own teams, often adds to the problems. – It is not surprise that businesses which keep a degree of continuity, provide adequate management training and support, have a strong ethical culture, or relatively flat and open management structures tend to be far more successful and suffer from less failings.


  4. An interesting detailed explanation but what is the solution to the problem?
    The main point I noticed was that the enterprises involved were not broken down into manageable elements, it seems to me that most problems can be managed or controlled by forming them into manageable bites. Control over 75 to 85% of the actions and the remainder to be closely managed in small groups could be an acceptable solution. Regular overviews and highlighting of those actions that come over or below the median norm. This may seem a simple solution but then most smart solutions are. Trying to understand the emotions involved is interesting but I can’t see how you could manage that, as said, the people involved are of a large cross section of the population types, surely preventing this happening again by loose control and identifying risks would be acceptable. Again probably only 75 to 85% identification but much better than where we seem to be. Don’t try for 100% before you do anything, or you’ll never be in a position to implement some form of risk control. As a manager you do not have to understand every process in detail to manage it.
    It seems, no thought was given to agree any rules, limits on expenditure without some limited consultation [the guy next door desk] in a group of 5 it wouldn’t be too difficult to converse?
    I trusted my guys and gals, but encouraged them to keep me in the loop, so I could support them if they got into difficulty and it gave me the opportunity to contribute and keep watch.
    As the Americans say, ‘It happen on my watch’, but it means you, as a manager, are supposed to ‘watch’.
    Sorry, but surely that is the main function of senior managers, to watch-out for risks to their company.


      1. I agree, but from my experience good line management of emotional elements can only be done by fairly close involvement, i.e. small teams with close contact, it seems we agree that we can’t eliminate extreme emotions, so we must, to some extent, recognise and control the extreme extents. Often these emotions come from outside the workplace.


  5. Very good points! Especially about the gap in how traders are being perceived by others. I know personally a number of traders, and what I have noticed is that because they understand the volatility of market they are actually more risk averse than many others.
    Thank you for interesting post Mark!


  6. Finally a useful and well focused analysis.
    A short background for myself: Retired after 40 years in International Bank Operations and Financial Risk Management, I was – responsible for International Operations at the EABs – strongly involved in the denouement of Herstatt, integration of Franklin National’s International Operations into EAB, merging the branch of Societe Generale France into EAB, moving EABs international l operations off-shore, running risk management of EAB globally in New York, and running the US Treasury and the related trading and risk management sector for Deutsche Bank North America. Ultimately, I ran the marketing and sales activities of Wall Street Systems, a trading/risk management software that provided cross asset class straight-through processing for Financial Institutions and International Corporations. I ran the trading room of EAB and DB North America for several years.
    Here is the summation of my analysis:
    I completely agree with your findings regarding traders and trader mentality. The fundamental component of attitude and behavior lies in the fact that they are “risking” not their own wealth, but the money of an “unidentifiable” source, so that an emotional link is not established. The limit parameters are defined by the policies and behavior of the management supposedly controlling their activities. I remember during my trading days – in the late 1980s – , I got a phone call from the global head of treasury and trading a day after I had an unusually profitable day in trading. But, instead of being praised, I got a lecture on excessive trading profits, meaning excessive risk positions, and I was told to close the positions and not to follow the trade concept I had develop again. The effect on my bonus: $0. Such managerial perspectives are missing in the organizations that only have a profit orientation and are unable or unwilling to control major sectors of their organization’s activities. This is a major management flaw, and I am not sure if it can be resolved for the 25 or so TBTF financial organization. I consider them too big to manage.
    One of the most frustrating aspects of the current bank bashing activities in the fact that they all seem to circle only around the numerous symptoms of a much deeper and serious aspect, that requires resolution before attacking the individual “incidences”. In a very broad brush, the problem started in the US in the early 70s, when the Money Market Accounts (MMAs) created by the investment banking community raised the funding cost of commercial banks substantially due to the resulting disintermediation of DDA balances – that paid no interest – to the MMAs, that paid interest in the range of 5%+ for accounts that fundamentally functioned like DDAs. The resulting drop in profitability in the commercial banking industry created credit downgrades of the banks (Citi, Chemical, etc.) that raised their funding cost to the point that enabled AAA rated corporations – the former “Prime” customer base for commercial banks – to fund themselves in the capital markets (CP, Notes, Bonds etc.) cheaper than the banks could. This resulted in a substantial deterioration of the credit quality of the loan portfolio of commercial banks, and the need to find alternative funding sources.
    Simultaneously, the Eurodollar market – “created” in the 50s by the USSR placing its $ denominated assets with banks in London to avoid getting these assets frozen be the US Government – exploded through the creation of the Petrodollar. These funds were rather competitive compared to the domestic CP and Fed Fund markets. The Eurodollar market became one of the main funding source for large commercial banks, but did little to improve the shrinking margins and deteriorating credit quality of the bank’s books. The shift of commercial banks to activities of the Investment Banking industry was the result of the shrinking revenues caused by the disintermediation. Trading became a revenue mainstay in an industry that was ill prepared to cope with the idiosyncratic risks imbedded in these new and dynamically developing products. Because of exploding competition, new product development concentrated on more and more complex structures, which became less and less risk transparent, and turned into cross asset risk correlations that nobody is able to identify, quantify and manage anymore. I remember providing a risk management analysis of a $4 billion planned M&A transaction, that involved 23 separate legal entities and a combination of 53 transaction components, including Fixed & Floating Loans, Fixed & Floating Deposits, Preferred & Common Stock, CP, MTNs, Swaps, FX, Caps, Floors, Collars, Swaptions, Credit Derivatives, Premiums, etc. They included cross-default clauses and swaps, and obviously a number of covenants – FX, Interest Rate and liquidity related – that made this transaction a true financial Rube Goldberg structure. Nobody was able to asses correctly the cross-product effect of all risks, though the individual risk components of the individual products were identifiable and quantifiable. Upon raising my concerns about the risk issues and the complete lack of transparency , the comments were “We’ll take care of the risks, and transparency is not in the forefront of our concerns”. Fortunately for me, the transaction never materialized.
    I remember Alan Greenspan’s comment during the 1986 Savings and Loan debacle here in the States that holds more true than ever today:
    “We must guard against a situation in which the designers of financial strategies lack the experience to evaluate the attendant risks, and their experienced senior managers are too embarrassed to admit that they do not understand the new strategies”


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