J.P. Morgan Chase (NYSE:JPM), along with five other financial institutions, was fined a staggering $2.32 billion (€1.71 billion) on Wednesday by European Union regulators. They were fined for colluding to manipulate benchmark interest rates. The five other financial institutions are some of the largest banks in the world: Deutsche Bank (NYSE:DB), Citigroup (NYSE:C), Royal Bank of Scotland Group (NYSE:RBS), and Société Générale SA.
This fine is the European Union's biggest penalty to date on any cartel. In total, EU regulators have levied $ 8 billion (€6 billion) in penalties against financial institutions and interest-rate benchmark to improve profits, including the Libor (London interbank offered rate) scandal.
In free market theory, there should be friendly competition between the banks to keep healthy interest rates, but, in practice, the banks found it more profitable to work with each other to fix rates.
J.P. Morgan Fighting on other Battlefronts
Besides its suspected role in colluding with other major financial institutions around the world to rig key rates, regulators are also pursuing J.P. Morgan in relation to other possible allegations. For instance, J.P. Morgan may have colluded in a separate cartel in a European version of Libor called Euribor. Additionally, J.P. Morgan has already been fined $109 million (€80 million) for its role in a Libor- like scandal related to the Japanese Yen.
A J.P. Morgan spokesman made it clear that the bank was planning on defending itself against the allegations by EU Competition Commissioner Joaquín Almunia. Meanwhile Mr. Aluminia is promising "adequate sanctions" for those financial institutions found guilty of grand-scale financial manipulations.
U.S. Banks Colluding With European Cartels
Before the Libor scandal, U.S. banks were absent from the list of punished institutions --which was limited to European financial institutions--due to insufficient evidence. However, after the Libor probe, J.P. Morgan and Citigroup, were fined $95 million (€70 million) for their role in manipulating key rates.
Exploring the Significance of the Findings
Although the fine on Wednesday may have appeared to come out of nowhere, it was, in fact, the result of an investigation begun over two years ago on EU cartels. Moreover, the EU regulators are not alone in their suspicions, because their findings are similar to probes made by British and U.S. regulators on widespread efforts to manipulate interest rates. These investigations by U.K. and U.S. regulators were focused on fraud by groups of traders within the same financial institutions; the E.U. regulators expanded this investigation by investigating interbank collusions.
What may be pivotal in the E.U. regulators investigations is not the size of the fines, although that certainly attracts attention, but that there is enough evidence to make it difficult for the banks to get away with complete denial. Obtaining even modest admissions for wrongdoing is a huge win for regulators.
Manipulating key benchmark interest rates is a serious issue affecting the world economy. It is not confined to the world of banking because it has a powerful influence on national economies, impacting important economic indicators like mortgages, corporate loans, and financial derivatives.
"We Didn't Know"
The primary defense by the banks has been a strategy that is familiar in politics-"the chief did not know." It was the classical defense in the Iran-Contra affair in the 1980s Oliver Laurence 'Ollie' North case. At that time, President Ronald Reagan and senior Government officials claimed not to know that the U.S. was involved in selling weapons to Iran to release U.S. Hostages in Lebanon and that the money was being diverted to assist Contra rebels in Nicaragua.
In the case of J.P. Morgan, a similar line of defense is being used: senior executives were not aware of a rogue band of traders in their very own institutions involved in less-than-ethical banking practices. However, regulators, especially EU officials, are taking a hard line against this defense, saying that the alleged lack of knowledge, cooperation, or participation by senior executives did not absolve the institutions for actions taken by their employees.
J.P. Morgan has settled again, but how long can it continue to get away with flaunting banking ethics. While this latest scandal may or may not negatively impact their stock price, the issue is actually much larger. After all, cartels do more than just improve their own profit margins; they also undermine national and global economies and increase recessionary trends.
What Should Investors Do?
Investors in these mega banks should consider taking some profits in the mega banks because they have done well this year along you the rising market and we believe more problems will surface in 2014 from their past bad behavior.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.