Imagine a great ship dominating the skyline on a distant sea. Imagine the complexity of that ship: keel, ribs, planks, masts, spars, and an infinite number of less readily named components. Each component was hand-crafted by a craftsman skilled in his trade, to precise requirements, and secured in position to take the stress and strain of a life at sea.
Now imagine a crew. They didn't build the ship. The crew are told that the one and only purpose of the ship is to realise a profit for every man jack aboard. Any hand not contributing a profit will be turned ashore.
Down below in the ship are nails. Thousands and thousands of nails. Nails are useful. Nails are much sought after in every port the ship enters. Nails can be readily sold and never traced.
The crew has been told that their purpose is profit. They have taken the lesson to heart. In every port they assess the value of the nails, and compare it to their function in the ship.
They tell themselves that the lubbers at Admiralty have no idea of ships. They specified too many nails in the regulations for ship procurement and licensing. The ship will be just fine with fewer nails.
So the crew below starts sneaking out the nails and selling them in the ports. They self-certify to their warrant officer, who self-certifies to the midshipman, who self-certifies to the lieutenant, who self-certifies to the captain, who self-certifies to the admiral, who self-certifies to the Sea Lords that every nail is where it should be and the supply of surplus nails remains adequate to meet unexpected reverses. And they turn a profit, so everyone is happy and the crew are given bonuses.
Until there is a leak, no one bothers to check the inventory of nails still in the woodwork. And when there is a leak, it is taken by all involved to be a localised problem that can be solved with a local solution, stemming the flow into the bilges from that one leak.
No broader inventory of nails is ever suggested. The crew are asked to conduct a stress test scenario that confronts a gale, or an enemy warship, and they self-certify that they would remain sound.
When RMBS valuations and ratings were questioned in 2007, it was taken to be a localised leak. Bear Stearns, Lehman and Northern Rock were sunk, but surely the rest of the fleet was still sound with a bit of extra liquidity to keep them afloat.
But a crew that is accustomed to enriching itself selling nails is unlikely to stop just because the Admiralty takes an interest and orders more nails be provided to shore up the creaking woodwork. They will take all the nails Admiralty is generous enough to provide and keep selling them in every port. Their purpose is profit, and profit they must. The ships still creak, the water gets deeper in the well each watch, but the self-reporting of the ships' condition improves in every dispatch to the Admiralty.
This is where we are, and this is what the LIBOR scandal reveals. Self-certified valuations of fixed income, OTC derivatives and other instruments not traded and valued on exchanges should all be suspect. Even the exchange valuations should be suspect, as they are influenced by the OTC positions. Some of those ships are being held together by the collective greed of the crews, unwilling to lose the means of profit at the Admiralty's (and taxpayers') expense.
No one suggests that we can let them all sink to the bottom as a lesson to seamen who follow. The navy is critical to our image of ourselves as strong and resilient. The navy must be saved. But how, when every nail that is sent aboard is sold in the next port to the profit of a man with no loyalty to the crown or the ship?