The following are cryptic notes and a photo taken at the 2013 Millstein Forum held June 24 & 25 at Columbia Law School. Be sure to check out the Forum’s photo gallery. I was probably paying more attention to my table-mates than the speaker but decided to post my note and an extensive interview conducted by Bill Moyers.
BofA wasn’t required to take over Countrywide. Regional banks performed better. People need to ask questions. Boards need to understand risks. Key problem was leverage. Borrowing $30 for every $1 of equity. International standard for leverage was 3%, now going to 6%. FDIC will take control of the holding company and will support the banks through default. Recapitalize from bond. Need to make sure there is plenty of secured(?) debt at holding company. Set debt requirements to give us better market discipline. Bond holders will put on more pressure.
Systemic Risk Council. There is a run problem with money market funds. Stable NAV like bank even if assets were worth less than $1. Had to put the gates down to stop resumptions. First mover advantage to cash out in full. Have money values float based on what assets are worth. Floating NAV for nongovernment. Retail will be left holding the bag.
SEC self-funding. CFDC have to go through resource draining process. Can’t build long-term systems like IT. Really need control of their own budgets.
BILL MOYERS: Welcome to the question of the week: are the banks – banks too big to fail and too big to jail – are these monsters courting another disaster?
That’s what it looks like. As you no doubt heard, last week, the Senate Permanent Subcommittee on Investigations issued a report and hauled in key executives from JP Morgan Chase — the world’s biggest derivatives trader — demanding to know how the bank blew 6.2 billion dollars in funny money — I mean, derivatives – and hid the losses with some fancy accounting tricks aimed at fooling both regulators and the public.
Senator Carl Levin, the Chairman, bluntly summed up what they found out: “It exposes a derivatives trading culture at JP Morgan that piled on risk, hid losses, disregarded risk limits, manipulated risk models, dodged oversight, and misinformed the public.”
The trail led directly to JP Morgan’s celebrated silver-haired Chairman and CEO, Jamie Dimon, said to be Barack Obama’s favorite banker. An e-mail requesting an increase in the bank’s “risk-taking” received a two-word reply from Dimon: “I approve.”
But the well-connected Dimon – whose bank was being bailed out by almost $25 billion from taxpayers even as he was making $35 million a year — was spared from testifying personally and having to disclose exactly what he knew about the shenanigans of his lieutenants — and when he knew it.
Among the many of us who will be anxiously awaiting those revelations, should they come, is my guest, Sheila Bair. A long-time Republican, she was appointed by President George W. Bush in 2006 to head the FDIC, the Federal Deposit Insurance Corporation. During the financial collapse, she oversaw the takeover of more than 300 banks that went belly up and was an outspoken opponent of the taxpayer bailouts. As one influential observer wrote during that time, Sheila Bair never forgot that her most important constituency isn’t the thousands of banks she regulates, but the millions of Americans who use them.
She now heads the Systemic Risk Council. That’s an independent committee formed by the Pew Charitable Trusts to monitor what’s being done to prevent another financial collapse. She was at this table a few months ago to talk about her book, Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself.
And I’m pleased to welcome you back.
SHEILA BAIR: Thank you. Thanks for having me.
BILL MOYERS: I felt perhaps we were getting the bull by the horns until I saw those hearings last week.
SHEILA BAIR: Yeah, it really was amazing. I mean, a lot of that we knew already. But it was really laid out in gruesome detail in that report. It was quite shocking. You know, I don’t think– I think the system’s got incrementally safer, a little bit safer but nothing like the dramatic reforms that we really need to see to tame these large banks and to give us a stable financial system that supports the real economy, not just trading profits of large financial institutions.
BILL MOYERS: Were you surprised by anything that you heard at those hearings?
SHEILA BAIR: Well, I was, you know? I viewed, like a lot of people viewed JPMorgan Chase as a pretty well-managed bank. And so yes, I was surprised at the ability of this trader in London to build these huge positions. And even when he started calling foul the senior, the next level of management above him really didn’t get on top of it. I was not surprised but appalled by the way they were manipulating their models that are supposed to be able to determine how much risk is involved in various trading positions.
BILL MOYERS: And what advantage did they gain from manipulating those–
SHEILA BAIR: Well, there were–
BILL MOYERS: –models?
SHEILA BAIR: There were a couple things going on. One was it’s clear that they were trying to boost their regulatory capital ratios in anticipation of some new capital rules coming into effect. This is a key defect with the way regulators, bank regulators view capital adequacy at these large banks. They let those capital ratios to be determined in part by the risk models of the banks. So if the banks produce models that say, “These assets are safer,” it means they can report a higher capital ratio. So it really gives them upside down incentives to manipulate their models.
BILL MOYERS: So for the layman, what is the capital ratio? And why is it so important?
SHEILA BAIR: A capital ratio is simply the percentage of your assets, what’s on your balance sheet, the percentage of that that is funded with common equity.
So when banks have a low capital level, that means that they’re borrowing a lot to support themselves. Whether it’s a household or a big bank, you borrow too much and you don’t have enough common equity to absorb losses you– that’s what it means to fail. You start having losses. You don’t expect them. You have a very thin capital base. You can’t make good on your debt obligations. You fail.
BILL MOYERS: And this is what–
SHEILA BAIR: We fail.
BILL MOYERS: –happened in the buildup to the big crash?
SHEILA BAIR: Yeah, exactly.
BILL MOYERS: What surprised me and others that they could hide these hundreds of millions of dollars in losses, as you say, and survive even internal scrutiny.
SHEILA BAIR: Yes, and even after it was in the Wall Street Journal, you know it–
BILL MOYERS: Hiding in plain site.
SHEILA BAIR: Yeah I think it, what was going on was they were in this big power game with a bunch of hedge funds who were trying to, who realized that this London Whale trader was building up huge positions in a fairly narrowly traded product called tranche CDS. And so they outed them. You know, they were trying to squeeze them. They let the public know, “Hey, you know, JPMorgan Chase is exposed here.” And then the losses really started to mount. And it’s amazing that the papers picked up on it before the senior managers or the regulators, for that matter.
BILL MOYERS: Yeah, where were the regulators?
SHEILA BAIR: I don’t know. You know, I think we need a culture change with the regulators. I think and I talk about this a lot in my book. You’ve got a lot of good, well-intentioned people. But they confuse bank profitability with bank safety and soundness. They are not the same things.
There’s the right way and there’s the wrong way to make money. They’re almost aligned themselves to some extent with bank managers and wanting to have the appearance of profitability, because they think that makes a sound banking system. And it’s really upside down. You can’t ignore the problems here. And some of that is overlooked. It’s overlooked a lot.
BILL MOYERS: We thought we were going to get a culture change after the big crash.
SHEILA BAIR: Yeah, well, I think it’s coming slowly. But not fast enough. It’s, you know, it’s amazing that, you know, so many years after the crisis hardly, you know, less than half of the Dodd-Frank rules have been completed. The ones that have been completed, a lot of them are watered down.
BILL MOYERS: By? By?
SHEILA BAIR: It really needs to, well, the regulators succumbed to industry pressure to do this. And even some of the statutory provisions in Dodd-Frank had too many exceptions. But then we get even more exceptions since these proposed rules come out, things like the Volker Rule. You know, it should be just a simple ban on proprietary trading, but we get these very complicated rules that are very hard to enforce and easy to game.
BILL MOYERS: When Dodd-Frank and the Volker Rule managed to get through a recalcitrant Congress, many of us were hopeful. Would you tell us briefly what Dodd-Frank was supposed to do and what’s happened to it and what the Volker Rule was supposed to do and what’s happened to it?
SHEILA BAIR: Right. So Dodd-Frank was, is a very large, a very, it is a complicated law. Probably more complicated than I would have preferred. But it is what it is. But at the heart of it is ending “too big to fail.” Giving the government new tools to resolve large financial institutions when they fail in a way that will not hurt taxpayers, not subject taxpayers to risk.
Well, it forced the losses on the shareholders and creditors of those large financial institutions, which is where they belong. It also requires the Federal Reserve Board to have much tougher what we call prudential standards. So higher capital more stable liquidity, more stable funding sources, less reliance on short-term debt.
Those are the types of things that were problems during the crisis. And the Fed has been mandated. And they haven’t finished those rules yet to have better regulation to prevent these banks from getting in trouble to begin with.
And the Volker Rule, too, a key part was designed to prohibit prop trading by those institutions that are in the government safety net. So if you’re a bank holding company that has an insured bank that has FDIC backed deposits or access to the Federal Reserve’s discount window, you know, you have a lot of government support, as is provided to traditional banks.
So Volcker’s really about customer service. And your banking model should be you serving customers, making loans or, you know, if you’re facilitating trading, you make your money off of a commission, not by by trying to make a profit off the spread.
And that’s really what Volker was about. And it turned into a lot more complicated thing than it should have been.
So I do think, you know, I talk a little bit about structural changes, too, that I think could make, give us a more robust regulatory system, because now I think we have cognitive capture, which means basically–
BILL MOYERS: Wait a minute, what does that mean?
SHEILA BAIR: It means the regulators tend to look at the world through the eyes of the banks. So they don’t look at themselves as independent of the banks. They view themselves as aligned with the banks, that their charter is not to protect the public, but to protect the banks. And this is the premise of the bailouts, that somehow if you take care of the banks, you’re going to take care of the broader economy. And it just didn’t turn out that way. They’re two very different things.
BILL MOYERS: As coincidence would have it, I took your book with me on a trip last week. And I was actually reading the last chapter again, in anticipation of your coming, before I actually looked at some of the hearings. You say, “When you read about problems like the Libor or Whale scandal or the JPMorgan Chase trading losses, don’t accept gobbledygook about regulators needing more information or needing more power.” Then the next day I look at the hearings and–
BILL MOYERS: –more gobbledygook, right.
SHEILA BAIR: Well, you know, they had the information.
I mean, there were plenty of warning flags. Those examiners should have been all over this. Senior managers at JPMorgan Chase should have been all over this. It really was remarkable how kind of lackadaisical things were until the losses were right there in front of them. And then it was, you know, all hands on deck. But that was too late, at that point.
BILL MOYERS: This is what is actually scary to me. The Senate found that not only did the regulators fail to act aggressively in uncovering the risk, but that Dimon on his own for a period of time decided not to comply with federal regulations and flatly denied the regulators crucial data. Does that scare you?
SHEILA BAIR: Right. Right. Right. Well, that was amazing. And what’s troubling in that, you know, to the extent it reflects how he views examines and their role.
He was apparently worried about leaks. But I, you know, I think that most examiners are quite, you know, confidentiality is sacred with examiners. So I wouldn’t, giving examiners information, I wouldn’t worry about leaks. I don’t think that was a legitimate concern. And one that couldn’t justify denial in any event.
BILL MOYERS: Could reckless behavior like this bring the system down again?
SHEILA BAIR: It was a very big loss. But, you know, I think it underscores how even in banks that are viewed as very well-managed, how there can be major management breakdowns.
And how these derivatives, these actively-traded derivatives can generate very, very large losses in a very short period of time, how volatile they are. So, you know, I think this is all problematic and should inform some future regulatory choices. One is on the Volker Rule. Another is on bank capital. Because we don’t know the next time that six billion could be $16 billion, so the capital rules are all upside-down, they need to be fixed, and the Volcker Rule needs to be fixed.
BILL MOYERS: Do they need to be fixed? Or do they just need to be used? I thought both Dodd-Frank and Volker had pretty well put into place the tools that regulators need.
SHEILA BAIR: Well, I think they do, too. You know, the statute could have been more prescriptive. Instead, it delegated authority to the regulators to fix it. And the regulators wanted it that way. The Fed and the Treasury wanted– they didn’t want a lot of prescriptive rules in the statute itself. They wanted the authority to do it themselves.
And so they got what they wanted. But the record has not been as good as it should be. You know, the Volker Rule is still not finalized.
And what’s been proposed is very weak. It needs to be strengthened. The bank capital rules still haven’t been changed. It’s, and again, what’s been put out there is pretty weak. It needs to be strengthened dramatically.
BILL MOYERS: So for the stranger who came up to me in the Dallas Airport, where I was reading this book, looked at it, and said, “You know, I don’t understand it. I don’t even know why I should care.”
SHEILA BAIR: Yeah, he should care. Or she.
BILL MOYERS: Why should he care? Why should he care?
SHEILA BAIR: Well, because look, when this crisis hit, first of all, there were a lot of bad loans were made by large institutions that should have known better. And were there borrowers that took advantage of it? Yeah. But there were a lot of innocent victims, as well. But it wasn’t just the mortgages. When all those losses came home to roost with financial institutions that did not have enough capital to absorb those losses, what did they have to do?
They had to pull back on their credit lines. They had to pull back on their lending. And people, small businesses couldn’t get their credit lines renewed or they couldn’t get their — a lot of homeowners couldn’t get their mortgages refinanced. You know, people who were in the middle of development projects had had their money pulled.
There was this huge pullback in credit, because these large financial institutions had too much leverage. And they had to pull in their horns and nurse their balance sheet.
So you have these large financial institutions with these huge trading operations that can be subject to very sudden, volatile losses, not enough capital to absorb them. You get into another recession.
BILL MOYERS: Is the banking system safer today?
SHEILA BAIR: Yes, it is. There is more capital in the system now. That’s been done through the stress testing process that the Federal Reserve Board has led. And that has helped. That has helped a lot. We do have more capital, more of these banks balance sheets being funded with common equity and less with debt. But the ratios are still far too low.
I think people can understand that basic notion. And if you get capital levels up, you reduce the leverage. And that makes the system much, much more resilient. You know, it also– they’re better than prescriptive rules, too. Because we never know what the next stupid thing is going to be that’s going to get a bank into trouble, but if you make–
BILL MOYERS: We human beings are brilliant at figuring out the next stupid thing.
SHEILA BAIR: Yeah, so exactly. But if they have a nice thick cushion of capital, whatever that next stupid thing is, they’re going to have a much better chance of surviving it and continuing to lend to the economy than if they have very thin capital levels, which means they have a lot of leverage, a lot of borrowed money there.
BILL MOYERS: Are these big banks still too big?
SHEILA BAIR: Well, I think they are. I think it’s more complexity than size. You know, most of the, all the London Whale, Libor even most of the losses during the crisis, those were occurring in the trading operations, not the lending parts of these banks. The loans, they made some bad loans, but we probably could have handled the losses on the loans.
A bank, even a very big bank, if it takes deposits and makes loans, I think we can deal with that. The FDIC’s been dealing with that kind of business model for a long time. When loans get into trouble, generally, it’s a slower process. You have time to work with the borrower, try to mitigate losses. But with a trading loss, it’s immediate and you’re really in the soup if it’s unexpected.
BILL MOYERS: Give me a quick definition of the Libor scandal?
SHEILA BAIR: The Libor, the London Inter-Bank Offered Rate, was a process that was easy to game. It was basically a survey to a bunch of large banks that said, “If you had to borrow today, what do you think the interest rate would be that you’d have to pay?”
And so they were allowed to guess, right? They didn’t have to base it on actual transactions. And so the Libor, the traders at these large institutions figured out that if they could manipulate the rate, if they colluded and gave information together that would raise or lower the rate, that they could make money. So it was just good old-fashioned manipulation of an interest rate that’s very important to a lot of municipalities and corporations that use interest rate swaps to manage interest rate risk, as well as people who have mortgages and credit cards.
BILL MOYERS: So it could impact all of us?
SHEILA BAIR: It absolutely could. I think, you know, there’s nothing more sacred than an interest rate to the financial system. I mean, the interest rate is the primary cost of credit products. And so if you’re manipulating that rate you’ve got a problem with your financial system. And the thing that frustrates me about Libor is that this is criminal manipulation. There’s no doubt about it.
You read their e-mails that show these guys colluding with one another. And I think only two traders at UBS have been charged with criminal charges. Nobody’s gone to jail yet on it. The settlements that have occurred there again are forcing the corporations, the corporate entities at the banks to pay these huge fines. But individuals aren’t being prosecuted or brought to justice. –I don’t understand that.
BILL MOYERS: Our attorney general, as well as other Washington officials say, “Well, we can’t really prosecute them, because they’re too big they would hurt related companies.”
SHEILA BAIR: I mean, honestly, I just look, if prosecuting the individual is going to — I mean, even if you accept the premise of too big to fail, which I don’t accept, you can still sue the individuals. That’s not going to bring the system down.
BILL MOYERS: So what’s going on?
SHEILA BAIR: The financial regulatory enforcement system. It’s basically become a cost of doing business, right? So you bring these cases. You settle them. It’s paid out of the corporate pocketbook. Individuals aren’t held accountable. Very few people have gone to jail. And you don’t change behavior.
You know, the whole point of this is to change behavior. We’re just not doing it.
BILL MOYERS: I read the other day that between 2009 and 2012, JPMorgan Chase, Jamie Dimon’s bank, paid $16 billion for legal defense fees and eight billion dollars in settlement for cases involving regulatory avoidance. I mean, that’s almost a third, this estimate was, of their profits. If I was a shareholder, I’d say, “Why are you spending all that money on that?”
SHEILA BAIR: It’s amazing that the easiest way to avoid all this is to stop doing these, you know, change these behaviors.
Yeah. Well, they do. And, you know, I’m hoping Mary Jo White is going to be the new SEC chairman. She’s got a long history in law enforcement. She was obviously in the private sector for many years and that’s created some controversy. But–
BILL MOYERS: Defending big banks.
SHEILA BAIR: Yeah, but I’m going to hope with her because I think, yeah, and I think she’s at the end of her career. Her legacy’s going to be how well she does at the SEC. She’s not actually someone like her could be the very best regulator. Because they’ve been they know where all the bodies are buried.
She’s not trying to cultivate a client list to go back into practice. She, this is the last thing she’s going to be doing. But I hope she looks at the SEC enforcement strategy and starts suing individuals and looks at it as a way to change behavior, just not to rack up a bunch of press releases. And, I, you know, I think that fresh look is going to be helpful, so let’s all wish her luck.
BILL MOYERS: There are some proposals floating around Congress to break up these last remaining big banks. Are you sympathetic toward them?
SHEILA BAIR: Well, I am, though I think, you know, government’s not doing much of anything these days. You know, and I never know, these large financial institutions still have a lot of clout on the hill. So reopening Dodd-Frank and trying to get Congress to do something on this, I think it’s a very healthy discussion. But it, you know, at the end of the day, I’m not sure where it’ll take us. And so my focus has been and the focus of the Systemic Risk Council, which I chair, has really been on the regulatory tools that are already available under Dodd-Frank to deal with this problem.
The Fed and the FDIC have the authority to order a restructuring of these large banks or divestiture if they cannot show that they can be resolved in a way that doesn’t hurt the rest of the system. If they fail, they can go into a government controlled bankruptcy or a traditional bankruptcy and not impose losses on anybody else. So that’s an important showing that they have to make. And if they can’t make it, the Fed and the FDIC now have joint authority to go in there and say, “Well, you need to get smaller. You need to restructure, so we can resolve you in a way that won’t hurt the rest of the system.”
BILL MOYERS: But they also–
SHEILA BAIR: Those both need to be used.
BILL MOYERS: They also have armies of lobbyists, these big banks, that–
SHEILA BAIR: Well, they do.
BILL MOYERS: –came after you, when you were at FDIC.
SHEILA BAIR: They, well, they still do.
BILL MOYERS: Now that you’re running the Systemic Risk Council. Describe how that lobbying and the pressure works–
SHEILA BAIR: Yeah, well, it’s–
BILL MOYERS: That culture of Washington.
SHEILA BAIR: It is not good. It’s, you know, I think the lobbyists view their success rate by how much good stuff they can get for their clients, right? And their clients want to make money. So their focus is regulatory changes that will make money for their clients, not that will promote system stability.
And I’m not saying, you know, “Listen to everybody.” Sure, but, you know, understand that when those lobbyists come in, whether you’re a regulator or a member of Congress, they’re arguing their own bottom line. They’re advancing positions that are going to make them more profitable. And making them more profitable is not members of Congress’ job and it is not a regulator’s job.
So there needs to be more separation. And people need to rise up and say, “I’m sick of this, you know? And I’m going to start voting– about my vote about you is going to, you know, determine whether I think you’re on top of financial reform and whether you’re standing up to these big banks, not whether you’re coddling them or your staff’s getting jobs with them or what have you.”
BILL MOYERS: You know, as I say, I was reading this the day before the hearings. And I went back to your final chapter, where you said, “We need to reclaim our government and demand that public officials, be they in Congress, the administration, or the regulatory community, act in the public interest, even if reforms mean lost profits for financial players who write big campaign checks.” I mean, that’s a marvelous aspiration, but in practice?
SHEILA BAIR: Well, you know, I think members of Congress need to rise above, look, I know they’re under tremendous pressure to raise money to get reelected. But why are they there to begin with if they don’t want to do the public service? And, you know, my sense is do what’s right. And let the chips fall where they may. But, you know, you and I have talked nostalgically about the 1980s when we had the World War II generation in leadership ranks in Congress, and especially in the Senate. And they did rise above a lot of the special interests with tax reform and fixing the Social Security system.
You know what? They managed to survive reelection. I think really if you take principled positions, stand up for them, explain them to your constituents, you know, it may be that they’ll raise more money by refusing the Wall Street guys and going to the Main Street constituents who vote for them. And I think, at the end of the day, they’ll sleep better at night, too.
BILL MOYERS: And that’s all the more reason to read Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself. Sheila Bair, thank you very much for what you’re doing and for being with me today.
SHEILA BAIR: Thanks for having me.