mission is to promote passion and creativity in our society. the bernard and audrey rappaport foundation. and gummowitz. the betsy and jesse fink foundation. and by our sole corporate sponsor, mutual of america, designing customized, individual, and group retirement products. that's why we're your retirement company. 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 an hauled in key executives from jpmorgan chase, the world's biggest derivative trader, demanding to know how the bank blew $6.2 billion 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 evan, the chairman, bluntly summed up what they found. quote, it exposes a derivatives trading culture at jpmorgan that piled on risk, hid losses, disregarded risk limits, manipulated risk models, dodged oversight, and misinformed the public. the trail that directed the jpmorgan celebrated silverhead 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 dispose 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 bear, a long-time republican. she was appointed the head of the fdic. 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 bear never forgot her most important constituency isn't the thousands of banks she regulates but the millions of americans who use them. she now has the systemic risk council, an independent committee formed by the pugh charitable trust 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." i'm please the to welcome you back. >> thank you. >> i thought perhaps we were getting the bull by the horns until i saw those hearings last week. >> yeah, it really was amazing. a lot 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 has incrementally safer, a little safer, but nothing like the dramatic reforms we really need to see to tame these large banks and give us a stable financial system that supports the real economy, not just trading profits of a large financial institution. >> were you surprised by anything you heard at those hearings? >> i was. i viewed i, like a lot of peopl jpmorgan chase as a free will managed bank. i was surprised at them to build these huge positions and even when he started calling foul, the next level of management above him really didn't get on top of it. i was not surprised by 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. >> what advantage did they gain from manipulating those positions? >> well, there were a couple things going on. one was it was clear they were trying to boost their regulatory capital ratios in anticipation of 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 left those capital ratios to be determined in part by the risk models of the banks. the banks produce models that say these assets are safer. that means they can report a higher capital ratio. it really gives them upside down incentives to manipulate the models. >> for the layman, what is the capital ratio? >> a capital ratio is simply the percentage of your assets, what's on your balance sheet, the percentage of that funded with common equity. when banks have a low capital level, that means 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, 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. >> this is what happened in the buildup to the big crunch. >> exactly. >> what surprised me is they could hide these hundreds of millions of dollars in losses that you say and survive even internal scrutiny. >> yes, and even after it was in the wall street journal, you know -- >> hiding in plain sight. >> yeah, i think what was going on was they were in this big power game with a bunch of hedge funds who realized this london oil trader was building up positions in a narrowly traded product. they were trying to squeeze them. they let the public know, jpmorgan chase has exposed you. then the losses really started to mount. it's amazing the papers picked up on it before most senior managers or the regulators. >> where were the regulators? >> i don't know. i think we need a culture change with the regulators. i talk about this a lot in my book. you've got a lot of good-will intentioned people, but they confuse bank profitability with bank safety and soundness. they're not the same thing. there's the right way and there's a wrong way to make money. they're almost aligning themselves to bank managers and wanting to have the appearance of profitability because they think that makes a sound banking system. it's really upside down. you can't ignore the problems here. some of that is overlooked. >> we thought we were going to get a culture change after the big crash. >> yeah, well, i think it's coming slowly but not fast enough. it's amazing that, you know, so many years after the crisis less than half of the dodd frank rules have been completed. a lot of them are watered down. >> by? >> well, the regulators have come to do this. some of the provisions in dodd frank had too many provisions, but we get more exceptions when these proposals come out such as the volcker rule. we get these rules that are hard to enforce and easy to game. >> when dodd frank and the volcker 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 volcker rule was supposed to do and what's happened to it? >> dodd frank is a very large -- it is a complicated law. probably more complicated than i would have preferred, but it is what it is. at the heart of it is ending too big to fail, giving the government new tools to resolve large financial institutions when they feel in a way it will not hurt taxpayers and not subject them to risk. well, it forced losses on the shareholders and creditors of the large financial institutions, which is where they belong. it also requires the federal reserve board to have much tougher prudential standards, so higher capital, more stable liquidity, less reliance on short-term debt. those are the types of things that were problems during the crisis and the fed has been mandated to have better regulation to prevent banks from getting in trouble to begin with. the volcker rule, too, a key part, it was designed to prohibit proprietary trading by those institutions in the government safety net. if you're a bank holding company that has an insured bank that has fdic-backed deposits or access to the federal reserves discount window, you have a lot of government support provided to traditional banks. so volcker is really about customer service. your banking model should be serving customers, making loans. if you're facilitating trading, make your money out of a commission and not by trying to make a profit off the spread. that's really what volcker was about. it turned into a lot more complicated thing than it should have been. i talk a little bit about structural changes that i think could give us a more robust regulatory system because now i think we have cognitive capture, which means -- >> what does that mean? >> it means the regulators tend to look at the world through the eyes of the banks. they don't look at themselves as independent of the banks. their charter is not to protect the public but to protect the banks. this is the premise of the bailout. if you take care of the banks, you'll take care of the broader economy. it doesn't turn to out that way. >> i took your book on a trip last week. i was reading the last chapter again in anticipation of your comi coming. you say when you read about problems like the libor scan dl or the jpmorgan chase trading losses, don't accept gobbledygook about regulators needing more information or needing more power. the next day i look at the hearing and more gobbledygook. >> well, you know, they had the information. there were plenty of warning flags. examiners should have been all over this. it really was remarkable how lackadaisical things were until the losses were there in front of them. then it was all hands on deck, but it was too late at that point. >> this is what's scary to me. the senate found not only did the regulators fail to act aggressively in uncovering the risk r 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? >> right. well, that was amazing and was troubling in that -- to the extent it reflects how he views examiners and their role. he was apparently worried about leaks, but, you know, i think most examiners are quite, you know, confidentiality is sacred with examiners. i wouldn't worry about leaks. i don't think that was a legitimate concern or one that was justified. >> could reckless behavior like this bring the system down again? >> it was a very big loss but, you know, i think it underscores how even banks that are viewed as very well managed how there can be major management breakdowns and how these derivatives can generate very, very large losses in a very short period of time, how volatile they are. so i think this is all problematic and should inform some future regulatory choices. one is on the volcker rule. another is on bank capital. the next time, that $6 billion could be $16 billion. the capital rules are all upside down. they need to be fixed. and the volcker rule needs to be fixed. >> do they need to be fixed or used? i thought both dodd frank and volcker had pretty well put into place the tools that regulators need. >> 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 treasury didn't want a lot of prescriptive rules in the statute itself. they wanted the authority to do it themselves. they got what they wanted, but the record has not been as good as it should be. the volcker rule is still not finalized. what's been proposed is very weak. it needs to be strengthened. what's been put out there is pretty weak. >> so for the stranger who came to me in the dallas airport where i was reading this book and looked at it and said, you know, i don't understand it. i don't even know why i should care. >> yeah, he should care, or she. >> why? >> well, look, when this crisis hit, first of all, there were a lot of bad loans made by large institutions that should have known better. were there borrowers that took advantage of it? yeah. but there were a lot of innocent victims as well. 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 the credit lines. they had to pull back on lending. people, small businesses, couldn't get their credit lines renewed or couldn't get their -- a lot of homeowners couldn't get their mortgages refinanced. you know, people who are in the middle of development projects had their money pulled. there was a huge pullback in credit because thee large financial institutions had too much leverage, and they had to pull in their horns and nurse their balance sheet. you had these large financial institutions with huge trading operations that could be subject to volatile losses, not enough capital absorbed them. you get into another recession. >> is the banking system safer today? >> 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. if you get capital levels up, you reduce the leverage. that makes the system much more resilient. they're better than prescriptive rules too. we never know what the next stupid thing is going to be that's going to get a bank into trouble. >> we human beings are brilliant. >> exactly. if they have a nice 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 our money. >> are these big banks still too big? >> well, i think they are. it's more complexity than size. most of the losses during the crisis, those were occurring in the trading operations, not the lending parts of these banks. the loans, they immediate some bad loans, but we probably could have handled the losses on the loans. even a very big bank, if it takes deposits and makes loans, i think we can deal with that. the fdic has 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. >> give me a quick definition of the libor scandal. >> the libor, the london inner bank offered rate, was a process that was easy to gain. 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? so they were allowed to guess, right. they didn't have to base it on actual transactions. so the libor, the traders at these large institutions figured out if they could manipulate the rate, if they colluded and gave information together that would raise or lower the rate, 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 used interest rates to manage interest rate risk as well as people who have mortgages and credit cards. >> so it could impact all of? >> it absolutely could. there's nothing more say sacred than an interest rate to the financial institution. if you're manipulating that rate, you got a problem with your financial system. the thing that frustrates me about libor, this was criminal manipulate. there's no doubt about it. you read the e-mails of these guys colluding with one another. i think only two traders at ubs have been charged. nobody has gone to jail yet on it. the settlements that have occurred are forcing the corporations, the corporate entities of the banks to pay these huge fines, but individuals are being prosecuted or brought to justice. i don't understand that. >> our attorney general and other officials say, well, we can't really prosecute them because they're too big. they would hurt related companies -- >> i mean, honestly, 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. >> so what's going on? >> 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. you don't change behaviors. the whole point of this is change behavior. we're just not doing it. >> i read the other day that between 2009 and 2012 jpmorgan chase, jamie dimon's bank, paid $16 billion for legal defense fees and $8 billion in settlement for cases involving regulatory avoidance. i mean, that's almost a third of their profits. if i were a shareholder, i'd say why are you spending all that money? >> it's amazing that the easiest way to avoid all this is to stop doing it, change these behaviors. mary jo white will be the new s.e.c. chairman. she's got a long history in law enforcement. she was in the private sector for many years. that's created some controversy. >> defending big banks. >> i'm going to hope with her. i think she's at the end of her career. her legacy is going to be how well she does at the s.e.c. someone like her can be the very best regulator because they know all the bodies are buried. she's not trying to cultivate a client list to go back into practice. this is the last thing she's going to be doing. but i hope she looks at the s.e.c. enforcement strategy and starts suing individuals and looks at it as a way to change behavior not just a way to rack up press releases. i think that fresh look is going to be helpful. let's all wish her luck. >> there are proposals floating around congress to break up these last remaining big banks. are you sympathetic toward them? >> i am, though i think government is not doing much of anything these days. i never know -- these large financial institutions still have a lot of clout on the hill. reopening dodd frank and trying to get congress to do something on this, i think it's a very healthy discussion. at the end of the day, i'm not sure where it will take us. my focus has been, and the focus of the systemic risk council, has been on the regulatory tools that are already on the table with 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 can't show 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. that's an important showing that they have to make. if they can't make it -- but then the fdic have now joined authority to say, well, you need to get smaller, restructure so it can resolve you in a way that won't hurt the rest of the system. >> they also have armies of lobbyists, these big banks, that came after you when you were at fdic. >> they still do. >> now that you're running the systemic risk council. describe how that lobbying and that culture of washington works. >> it is not good. you know, i think the lobbyists view their success rate by how much good stuff they can get for their clients, right. their clients want to make money. their focus is regulatory changes that will make money for their clients, not to promote system stability. i'm not saying, you know, listen to everybody, sure, but understand when those lobbyists come in, whether you're a regulator or member of congress, they're arguing their own bottom line. they're advancing positions that are going to ma