Bill Moyers: Are the Monster Banks on the Verge of Unleashing Fresh Economic Disaster?
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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.