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