Bethany McLean

This article was written in response to “How Ralph Nader learned to love Fannie and Freddie” (February 18) by Bethany McLean.

Bethany McLean’s article deserves a number of clarifying responses.

McLean injects an air of complexity and confusion with regard to my positions on a number of separate issues in what seems to be an attempt to imply a more interesting narrative for her article than exists in reality. Some clarifications are in order:

In the 1990s and early 2000s I opposed corruption in the government-sponsored enterprises (GSEs). I was clear about my admonition of the government subsidies they received in the form of an implicit government guarantee without meeting their obligations to advance affordable housing. I was clear that their drive for profits could tempt them deeper into murky legal waters. My opposition to their management compensation packages and questionable accounting practices were made plain.

Now I am advocating for the GSEs’ shareholders’ rights. This is an issue separate from the previous transgressions and corruption.

In its conservatorship of the GSEs, the federal government has used and abused GSE shareholders. It has unfairly treated the GSEs differently than other bailed-out corporations that were equally -- or more -- at fault for the financial crisis.

Corrects story issued February 18 in third-to-last paragraph regarding efforts to contact Ralph  Nader.

“It is time for [government-sponsored enterprises] to give up ties to the federal government that have made them poster children for corporate welfare. Most of all, Congress needs to look more to the protection of the taxpayers and less to the hyperbole of the GSE lobbyists. –Ralph Nader, testimony before the House Committee on Banking and Financial Services, June 15, 2000

“Fannie Mae and Freddie Mac should be relisted on the NYSE and their conservatorships should, over time, be terminated. –Ralph Nader, letter to Treasury Secretary Jacob Lew, May 23, 2013

The fate of Mathew Martoma, the former SAC Capital portfolio manager charged with the biggest insider trade in history — more than $275 million in profits and avoided losses, says the government — is now in the hands of a 12-person jury, which began deliberations in a Manhattan courthouse Tuesday afternoon.

But whatever the verdict for Martoma, the trial has been bad news for someone else: Martoma’s former boss, SAC head Steve Cohen. Given the slow, but relentless, nature of the government’s actions against Cohen, it might be worth remembering the old adage: It ain’t over til it’s over.

Cohen has, to date, famously avoided any criminal charges personally — despite a string of other government actions against both him and his firm. Last March, SAC agreed to pay more than $600 million to settle civil insider trading charges, brought by the Securities and Exchange Commission, involving Martoma’s trade. Then, on July 19, the SEC charged Cohen with failing to supervise his employees, alleging that he “received highly suspicious information that should have caused any reasonable hedge fund manager to investigate the basis for trades” made by Martoma and another manager.

Five years after the financial crisis, there’s still a hue and cry about sending people to jail. After all, financiers were, at best, self-servingly optimistic about the future. At worst, they said things that weren’t true, and made promises they couldn’t keep. Investigations are still ongoing, and although it’s doubtful, maybe some big guys will go to jail. But there’s another group of people who have injured, and are continuing to injure, millions of Americans with purposefully blind optimism and false promises. Those are politicians in every city and state that is facing a pension shortfall.

You can’t read the news without hearing about the pension problem. Last week, federal judge Steven Rhodes ruled that Detroit can proceed with the largest municipal bankruptcy in history, thereby allowing the city to cut billions of dollars in payments that are owed to city employees, retirees, investors and other creditors. In Illinois, Governor Pat Quinn signed into law a plan that will trim Illinois’s pension hole, which is viewed as being one of the deepest and darkest in the country. (Labor unions say they will challenge the plan in the courts; credit rating agencies have pointed out that the legal protection of pension benefits is particularly strong in Illinois, so it remains to be seen what will happen.)

Inevitably, there is more to come. Rhodes’s ruling could have implications for California cities, like San Bernardino and Vallejo, that are wrestling with bankruptcies. In Chicago, the pension hole is estimated at $20 billion, and according to the New York Times, payments to the local pension fund are expected to increase by $590 million in 2015 to a total annual contribution of almost $1.4 billion. “Should Chicago fail to get pension relief soon, we will be faced with a 2015 budget that will either double city property taxes or eliminate the vital services that people rely on,” Mayor Rahm Emanuel told the Times.

In capital we trust. Capital is our savior, our holy grail, our fountain of youth, or at least health, for banks. Seriously, how many times have you read that more capital will save the banks from another Armageddon? Even the banks point to capital as a reason to have faith. “Financial institutions have also been working alongside regulators to make themselves and the financial system stronger, more transparent, more resilient and more accountable,” wrote Rob Nichols of the Financial Services Forum, which is made up of the chief executive officers of 19 big U.S. financial institutions. “Specifically, capital, which protects banks from unexpected losses, has doubled since 2009.” If you were a cynic — who, me? — you might say that the mere fact that the banks are pointing to capital is proof that capital is not all that.

Everyone seems to be ignoring the basic fact that capital isn’t a pile of cash. It’s an accounting construct. On his Interfluidity blog (which I found courtesy of Naked Capitalism), Steve Waldman writes, “Capital does not exist in the world. It is not accessible to the senses. When we claim a bank or any other firm has so much ‘capital,’ we are modeling its assets and liabilities and contingent positions and coming up with a number. Unfortunately, there is not one uniquely ‘true’ model of bank capital. Even hewing to GAAP and all regulatory requirements, thousands of estimates and arbitrary choices must be made to compute the capital position of a modern bank.” In other words, even if you give bankers credit for good intentions, the accounting that would truly capture “capital” may not exist. Or as Waldman writes, “Bank capital cannot be measured.” Layer in some real world realities. The next time things get tough, will regulators once again practice forbearance and allow firms to overstate their capital, which has the perverse effect of making no one trust reported capital? Let’s not forget Lehman, which according to Lehman had a very healthy Tier 1 ratio of 10.7 percent on May 31, 2008 and a total capital ratio of 16.1 percent. This didn’t matter, because no one believed Lehman’s capital was real.

On the list of cures for the sick financial system, the concept of “risk retention” ranks right behind capital — but there are a couple of neat little twists here. The narrative of the crisis is that because mortgages could be sold off to banks, who would turn them into securities and sell those on to investors, who thought they were buying triple-A paper courtesy of the rating agencies — well, no one had any incentive to care about credit quality. In a piece in the Wall Street Journal entitled “How to Create Another Housing Crisis,” MFS Investment Management’s former chairman Robert Pozen writes, “With ‘no skin in the game,’ the originators had little incentive to determine whether the borrower was likely to default.” As a result, one provision of Dodd-Frank requires securitizers of any asset, not just mortgages, to retain 5 percent of the risk of loss. Barney Frank has said that the risk retention rules are the “most important aspect” of the legislation that bears his name.

Limbo. That’s the word most people use to describe the state of affairs in a critical part of our economy — housing finance. The government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, which were nationalized almost five years ago with the seemingly noble goal of eventually getting rid of them, now back some 90 percent of American mortgages. So much for good riddance!

But talk of reform finally seems close to action. Senator Bob Corker (R-Tenn.) and Senator Mark Warner (D-Va.) have proposed a bipartisan bill called, appropriately enough, Corker-Warner. Meanwhile, the House Financial Services Committee, led by Representative Jeb Hensarling (R-Texas), has produced its own bill, the more grandiosely entitled Protecting American Taxpayers and Homeowners, or PATH Act. Last Tuesday, during a speech in Phoenix, President Barack Obama weighed in. “Private lending should be the backbone of the housing market,” the president said. That same day there was also a housing policy forum at the George W. Bush Presidential Center in Texas, where, among others, Hensarling spoke.

Everyone (well, almost everyone) seems to agree with the president: Private lending should be the backbone of the housing market. But just how much private capital does that entail? Hensarling and most of the Republicans think the government should get out of the game entirely. American Enterprise Institute scholar Peter Wallison, a long-time critic of the GSEs, recently wrote a piece in the Wall Street Journal entitled “Competing Visions for the Future of Housing Finance,” in which he called any remaining government presence “faux reform.”

“Ex Goldman Trader Found Guilty for Misleading Investors.” “Bond Deal Draws Fine for UBS.” “JPMorgan Settles Electricity Manipulation Case for $410 million.” “Deutsche Bank Net Profit Halves on Charge For Potential Legal Costs.” “US Sues Bank of America Over Mortgage Securities.” “Senate Opens Probe of Banks’ Commodities Businesses.” “US Regulators Find Evidence of Banks Fixing Derivatives Rates.” “Goldman Sachs Sued for Allegedly Inflating Aluminum Prices.”

So goes a sampling of headlines about the banking industry from the past week — yes, just one week. We seem to be living in an era where bankers can do no right. I can’t put it any better than a smart hedge fund friend of mine, who upon reading the news about the $410 million that JPMorgan paid to make allegations that it manipulated energy markets go away, sent me an email. “I am a bank friendly type,” he said. But, he added, in typically terse trader talk, “Something structurally amiss when so much financial activity is borderline.”

By one measurement, the problem has gotten worse by an order of magnitude in recent years. In the annual letter he writes to shareholders, Robert Wilmers, the chairman and CEO of M&T Bank, has started keeping track of the fines, sanctions and legal awards levied against the “Big Six” bank holding companies. In 2011, those penalties were $13.9 billion. In 2012, they more than doubled to $29.3 billion. Wilmers writes that the past two years represent the majority of the cumulative $52 billion in charges, from 236 separate actions in eight countries, over the past 11 years. Wilmers also cites a study done by M&T, according to which the top six banks have been cited 1,150 times by the Wall Street Journal and the New York Times in articles about their improper activities. Perhaps not surprisingly, the biggest bank, JPMorgan, accounts for a sizable chunk of all this. According to a report by Josh Rosner, a managing director at independent research consultancy Graham Fisher & Co, JPMorgan has paid $8.5 billion in fines between 2009 and 2012, or about 12 percent of its net income over that period.

The government is cracking down on insider trading; isn’t that great news for you? Last Friday, the Securities and Exchange Commission charged hedge fund mogul Steve Cohen with failing to supervise two employees who themselves face insider trading charges; on Thursday morning the Justice Department filed criminal charges against his firm, SAC Capital. Earlier this summer, the news broke that New York’s attorney general, Eric Schneiderman, was investigating the early release (by Thomson Reuters, which publishes this column) of the University of Michigan’s widely-watched index on consumer sentiment to a group of investors. Faced with a court order, Thomson Reuters agreed to suspend the practice, while asserting that “news and information companies can legally distribute non-governmental data and exclusive news through services provided to fee-paying subscribers.”

In a statement, Schneiderman said that “the securities markets should be a level playing field for all investors.” Preet Bharara, who is the U.S. Attorney for the Southern District of New York, has also invoked the notion of fairness. He told CNBC’s Jim Cramer, “I think people need to believe that the markets are fair, and that the same rules apply to everyone…I don’t want to buy a stock because I have a feeling that someone knows more than I do.”

Let’s give both Schneiderman and Bharara credit for good intentions. What could be more desirable than a level playing field in the all-important game called our financial security? But the playing field isn’t level, it never has been, and I’m not sure it can ever be. If history is any evidence, attempts to level it have only tilted it all the more. So, maybe the real problem is the pretense of fairness.

So today is the day.  After weeks of near-constant coverage of the big decision — will JPMorgan Chase shareholders keep Jamie Dimon as chairman and CEO or relegate him to just CEO? — the verdict came at JPMorgan’s annual meeting in Tampa, Florida:  Dimon gets to keep both titles. The next question is whether the result will get as much press as the original question did.

The subject has gotten so much coverage in part because Dimon is so divisive. To his supporters, he’s the personification of everything that’s best about the financial system. Those who defend Dimon, like New York Times columnist Andrew Ross Sorkin, point out that JPMorgan Chase hasn’t lost money in any quarter while Dimon has been in charge. Others, including Warren Buffett, Jack Welch, Michael Bloomberg and Rupert Murdoch, praise Dimon, who is often called “America’s most famous banker,” for his management skills. But to detractors, he’s the personification of all that’s wrong with modern banking — the arrogance, the resistance to new regulation, the astronomical pay in the face of obvious mistakes. The way he acted — threatening to resign entirely if his chairmanship was taken away — is proof that he’s no more than a spoiled child.

But I wonder if the vote has gotten so much attention for another reason, which is that it’s easier to chew over Jamie Dimon than it is to think about the right structure for our financial system. Sure, the management, and the structure of that management, at JPMorgan matters.  But if I were a conspiracy theorist ‑ and really and truly, I’m not! ‑ I might even suspect that all the fuss about Dimon is supposed to make us “watch the birdie.”  It’s a distraction, meant to deflect attention from the real point, which is how we structure a financial system that best serves the needs of consumers and businesses in as safe a way as possible.

The government’s 119-page civil lawsuit against credit rating agency Standard & Poor’s for allegedly inflating the ratings it gave to residential mortgage-related securities, or RMBS, in the run-up to the crash has removed whatever lingering doubts (there weren’t many!) might have remained about just how problematic the ratings game is. But it also raises a question: Why, in cases of white-collar wrongdoing, is it often the cogs in the wheel that seem to pay the highest price?

Let’s stipulate that there are weird things about this case. To lower its burden of proof, the government is using a 1989 law that is supposed to protect taxpayers from frauds against federally insured financial institutions. The result, as Bloomberg columnist Jonathan Weil has pointed out, is that the government is claiming that some of the very banks — mainly Citigroup — that packaged the securities were also defrauded by the rating agencies.

Plausible? Well, yes, particularly for Citi, where the right hand often doesn’t know what the left hand is doing. And just because the banks fell for their own scam doesn’t mean it wasn’t a scam. But it’s still weird. It’s also weird that the government names some S&P executives but leaves others anonymous. And  it’s weird that the government has sued S&P but not Moody’s Investors Service, which at least in outward appearance was equally culpable. (S&P, for its part, has stated that it is “simply false” that it compromised its analytical integrity, and that it has a “record of successfully defending these types of cases, with 41 cases dismissed outright or voluntarily withdrawn.”)