Are We Safer?

After all the hearings and all the attention spent on it all, the lessons we should draw from MF Global [derivatives broker]?

Well, it's really quite striking. Here we are again, three years after the crisis. And here is a major financial house that's leveraged 40-to-1, meaning for every dollar of capital, they're borrowing $40, the same kind of leverage ratios that brought down Bear and Lehman and would have brought down Goldman or Merrill or the others had they not been rescued by the United States government.

Now, if MF Global ends up being a small enough institution, where they rise and fall, fine. Of course, what's also striking is the extent to which it looks like, again, the regulatory system and their own internal checks missed what may be, you know, enormous sums of money not yet found.

What was your overview of what Dodd-Frank [Wall Street Reform and Consumer Protection Act] became? Is it too weak? Does it do enough? It still doesn't break up "too big to fail" banks.

Look, yes and no. I think Dodd-Frank does a lot of things good that needed to be done. Now, on addressing "too big to fail," no phrase is more misleading than "too big to fail," because it wasn't about big. If you took the biggest banks in America, if you took Bank of America and you said, "We are going to just break them up to make them smaller," you could break them into six pieces, and every one of those pieces would be bigger than Bear Stearns was.

That wasn't the problem. It wasn't just the size of people that made them dangerous. It was how connected they were and how much fear of contagion was there. So if they went down, would they take down their neighbors? Dodd-Frank does a lot of things to try to limit the ability of one bank to blow up its neighbors and thereby to take a bunch of people hostage when they get in trouble. And that part is very important.

Now, like all legislation, there's a whole bunch of other stuff in there, too. And I'm sure people will go back and argue about a lot of other things for years to come. But the idea that we ought to stick with the status quo, that got us into the worst financial crisis ever is almost criminally insane.

So we have a problem again. What does the federal government have to do?

Well, for all the rhetoric that there won't be bailouts again -- and Dodd-Frank has changed the law so as to not allow emergency loans to specific institutions -- it's hard to imagine that we won't face the same kind of dilemma as we did in 2008 unless we make fundamental changes, unless we perhaps break apart the largest banks in this country, unless we really do move away from a system that's crippled by too-big-to-fail“too big to fail” institutions in the critical moments.

Dodd-Frank is supposed to do a big piece. But again, a big rearguard action being waged by Wall Street and by political allies on the Hill who keep, for example, trying to strip away money from the Securities and Exchange Commission, strip away money from the Commodity Futures Trading Commission so they can't succeed, blocking appointments to key positions -- Wall Street, in the first quarter of 2011, after Dodd-Frank was signed, spent about $52 million on lobbying to try to thwart the implementation of that law and its regulations.

And so next, what did you do?

So the next thing is I learned about working groups and how working groups are organized. And I thought to myself, I just don't have time for that. I have three kids; I have a full-time job. But I would love to join someone else's working group and go to the meetings.

And pretty soon my friend, who, as I said, walks through Zuccotti Park every day, told me that there was an alternative banking working group being set up. So I went down to Zuccotti Park and I found the e-mail address of [director of diplomatic advisory group Independent Diplomat] Carne Ross, and I e-mailed him and said, "I'd love to be part of this group." So I --

He's the guy running the group?

Yeah, he started the group. And I went to the first meeting in his office. And it was really exciting, and there were quite a few people there, maybe 30 or 40 people, and a bunch of people on the phone, and we had a really exciting feeling. You know, here we are; we want to help this system; we want to fix it or create a new one, like, "Let's do this." You know, it was really cool.

And we met again the next week. It was even more popular by then. I think there were more like 60 people. And we had some really interesting people join it. A lot of the people were from the inside, so I realized I wasn't the only person -- and my friend who told me about it was also there -- that was in finance and wanted to change the system. We had quite a few people from the SEC [Securities and Exchange Commission], from banking, from hedge funds, all over the place. It was so large, in fact, the meeting, that Carne asked us to split into two groups at the end of the second meeting.

So we split into two groups. One of them, which Carne is still with, talks about reimagining the financial system, just starting a new system. And they're trying to work on opening a bank that sort of follows kind of a mission that they've written down, and an ethic.

And the other group, which I started facilitating in that second meeting, is talking about how the current system works and possible improvements to the current system -- reform, essentially. So to that end we do things -- we are trying to help the regulators do their job, become adversaries of Wall Street. One of the projects we're working on is submitting public comments to the Volcker Rule, [a section of the Dodd-Frank Wall Street Reform and Consumer Protection Act]. So there's a subgroup called Occupy the SEC that's part of alternative banking.

And they're putting together a long letter to the SEC explaining what their comments are on the implementation the SEC is suggesting for the statute, which is written from the Volcker Rule. And I was actually on a call with the SEC last week about that. It was really fascinating.

One of the things I realized is that the SEC is filled with people that are probably not quants. They're closer to lawyers, I think, so they're very technically correct on a lot of things. But when I asked them about, "How is this risk section going to really expose proprietary trading so that the Vol…" To back up just a second, the goal of the Volcker Rule is to separate proprietary trading from banks that are supposed to be deposit holding banks and only engage in market making, not proprietary. So they're not supposed to take risky bets if they have people's money.

And, well, how do you tell? How can you figure out whether someone's taking risky bets? And one of the ideas in the Volcker Rule is we'll keep an eye on the risk numbers. If the risk numbers vary wildly, then it's a good chance that they're doing proprietary trading.

But the risk section of the Volcker Rule is really vague, really vague. And, you know, I worked in risk, so I explained to them: "... If I'm a bank, I can game this. I can game this requirement to make my risk numbers as small as I want for various reasons." And the SEC people -- there were 11 people on the call, and I mean, they were really nice, right; this is not a criticism of them as people, but their background, I mean, they just said, "Well, we'd really love if you could come up with better wording for that section."

And it just hit me. I was like, these people, they're not experts in this. We need people at the SEC who are experts, who have gamed the system in this way, and write down the regulations so that they couldn't even game that system."

Is there some truth to the fact that Washington is soft on Wall Street?

Oh, is Washington soft on Wall Street? I think yes. I do think that in 2009, the Dodd-Frank bill did make some important changes that Wall Street resisted. And the administration stood up, and the Democratic leadership in Congress stood up. But, you know, it's going to take some real work to change a culture that developed over 30 years. I mean, first of all, for 30 years, many regulators approached banks on the basis that they were not so much regulated entities as partners together, when, in fact, the job of public oversight is to exercise public oversight.

In fact, if you listen to some of the testimony given to us during the commission, regulators told us time and time again that they were urged not to be confrontational with banks. But in fact, in the end of the day, what we want are regulators who are. So that culture changes slowly.

Secondly, there is a real mismatch here. I mean, we have regulatory agencies that are understaffed, where pay is not what it needs to be to attract and keep people. What I saw -- and I really wasn't aware of this before I took this position -- but I was struck by the number of people who would work for a regulatory agency for three or four years, and then it was three or four years up and out to Wall Street.

And look, unless we have the political will to back our regulators and then give them the pay and the resources to do their job, it's going to be a mismatch. Look, Wall Street is like a greased pig. It moves fast. It's always looking for the new opening. Hard to catch. And unless you recognize that mismatch, you're going to continue to have Wall Street with victories at the expense of the American people.

The fact is that in the wake of this crisis, there has been very little rethinking of the practices on Wall Street. Why is that? Generally we learn, we grow from the consequences of our mistakes. But Wall Street was spared the consequences of their mistakes. They didn't really pay a price for those kind of practices in any real terms.

And the irony of the bailout is it may have saved the financial system, but it may have done great damage in terms of our ability to have Wall Street rethink what was right, what was wrong, what was sustainable, what was not.

So let's go to the basics.

Sure.

"Too big to fail." Number one, what does it mean? And why is it the danger that you define?

Well, "too big to fail" means an institution that, if it falls, essentially sets off a domino effect. And the fact is that leading into this crisis, we had a set of very large institutions that were woven together, interconnected very closely, so that if one of those major institutions fell, it ran the risk of creating ripples throughout the whole system, through its derivatives contracts, through the repo lending, which is that massive overnight lending market. So these institutions were very woven together and very concentrated in terms of these assets and power within the financial system.

Now, where we are today? In worse shape. Ten biggest banks in this country control 77 percent of the banking assets in this country today. Fewer banks that are even bigger, and I think that presents a real challenge for this country going forward.

Can banks be reformed?

Oh, yeah. Banks were reformed after the Great Depression. They absolutely were. Glass-Steagall really did it. It was a political-will issue, and it continues to be. We can absolutely reform banks. We just have to care enough about it, and we have to trust that the world won't collapse in the meantime. But, I mean, we can also set that up.

What I keep saying is, we can't set up a perfect system, but we have to compare what we can set up to what already exists. And what already exists is dysfunctional. What we have is a bunch of "too big to fail" banks that are insolvent, currently. They're zombie banks. And same thing for Europe. Europe is a mess. And the question isn't, "Are we going to create something perfect?" The question is, "Are we going to create something better than this?" It's actually pretty low bar, so I think it's definitely achievable.

What kinds of things are you doing with your alternative banking group?

So one of the things we're working on is a Move Your Money app. So the idea is to make it really easy for people to move money from their big banks to credit unions. It's a great idea to do that, but there's a pretty big obstacle for most people, that they don't know credit unions that they're eligible for.

Credit unions have something they call the field of membership where you have to work someplace or live someplace or be a part of some union to actually be a member of their credit union. So the idea of the app is you will enter information into the app and it will give you a list of credit unions -- their locations, the ATMs nearby and their services, to make it easier for people to do that.

What did you think when the MF Global fund came down?

Sadly, I wasn't surprised. I mean, one of the things I'm working on now on Occupy Wall Street is this idea that we have not made progress in fixing the system. I eventually left the risk company in disgust essentially that, you know, here I am working hard as a researcher at risk, but no one cares. It's not changing the system.

No one cares about good risk if no one's reading the risk reports. And I just -- I lost faith altogether in regulators fixing the system. I didn't see it happening. Let's say it that way. And this was at the beginning of 2011.

And then later, in 2011, I kind of had a change of heart in the sense that I didn't think I could trust the system to change itself. But I realized that these sort of techniques I learned, the statistical and modeling techniques I learned from finance, were still really powerful techniques and should be opened up; that it's treated something like a guild.

People, the quants at D. E. Shaw and at other hedge funds, they've developed a pretty incredible set of techniques to try to measure these very small signals in the market. And they hide these techniques. And I thought to myself, well, at the very least, I can expose these techniques, because you can use them to detect other things, too.

One of the ideas I had when I first started was to use them to help my friend figure out when his blood glucose level was low so he needed to take insulin. So, you know, that kind of thing, I was like, "Well, ... [the] same techniques would work in other ways." So I started my blog to sort of open up some of these techniques, but also to -- the other goal of the blog was to sort of object to and point out contradictions in the financial system and point out corruptions in the way that finance worked.

But some will argue that we missed the opportunity, the only opportunity you're going to get unless there's another disaster to change the system more dramatically.

When they say that we missed the opportunity to change the system more dramatically, I'm not sure I agree with that. We live in a dynamic system, changes every day. Whether there's a war or there's an energy crisis or there is discussions on education and immigration, there's going to be a political campaign and debates coming. Every day our industry changes based on the workings around us. You can read the front page of the newspaper. My guess is 75 percent of the stories impact our industry in some way.

So, to me, we're always in a changing history. If people think that, well, the administration missed their chance to change the industry in a more hardened fashion, I don't agree with that. I think that they looked at the industry and said, "OK, what are the real problems that this industry needs to rectify most quickly?" And I think that those were leverage, i.e., real capital, the equity; those were making sure we understand what's on our balance sheet -- so, whether it's the Level 3 assets or the derivatives -- and making sure we had the right transparency, and making sure we were servicing our clients the appropriate way.

I think that we understand that's the direction we're going, and as we continue to go that way I think our industry will be better for it. So I don't think it's an idea of we need to all of a sudden have a 180-degree turn of our industry. Our industry does a lot of great things. Our industry got in a situation where we were highly levered at a time where there was not a lot of liquidity, and we had to change. And, unfortunately for our industry, part of the change was the action of more government involvement using their capital. And once you use government capital, that's a major change for our industry. And our hope is that the regulations move quickly, we will abide by them, and then we're back in business as quickly as we can get. ...

A lot of people argue throughout this process there were opportunities to leverage power, to change the system somewhat, to make a system where the banks were not so much in control because they were so big and you had to deal with them. What were your concerns back then? What are your concerns now about that issue?

I think the main way that we wanted to deal with the long-run health of the banks and this question of "We never want to go through what we went through in the fall of 2008," the focus turned to financial regulatory reform. And that's a case where the administration was incredibly aggressive, and this very much wrote the giant report about "Here's what we're thinking about financial regulatory reform; here's our proposed plan for what should be in it"; that that was the right way to deal with the structural issues [of] too big to fail, and how do we make sure we don't have another crisis and all of that.

And I think that was incredibly important legislation. I think it was fundamentally good legislation. The decision that was made was not to say every bank has to be little, because there are certainly issues of international competitiveness. And you also want a very strong banking system, and you want it here in the United States. You don't want it to all go to the Cayman Islands or someplace where it isn't regulated.

So how do you get a financial system that works for the economy, that's safe, that doesn't ever need government bailouts again? And that's, I think, what the Dodd-Frank [Wall Street Reform and Consumer Protection Act] financial regulatory reform bill is designed to do. And the big way in which it does that is fundamentally with capital requirements. So it changes the regulatory structure. It makes sure that one person, the Federal Reserve, is watching all of those big financially important institutions, including things that hadn't been in the regulatory net, like the AIGs of the world are now in that net very firmly.

But it basically said the best way to make a financial system stable is to make them have a lot of skin in the game, so to have big capital requirements so that if there is a run, if there are losses, there's a lot of investor capital there to take the loss, that it's not immediately the government has to be in there. And I think that is the fundamental logic behind it, and I think it's good logic.

What is the worst possible consequence? What’s the worst case scenario?

I just want to say, in many respects, the financial crisis never ended. It never ended. People seem to think about this financial crisis as one in which there was a run up to September, 2008, a bailout, and then the crisis passed. But, in fact, those clouds are still hanging over the global economy. And they're still filled with risk.

This crisis really never ended. There was a period of reckless lending, securities activity that extended over a number of years. And the overhang of that is still there. And it still hasn’t washed out of the system completely. Now, up until now, who has been asked to bear the brunt of that, have really been not the financial sector, but it’s been homeowners and workers. And, by the way, in the U.S. and in Europe. So you look at Europe, every effort [is] being made to protect the lenders, potentially driving countries like Greece and Spain into a depression. Here in the U.S. every effort [is] being made to protect lenders, at the same time that homeowners are drowning under a mountain of debt in this country. …

How is this possible when Obama was considered such a reform kind of guy, a guy who was a president for the people? The expectations for him were much different. Why do you think this administration got caught in basically coddling with banks and bailing out the banks, and not bailing out Main Street?

Well, they inherited the bank bailout, and it was already in place. The real question is, in the wake of the bank bailout, why hasn't there been the kind of hard pivot to remaking the financial industry? And I think that's still a very troubling question. There needs to be. And we're seeing the president articulate more and more concerns about income inequality, about the damage done by recklessness to the economy. And my hope is that it takes hold, that beyond rhetoric it becomes real policy.

Again, I don't believe reform is too late, because the fact is, the country is still hurting deeply. I mean, we've got the lowest ratio of wages to GDP since the Great Depression, 24 million people out of work; the foreclosure disaster continues each and every day. So therefore, in many respects, the political ballast for real reform still exists today, even though a lot of revisionists would want to wish away the truth of what happened in the crisis, and although Wall Street has more power than it had clearly in the wake of the meltdown of September of 2008.

The way they dealt with -- we talk a lot with Democrats as well as Republicans about the pressure that they did or did not bring on the banks. Would it have changed the dynamics of the relationship with the banks if they had taken some harsher sort of decisions and tactics?

Well, to this day, we have not held those responsible for the decisions that they made and for the position that they put this country in, our economy, we -- first of all, they need to be held responsible, and then ultimately -- you know, I'm offended by the fact that the executives in so many examples even walked away with the bonuses ultimately, that [ranking member on the House Financial Services Committee Rep.] Barney Frank [D-Mass.] and Secretary [of the Treasury Tim] Geithner, they were working behind the scenes to make sure that those executives still got the bonuses. And you tell that to hardworking Americans all across this country, you know, they have a right to be offended, to be frustrated by what they saw happen.

Those banks needed to be held accountable. And I believe that if they would have been -- if we would have handled that differently, if they would have been forced to accept the situation in which they found themselves, and the decisions that they had made that found themselves, they would have had to make -- they would have, first of all, had to make different decisions. And I also believe that maybe it would have resulted in there being a change in the banking structure so we don't have just a small number of banks that are controlling so much of the banking in America. I'm a big believer in our independent and our community banks. And one of the unfortunate realities of where we find ourselves today is that independent community banks are being -- you know, the heavy hand of the federal government now has come down on them. And these are the guys, these are the bankers that are in the communities, know the communities, have the relationships, know when it's appropriate to take a risk. And I'm very concerned about their future over the next three to five years. How do they survive? And at the same time, the big banks are continuing to -- you know, they have the relationships. They have the money to handle the new regulations or come down here and try to get a change here or there that would protect their interest.