Bethany McLean

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.

We’ve been getting close to having that conversation lately.  In late April, Senators Sherrod Brown (D-Ohio) and David Vitter (R-La.) rolled out the Brown-Vitter bill, which some have called the “break up the big banks” bill because the capital requirements it would impose on large banks, those with over $500 billion in assets, are so onerous as to force a breakup. At the least, the bill is a start to a much-needed conversation — or it was until Dimon began to dominate the headlines.

JPMorgan, which is the nation’s largest financial holding company with $2.4 trillion in assets, is not only one of the central targets of Brown-Vitter, it’s also a cause of the bill.  That’s not just because JPMorgan is big. Last summer, as most people know, JPMorgan lost more than $6 billion because of a trade in credit derivatives gone wrong. (The bank still made money that quarter.) Dimon, who initially and famously dismissed rumors as a “tempest in a teapot,” was forced to testify twice in Washington, and to offer a rare mea culpa, not once but repeatedly, for what he called a “terrible mistake.”

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.”)

According to the numbers, Apple’s battered stock is one of the best bargains of all time. Since hitting a high of almost $700 last fall, shares have plummeted 37 percent, to $442, including a 12 percent drop in late January after Apple posted flat year-over-year profits, which bitterly disappointed the Street. Apple now trades at just over 10 times last year’s profits and roughly eight times Wall Street’s estimate of next year’s earnings — well below the average of the Standard & Poor’s 500-stock index. Plus, Apple is set to begin paying a dividend of $10.60 a share, well above the yield on Treasuries.

Fortune estimates that 29 of 36 analysts covering Apple rate it some form of buy, with a median price target of $605 per share. One analyst, who dubbed the company the “trillion dollar baby” based on his belief that Apple will one day have a market value that exceeds $1 trillion, still maintains his price target of $880 per share.

Maybe so. But scratch beneath the surface, and there is an argument that Apple isn’t so much a great bargain as it is a classic “value trap” — a company whose stock price is depressed for good reason.

In the aftermath of the 2008 financial crisis, the most commonly heard complaint has been: “Why hasn’t anyone gone to jail?” This past May, Newsweek asked, “Why Can’t Obama Bring Wall Street to Justice?” and Forbes wondered, “Obama’s DOJ and Wall Street: Too Big for Jail?” Even Rupert Murdoch’s New York Post recently chided the president because “not a single Wall Street fat-cat has been charged with violations of securities laws in connection with the 2008 collapse.”

There are many explanations — and plenty of conspiracy theories — about why this is the case, but there’s a different, more important question that needs to be asked: Has sending people to jail fixed anything?

Think back to the post-Enron years. The government convicted roughly a dozen former Enron executives, including former CEOs Kenneth Lay, who died awaiting sentencing, and Jeffrey Skilling, who is serving a 24-year prison sentence, and took accounting firm Arthur Andersen to trial, resulting in its demise. During that era, former WorldCom CEO Bernie Ebbers, former Quest CEO Joe Nacchio and former Adelphia executives were also convicted for misdeeds.

Last week, New York Attorney General Eric Schneiderman, who is the co-chairman of the Residential Mortgage-Backed Securities Working Group – which President Obama formed earlier this year to investigate who was responsible for the misconduct that led to the financial crisis – filed a complaint against JPMorgan Chase. The complaint, which seeks an unspecified amount in damages (but says that investors lost $22.5 billion), alleges widespread wrongdoing at Bear Stearns in the run-up to the financial crisis. JPMorgan Chase, of course, acquired Bear in 2008. Apparently, this is just the beginning of a Schneiderman onslaught. “We do expect this to be a matter of very significant liability, and there are others to come that will also reflect the same quantum of damages,” Schneiderman said in an interview with Bloomberg Television. “We’re looking at tens of billions of dollars, not just by one institution, but by quite a few.”

The prevailing opinion seems to be, Yay! Someone is finally making, or at least trying to make, the banks pay for their sins. But while there is one big positive to the complaint, overall I don’t think there’s any reason to cheer.

Schneiderman’s case clearly lays out the alleged bad behavior at the old Bear Stearns. Although Bear promised investors it was doing due diligence on the mortgages it purchased, it wasn’t. Defendants “systematically failed to fully evaluate the loans, largely ignored the defects that their limited review did uncover, and kept investors in the dark about both the inadequacy of their review procedures and the defects in the underlying loans,” alleges the complaint. Even worse, Bear would make deals with the sellers of mortgages in which it would force them to make a payment for failed mortgages, but instead of taking the bad loan out of the trust, Bear would just keep the money – even though both Bear’s lawyers and its accountants (this is truly stunning), according to Schneiderman’s case, warned them that wasn’t OK.

From the wonder of the Olympics to the horror of Libor, there’s been plenty of news this summer. So maybe it’s not surprising that a 1,676-page bill called Moving Ahead for Progress in the 21st Century, which President Obama signed into law on July 6, has escaped attention. (Really? You’d rather watch Gabby Douglas win the all-around gold than read this bill? Shocking.) But buried within the bill, which is also known as the Highway Act, is a provision that matters to many Americans, a provision that sums up a lot of what’s wrong with Washington today, a provision that is not just bad finance but also reeks of the cronyism we should all fear.

The provision is called the Pension Stabilization Act, and really, it should be renamed the Pension Destabilization Act. Pensions are fairly unstable already, relying on markets of the future that smart prognosticators doubt are going to be as generous as the markets of the past. And yet, many pension plans are counting on similar rates of return anyway. In his August letter, Pimco’s Bill Gross pointed out that one of the country’s largest state pension funds says it will earn what sounds like a modest real rate of 4.75 percent. But as Gross notes, assuming a portion of that is in bonds yielding 1 to 2 percent, the pension would need stocks to return 7 to 8 percent after adjusting for inflation to hit its target. That is, as Gross writes, “very heavy lifting.” Nor are we heading into tough times with a cushion. Different sources put the funding deficit for large corporate pension plans at somewhere between $475 billion and $500 billion as of the end of 2011.

Given that, and given that corporate profit margins and cash balances are near all-time highs, you might think, or hope, that Congress would be cracking the whip. And it did, sort of, by passing the Pension Protection Act in 2006, which among other things generally required companies to fund their pension shortfalls over seven years.  But then the financial crisis hit, and companies begged for relief, and now, in 2012, we have the Pension Stabilization Act. While the math is complicated – Jim Moore, a managing director at Pimco, calls it a “Rube Goldberg contraption”– most people who have looked at it say that the overall effect is going to be, as JPMorgan put it in a recent piece, to “significantly reduce” the cash that companies are required to contribute to their pension plans in the next few years.  It does so, in essence, by increasing the discount rate that companies use to calculate their pension liabilities when they’re determining how much money they need to put in. Using a higher discount rate makes the liability look smaller, thereby decreasing the funding requirement.

“Exceptional.” “Very forceful.” “Early.” Those are the words used by Treasury Secretary Tim Geithner recently to describe what he did in the spring of 2008 to address problems with the key interest rate known as Libor. During Geithner’s congressional testimony this week, New York Senator Charles Schumer called Geithner “proactive.” Not to be outdone, White House Press Secretary Jay Carney chimed in after Geithner’s testimony, calling what Geithner did “aggressive.” The key piece of what he did, of course, was to send a memo dated June 1, 2008 to Bank of England Governor Mervyn King suggesting changes to improve the credibility of Libor.

Plenty of commentators, and especially Republicans, have given Geithner a hard time about his lack of other action. That’s not entirely fair because Geithner didn’t completely ignore the Libor problem; in addition to his memo, he also brought it up to the President’s Working Group on Financial Markets and to the Treasury. But at the same time, the lavish praise is hard to understand. How can it have been exceptional, forceful, early or aggressive for Geithner to have sent a memo across the Atlantic, when the press and the financial research community had already written not just about the problem with Libor but also about its potentially far-reaching consequences?

Consider that six weeks before Geithner’s memo, the Wall Street Journal’s Carrick Mollenkamp wrote an April 16, 2008 story entitled “Bankers Cast Doubt on Key Rate Amid Crisis.” The piece noted that Libor – which is supposed to be the average interest rate at which banks make short-term loans to each other and which serves as a basis for trillions of dollars in other loans – had become such a fixture in credit markets that many people trusted it implicitly. Mollenkamp quoted a mortgage banker who said he depended on Libor to tell him how much he owed his bank. Concerns about Libor’s reliability are “actually kind of frightening if you really sit and think about it,” the banker told Mollenkamp. On May 29, the Journal followed up with another, even more detailed analysis, which crunched the numbers to show just how much the banks might be understating Libor.

Among those who believe that Goldman is basically the devil’s spawn, there’s of course only one answer to the above question: Yes! But there’s another group that seems to be asking the same question, and that’s investors.

Consider that in the past year, Goldman’s stock has fallen some 30 percent. It trades for just 0.7 times book value, which says that investors either think that Goldman can’t earn enough to cover its cost of capital, or that its assets are overstated or liabilities understated. Consider this: Except during the financial crisis, Goldman’s market capitalization was last around $50 billion back in the fall of 2005. Back then, Goldman had $670 billion in assets, and $27 billion in shareholders’ equity. Today, Goldman has $951 billion in assets, and $72 billion in shareholders’ equity.

Goldman Sachs stock price, July 1, 2011 - July 1, 2012

Another way to think about Goldman’s valuation is that the firm effectively has $300 billion in cash and close cash equivalents on its balance sheet. You can get to that figure by adding cash, Level 1 assets, and Level 2 assets that could be easily liquidated. Goldman has total long-term and short-term debt of $220 billion, and a market value of $50 billion. In other words, the market is giving Goldman very little credit for the ongoing earnings of its business, and Goldman has a lot of dry powder relative to the opportunities it has. (A caveat: Goldman’s immense derivatives business would gobble up lots of cash were the firm to be hit with credit downgrades.)

Are student loans the new subprime mortgages? Among professional skeptics, the comparison has become something of a cliché, and in last weekend’s front page story, entitled “A Generation Hobbled by College Debt,” the New York Times invoked it in recounting the nightmare that student loans are becoming for so many. At the same time, others have pointed out important differences between the two kinds of debt. But history never repeats itself exactly – and there are reasons to fear that the growing mountain of student debt could have every bit as profound an impact on our economy as the housing bubble did.

Start with the structure of the student loan market. Of the roughly $1 trillion in student debt outstanding, according to a recent estimate by the Consumer Financial Protection Bureau, $848 billion consists of federal student loans, like Stafford, PLUS and Perkins loans – meaning they are explicitly backed by the U.S. government, aka taxpayers. The rest are so-called private loans, meaning they’re made by private lenders without government backing; students usually turn to these more expensive loans when they’ve exhausted other alternatives, just as homebuyers turned to subprime mortgages when they couldn’t qualify for more conventional loans .

The involvement of the government in student lending is both important and scary, because the government backing removes a level of discipline. It’s doubtful that private lenders who had to evaluate and bear the credit risk of students would extend this much money. Of course, that was also true in the housing market, where the presumed (and, as it turned out, actual) government backstop of Fannie Mae and Freddie Mac allowed debt to proliferate.

Although our understanding of what instigated the 2008 global financial crisis remains at best incomplete, there are a few widely agreed upon contributing factors. One of them is a 2004 rule change by the U.S. Securities and Exchange Commission that allowed investment banks to load up on leverage.

This disastrous decision has been cited by a host of prominent economists, including Princeton professor and former Federal Reserve Vice- Chairman Alan Blinder and Nobel laureate Joseph Stiglitz. It has even been immortalized in Hollywood, figuring into the dark financial narrative that propelled the Academy Award-winning film Inside Job.

As Blinder explained in a Jan. 24, 2009 New York Times op-ed piece, one of what he listed as six fundamental errors that led to the crisis came “when the SEC let securities firms increase their leverage sharply.” He continued: “Before then, leverage of 12 to 1 was typical; afterward, it shot up to more like 33 to 1. What were the SEC and the heads of the firms thinking?”