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.”

Just before Brown and Vitter produced their bill, in mid-March, the Senate Permanent Subcommittee on Investigations finished a report on JPMorgan’s big loss.  The trades “provide a startling and instructive case history of how synthetic credit derivatives have become a multi-billion dollar source of risk within the U.S. banking system,” wrote the PSI. “They also demonstrate how inadequate derivative valuation practices enabled traders to hide substantial losses for months at a time; lax hedging practices obscured whether derivatives were being used to offset risk or take risk; risk limit breaches were routinely disregarded; risk evaluation models were manipulated to downplay risk; inadequate regulatory oversight was too easily dodged or stonewalled; and derivative trading and financial results were misrepresented to investors, regulators, policymakers and the taxpaying public who, when banks lose big, may be required to finance multi-billion-dollar bailouts.”  OK, then!

Around the same time, Joshua Rosner, a managing director at independent risk consultancy Graham Fisher & Co., wrote a report called “JPMorgan Chase: Out of Control.”  He noted that since 2009, JPMorgan has paid more than $8.5 billion in settlements for various regulatory and legal problems.  That amount represents almost 12 percent of the net income the firm has produced from 2009 to 2012, according to Rosner, who also alleges that “many of JPM’s returns appear to be supported by an implied guarantee it receives as a too-big-to-fail institution.”

These are huge issues that everyone should be concerned about. But inadequate risk management, derivatives exposure, incentives to put excess money to work by making trades rather than loans and a torrent of legal issues aren’t — unfortunately — unique to JPMorgan Chase. We’ve created a Frankenstein of a financial system, one that is manmade but often so complex that it can eclipse our ability to measure or manage it. Add to that the constant pressure for profits and the opportunities to arbitrage an increasingly prescriptive, expensive set of rules and regulations.  It’s a toxic combination.  Plus, we live in a world where size and money equals political power, making effective oversight difficult. Would replacing Jamie Dimon as chairman help? A Wall Street Journal story quoted Michael Garland, who is an assistant comptroller for New York City and a co-sponsor of the shareholder resolution to split the roles, saying that an independent chairman would have more time than Dimon to deal with unhappy regulators. Great: more placating and handholding. Garland also says that it would send a strong message to the bank that the board needs to strengthen its oversight. Raise your hand if you think there’s a board out there that truly can oversee a modern financial institution.

It would be nice if all of this were fixable by adding or swapping the players at JPMorgan. But does anyone believe that if JPMorgan had had another chairman during this period — say, Bill Harrison, who was the bank’s CEO before Dimon — that last summer’s derivatives losses wouldn’t have happened? If JPMorgan had a different CEO, that wouldn’t make the issues go away. Arguably, it would make things worse.

Dimon certainly hasn’t navigated the fraught world of big banking perfectly. But name one person who has. The world’s next great banker might be being groomed inside or outside JPMorgan, but for now, if we’re going to live with the banks we’ve got, I’ll take Dimon over Dimon-lite.

The problems with JPMorgan aren’t a result of who the people are or aren’t at JPMorgan. They’re a result of the system. And while it may or may not make sense to change the people, don’t be deluded:  That’s not changing the system.

PHOTO: JPMorgan Chase & Co CEO Jamie Dimon speaks about the state of the global economy at a forum hosted by the Council on Foreign Relations (CFR) in Washington October 10, 2012. REUTERS/Yuri Gripas

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.”)

That said, you can’t read the case and feel good about the critical role that the rating agencies continue to play in our markets. At least according to the emails the government released, S&P’s claim that business considerations don’t affect its ratings is just flat-out false. Back in 2004, S&P circulated new criteria for rating structured securities. The agency’s “client value managers,” who were responsible for “managing the commercial relationship with clients” were to be “consulted for client information and feedback,” which would then be incorporated into the ratings. In a memo, an unnamed executive wrote, “Are you implying that we might actually reject or stifle ‘superior analytics’ for market considerations … does this mean we are to review our proposed criteria changes with investors, issuers and investment bankers?” He never got a response. In January 2005, S&P didn’t roll out a new model that would have made it harder to assign triple-A ratings to some CDOs (collateralized debt obligations). An analyst wrote that the model “could’ve been released months ago … if we didn’t have to massage the subprime and Alt A numbers to preserve market share.”

“Our old methodology gave us one single ‘best coin’ that is data driven,” wrote another S&P employee in 2007 as part of a discussion about how best to update models. “But if it turns out to be business unfriendly, we are stuck.” And so on.

Even worse, as the market began to melt down in 2007, S&P fully understood that it was helping the investment banks move bad securities off their books and onto the laps of investors — and took pride in the money it was making as a result. As S&P Managing Director David Tesher wrote in a March 2007 email, “Many dealers accelerated the timing of CDO’s that were in the pipeline in order to mitigate/manage their respective warehouse exposure.” A few months later another managing director wrote, “Because of the effect of the subprime RMBS situation, in March we experienced the highest monthly deal volume ever, doubling the total from the previous two months.” (Investors could and should have done their own due diligence. They might have been more inclined to do so, however, had S&P informed them that the investment bankers were using them as garbage disposals.)

There is something more dangerous than sheer venality, though, and that’s venality mixed with incompetence ‑ which S&P had in spades, according to the complaint. Although the agency told investors it was doing “surveillance”—monitoring existing mortgage-backed securities to see how they performed—the analysts who rated CDOs, which of course were composed in large part of RMBS, simply weren’t told whether the surveillance team was considering a downgrade—sort of akin to a chef not being informed that the ingredients have gone bad. As a result, those analysts would simply accept the RMBS rating at face value, thereby inflating the CDO rating. Even after S&P had decided that it would do large scale downgrades of non-prime RMBS, no one communicated that to the CDO team, which continued to confirm ratings on billions of dollars of CDOs.

In July 2007, an S&P analyst wrote to an investment banker: “The fact is, there was a lot of internal pressure in S&P to downgrade lots of deals earlier on before this thing started blowing up. But the leadership was concerned of p*ssing off too many clients and jumping the gun ahead of Fitch and Moody’s.” The investment banker wrote back: “This might shake out a completely different way of doing biz in the industry. I mean come on, we pay you to rate our deals, and the better the rating the more money we make?!?! Whats [sic] up with that? How are you possibly supposed to be impartial????” Yes, Virginia, the model is broken.

But what’s also apparent from the complaint is that while S&P’s piece of the wheel was critical, S&P’s share of the loot was tiny, at least relatively speaking. The government says from September 2004 through October 2007, S&P slapped credit ratings on over $2.8 trillion of residential mortgage-backed securities and an additional $1.2 trillion of CDOs fashioned out of those RMBS. Without a triple-A rating, those securities couldn’t have been sold. But S&P got just a sliver of what the designers of the wheel received. According to the government, S&P charged a fee of $150,000 for each non-prime RMBS it rated, and up to $500,000 for each CDO. In contrast, one knowledgeable source told me that on some CDOs, the fees and expenses chewed up 40 percent to 50 percent of the cash flow; according to Forbes, banks typically charged up to $8 million to underwrite an RMBS securitization and as much as $10 million for a CDO. Another way to think about this is that the entire fee S&P earned for rating a CDO was less than the average 2006 compensation — about $623,418, according to the New York Times — for a Goldman Sachs employee.

The New York Times and others have reported  that the  government is seeking some $5 billion from S&P, which is more than five times what it made in 2011. Some say this could put S&P’s parent company, McGraw-Hill, out of business, or at least prompt a reorganization; its stock has lost nearly a quarter of its value since the lawsuit was filed. Investment banks, by contrast, have paid some fines, but nothing life-threatening. As bad as S&P’s behavior allegedly was, it’s got nothing on the banks. Sure, S&P told investors it was doing surveillance of its ratings. Well, the investment banks promised investors they were doing due diligence on the mortgages they packaged — but when the news was bad, the bankers ignored it. Sure, S&P masqueraded as investors’ best friend. Well, that’s the definition of a salesperson at a bank. And neither S&P nor the bankers had a fiduciary duty to investors.

Maybe cases stemming from the financial crisis really are so difficult for the government to make that the only option is to use a random law in order to get the cog in the wheel. Maybe it’s better to punish the cog than to punish no one. But let’s not pretend it’s fair. And if the government’s case doesn’t result in fundamental changes to the ratings game, then no one has won.

PHOTO: A view shows the Standard & Poor’s building in New York’s financial district February 5, 2013. REUTERS/Brendan McDermid

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.

Start by looking closely at what has been the driver of Apple’s phenomenal growth — the iPhone, which accounted for just over 50 percent of Apple’s fiscal 2012 revenues and almost two-thirds of profits, according to one longtime Apple analyst.

Although Apple did hit estimates for iPhone sales in its last quarter, the stock declined in part because of intimations that the age of the iPhone might be coming to an end. “Fight to unseat iPhone intensifies,” wrote the Wall Street Journal in late January, which said that while two-thirds of the smartphones Verizon said it activated in the fourth quarter were Apple devices, more than half were older, heavily discounted models. The Journal also reported that iPhone sale srose less than the overall increase in the global smartphone market. Meanwhile, a Reuters piece reported that in Singapore and Hong Kong, Apple’s share of mobile devices seems to be falling. Reuters noted that these regions are leading indicators of what’s going to be hot in Western Europe and North America.

Apple’s position is still enviable. But built into Wall Street’s stock price targets was the expectation that the iPhone would rule the world. And for a while, it looked like it would. But maybe that was a fluke. After all, Steve Jobs didn’t build devices that were supposed to appeal to everyone. Instead, he built expensive products for which Apple, and Apple alone, curated the technology that would be available to users. That’s not a recipe for market share dominance.

One reason Apple looked like it would dominate despite that mindset is the quirkiness of the mobile phone market. In many areas of the world, including the U.S., mobile phone purchases are subsidized, so even though Apple’s phone is far more expensive, the carrier pays more, and the end customer doesn’t see all of the price difference. There has long been a discussion about whether that arrangement will come to an end, and there are a few reasons to believe it might. If bandwidth is indeed in short supply, then the carriers will have more clout, and they’ll start pushing back against the subsidies. That implies margin pressures for all mobile phone makers, but in particular Apple, given the abnormal subsidy it has been able to extract. In addition, if the iPhone is no longer the single must-have product, then Apple may lose some of its clout with carriers. Apple’s virtuous circle—because customers crave its products, carriers have not choice but to pay up — could turn vicious.

Some stellar new product, like a full-blown Apple TV or an electronic payment system, or something we haven’t even imagined, may be about to explode on the scene. Maybe. As a company, Apple doesn’t talk about what’s next, and anything is possible. But the evidence isn’t promising. On Apple’s most recent earnings call, Chief Financial Officer Peter Oppenheimer said that today was the “most prolific product period in Apple’s history … in the last few months, we’ve introduced new products in every category we make.” But the products are more evolutionary than revolutionary. And what we do know is that many of the people who created the Apple that now exists — Jobs, former retail chief Ron Johnson, former software chief Avi Tevanian, former hardware maestro John Rubinstein — are no longer there. Just like the Magellan Fund of the 1990s wasn’t Peter Lynch’s Magellan, this company is no longer the same Apple.

There are also challenges. For instance, Apple TV isn’t iTunes: The cable companies seem to understand that they are better off protecting their own ecosystem, instead of letting the wolf in the shape of Apple waltz in the door and pick off the choicest part of their revenue stream. And while Apple could indeed blanket the earth with products that fill every niche, that would entail a very different strategy than the one that brought the company to where it is today.

You might argue that all these fears are reflected in Apple’s discounted stock price. But while the stock is cheap based on the profits of the past few years, value investors generally look to what they call normalized earnings, or true earnings power. To put this a different way, price-to-earnings ratios don’t matter that much when you don’t know what real earnings are. We won’t know for a few more years, but there’s an argument that Apple’s last few years of blowout earnings have been well above normal. If that’s true, then Apple’s real p-e ratio might be much higher than it appears.

Apple believers also point to Apple’s massive cash hoard—$137.1 billion and counting—as a floor beneath the stock price. (The Wall Street Journal has pointed out that since much of the cash is parked overseas, adjusted for taxes, it’s more like $111 per share, but that’s still an awful lot of money.) Historically, Apple has been disciplined with its cash, and Chief Executive Officer Tim Cook is regarded as a master of supply-chain management, meaning that even if Apple’s volumes decline, the company isn’t going to start bleeding cash. The counter is that, especially in tech land, companies that start to dry up on innovation soon start to burn cash, whether because shareholders demand more and more return in the form of dividends or because the company feels forced to do cash acquisitions. In Apple’s case, its retail stores could become a millstone around the company’s neck if huge sales of high-margin iPads and iPhones no longer pay for all that premium real estate.

Too dire? Quite possibly. But just because Apple’s stock once sold for almost $700 doesn’t mean it should ever see those heights again. Just ask the investors who owned AOL back in 2001.

PHOTO: The Apple logo is shown on the front of the company’s flagship retail store near signs for the central subway project in San Francisco, California January 23, 2013. REUTERS/Robert Galbraith

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.

The goal, of course, was to deter future wrongdoing by those who don’t want to play by the rules, and those whose
appetite for risk could destroy a company. After that string of prosecutions, pundits (including yours truly) said that the world — or at least the business world — would be a much safer and steadier place.

Hmmm. By 2007, just one year after Lay and Skilling were convicted, the financial crisis, which had been decades in the making, was about to come crashing down on our heads. Part of the problem is that in corporate America, the odds are still very much in favor of those who game the system because the government, even at its most aggressive, doesn’t have enough resources to go after everyone. In addition, the rules create loopholes that clever people exploit, violating the spirit while still remaining within the letter of the law. On top of that, a lot of what most of us would call wrongdoing doesn’t involve intent — a necessary ingredient for a criminal prosecution. Instead, you find the very human capacity for self-delusion — and, sometimes, sheer stupidity.

Another big part of the problem is that there’s too much money to be made by pushing the envelope, or by keeping your mouth shut when you see others doing it. One Wall Streeter explained it to me this way: “When you work on Wall Street, you have a seat. If you stay in that seat, you know you’ll make a small fortune. So you look around, and you see things going on that you don’t think are right. But you’re not sure — let’s face it, in the modern world, you’re almost never sure… So you have a choice: Leave, forfeit your seat, and watch everyone who stays make a fortune. Or stay, get yours, and when [trouble comes], well, you were just one of the crowd.”

When you probe more deeply into this dilemma you realize that outright crime and envelope-pushing are only subsets of what’s wrong in the bigger crime is that people are being paid huge sums for failure. A banker recently told me the financial crisis was one of the greatest heists in financial history, because so many people made so much money not by succeeding or creating but by failing and destroying. Stan O’Neal drove Merrill Lynch into the ground and walked away with retirement funds and securities worth $160 million. Citigroup CEO Charles Prince got almost $14 million in cash right before Citi began to hurtle toward collapse. And countless inept or crooked junior people, whose names we’ll never know, walked away with fortunes.

In a recent report, veteran analyst Mike Mayo at CLSA noted that the link between bank performance and CEO compensation is weak. Mayo says CEO pay has almost doubled over the past decade, growing more quickly than revenue or profit and almost twice as fast as employee compensation. Over the past decade, Citigroup and Bank of America have had the highest CEO pay and the worst performance. This isn’t an issue that afflicts only the financial world— it is a problem across corporate America. James Stewart recently wrote in the New York Times about Leo Apotheker, whose brief, miserable tenure as the CEO of Hewlett-Packard earned him more than $13 million in termination payments. The Motley Fool notes that Gregg Engles, the CEO of Dean Foods, has received an average of $20.4 million annually over the past six years even as his company’s stock price has fallen 11 percent a year, on average.

Every year, Forbes puts together a list of the worst CEOs based on performance relative to pay. In 2011, Engles got the top honor, but close behind him was Mayo Shattuck of Constellation Energy, whose average annual compensation has been close to $15 million, while shareholders have seen only a 6 percent total return during his tenure. There are countless more examples. So maybe it shouldn’t be people’s liberty at stake but rather their money. Pay people for success — long-term success — that benefits all stakeholders, from shareholders to employees to communities. While that won’t completely eliminate self-delusion, it will certainly help, because it’s often money that blinds people to the improprieties they should see. Unfortunately, there’s nothing easy about administering this cure. The history of attempts to tie pay to performance isn’t a pretty one. Start with stock options. It’s hard to think of a better way to align executive and shareholder interests, but it seems that once people have pocketed enough in cash, or sold enough stock, that alignment goes askew. In its post-mortem on Enron — where the top 200 executives made over $1 billion from stock options in that company’s final year — the Joint Committee on Taxation wrote, “The Enron experience raises a potential conflict between short-term earnings from which executives can reap immediate rewards and longer-term interests of shareholders.”

Under Dodd-Frank, the Securities and Exchange Commission must devise rules so companies disclose how compensation is paid and how it’s linked to performance. Public companies will need to have “say on pay” votes for shareholders. And there are clawback provisions. Goldman Sachs employees who get stock grants are subject to forfeiture and clawback provisions if, for instance, they fail to flag risks that could hurt the firm or the financial system. When JP Morgan suffered a $6 billion trading loss last summer, the executives deemed responsible had pay clawed back for about the last two years. There is also a faint glimmer of hope that shareholders, who have long been silent on this issue, are ready to speak up. Last spring Citigroup shareholders rejected a $15 million package for then-CEO Vikram Pandit (who, by the way, pocketed $6.7 million in compensation for less than a year of work after the board abruptly fired him in October). These changes all seem like lurches in the right direction. Public shaming and even prison sentences haven’t had much impact on malfeasance, so let’s put our energy into ranting about pay, rather than prosecutions, and maybe we can get CEOs thinking more about shareholders, employees and investors than their own overstuffed wallets.

PHOTO: Protesters march through New York’s financial district during a rally against government bailouts April 3, 2009. REUTERS/Brendan McDermid

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.

The complaint shows just how complicit the Bear bankers were in the proliferation of bad loans that almost took down the economy, and that alone makes it valuable. “He’s finally telling the story so that people can understand the depth and magnitude of what went on,” says Eliot Spitzer, who had Schneiderman’s job after the dot-com bust.

But beyond that, there’s not much to applaud. The biggest flaw is that Schneiderman decided not to name any individuals, a practice that is sadly all too common in financial fraud cases. The New York Times argued that it’s a strength that the case doesn’t focus on individuals and specifics, and instead alleges a broad pattern of fraud. But naming names is powerful. Anonymity is weak, and that is amplified when the generalized wrongdoing allegedly occurred at a now-defunct bank. In addition, the lack of names is weird. How could the actions alleged in the complaint have been accomplished if real people didn’t do them?

Schneiderman’s office also brought charges under a specific New York State law called the Martin Act. The Martin Act doesn’t require prosecutors to show that the defendants intended to commit fraud. This seems ridiculous. If Bear employees committed the acts detailed in the complaint, especially pocketing money that should have gone into investors’ pockets, against the warnings of lawyers and accountants, how can they have intended anything other than fraud?

Which, of course, raises a few other questions. Chief among them: Why haven’t Justice Department investigators brought criminal charges, and why hasn’t the Securities and Exchange Commission even brought civil charges? Technically speaking, both are also members of the Residential Mortgage-Backed Securities Working Group, but both also have been conducting their own investigations since the crisis hit. The answer cannot be that Schneiderman discovered something new. JPMorgan has complained that his suit relies on “recycled claims already made by private plaintiffs” and, well, it does. The notion that investment banks were knowingly putting bad loans into securitizations has been public knowledge since the fall of 2010. That was when executives from a company called Clayton Holdings, which was retained by many of the big banks to do due diligence on the mortgages they were buying, told the Financial Crisis Inquiry Commission that Wall Street knew that almost one-third of the mortgages they were securitizing didn’t meet their own standards. Spitzer wrote a column for Slate calling the documents the “Rosetta stone” because he thought they provided such a clear road map for investigators. That’s not all. Schneiderman’s predecessor, Andrew Cuomo, actually entered into a cooperation agreement with Clayton back in 2008! Did it really take over four years to put together a complaint that doesn’t even name real people?

As for the part about Bear pocketing money that should have gone to investors, that’s been well known since at least early 2011, when Teri Buhl did an in-depth piece for the Atlantic on a lawsuit that bond insurer Ambac filed against JPMorgan in 2008, which was unsealed in early 2011. Buhl wrote that Bear traders were “pocketing cash that should have gone to securities holders.” And the Ambac lawsuit named names!

In other words, everyone has had plenty of time.

So there are a couple of possibilities. One is that Justice and/or the SEC will follow up with their own charges now that Schneiderman has laid the groundwork. Maybe. But that doesn’t make a lot of sense given the widespread availability of the information in his lawsuit and the length of time that has passed since the financial crisis. It’s an old saw in legal circles that the more time goes by, the harder it is to file criminal charges. By now, it will feel strange if the Justice Department yanks four people who worked at the old Bear and in effect says: “You and only you are going to take the fall for the entire financial crisis!”

Another possibility is that those who say that federal agencies simply don’t have the appetite to pursue the banks are right. Whether that’s because they lack the resources and the political will, or because bringing criminal charges against individuals would inexorably lead up the chain to the institution, which would destroy it, and no one wants to see that happen, it doesn’t much matter. If Schneiderman’s lawsuit is the best we can manage under those constraints, then that’s a tragedy.

A third possibility is that there’s more nuance to what happened than Schneiderman’s suit allows. (JPMorgan, for its part, has said it will contest the charges.) Some would still say that’s all right, because if there are 50 shades of bad behavior, this is clearly one of them; so even if it’s not the darkest, let’s make the bankers pay up. The problem is that it’s not the bankers who will pay. It’s not the individuals who did these awful things, or former Bear Stearns executives who may have sanctioned it knowingly or unknowingly, or even current JPMorgan executives who will pay the big fine that will likely be the end result of all this. It’s JPMorgan’s current shareholders, which include mutual funds like indexers Vanguard and Wellington. In other words, we, the American investor class, are the ones who are going to pay. And if Schneiderman does indeed apply this same method to other banks, well, then we’ll pay even more. I fail to understand why this is justice, or why this will do anything to dissuade bad behavior in the future.

I’m also bothered by what happened after Schneiderman filed his suit. First, JPMorgan Chase raised a stink, because in the minds of many JPMorgan executives, they performed a public service by purchasing Bear and have already paid enough for its misdeeds. Maybe it’s not fair to blame Schneiderman’s office for responding with a press release trumpeting the myriad ways in which JPMorgan Chase benefited from government assistance. But whether you love or hate the big banks, the alleged wrongdoing that happened at Bear has nothing to do with whether or not JPMorgan Chase benefited from government help. The punishment the bank should face for any misdeeds should be purely a matter of law, not public opinion about the bank bailout. Otherwise, we risk bastardizing the law.

Finally, I worry that this is all a classic “watch the birdie” exercise: Hey, folks, look over here at this facsimile of justice! Making the big banks pay somehow sure feels good, and if you don’t look too closely, it may even distract you from the big questions. Namely, what should a financial institution that serves the needs of businesses and consumers—instead of one that uses us as fodder for its own profits and executive bonuses – look like? And how do we get from here to there? Instead, we’re going to pay up, and in exchange, get business as usual. That’s not a good deal.

PHOTO: The Bear Stearns logo is seen at the lobby of the headquarters in New York, March 26, 2008.  REUTERS/Shannon Stapleton

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.

Right after the bill was signed into law, Sears, which is controlled by multibillionaire Eddie Lampert and has a pension plan that, according to JPMorgan, is underfunded by some $2.3 billion, announced that it would contribute from $380 million to $430 million to its pension plan in its fiscal 2013, down from its previous estimate of $740 million. Alcoa is reducing its contribution by $100 million to $130 million. And so it goes. Overall, the Society of Actuaries predicts that the required 2012 pension contributions will be 43 percent less under the new law than they would have been under the previous law – $45 billion instead of $80 billion.

The idea is that in the future, when everything is coming up roses, companies will make the shortfalls. Or as Society of Actuaries puts it drily: “The solvency of plans would decline in the short term due to lower contributions, and would eventually return to the levels expected under current law as contributions increase.” That sounds good, and it’s true that providing troubled companies with some relief may give them flexibility to figure things out. But what happens if they don’t, and what if, when the time comes to pony up the cash, there is none? Given the troubled status of many pension plans, there’s a cliché that describes this situation perfectly: kicking the can down the road.

Now, if your company can’t pay your pension, there’s supposed to be a backup, which is called, appropriately enough, the Pension Benefit Guarantee Corporation. There have long been questions about its solvency. So as a sop to their constituents’ financial health, Congress did also increase the fees that companies have to pay the PBGC. (While the PBGC gets to count the increased fees as revenues, it doesn’t have to increase its reserves to account for the increased risk of default, as a normal insurer would. Go figure.) Again, the math is complicated, but the end result of Congress’s machinations is that stronger companies, those that are unlikely to need to get out of their pension obligations, will pay the PBGC just as much as companies that are likely to fail to meet them. This is why Pimco’s Moore writes that Congress “essentially extended a welfare transfer from the Haves to the Have Nots.” Or to put this a different way, whether you work for a strong company or a weak one, we really are all in this together.

Just about now, you might be wondering why on earth Congress would include the Pension Stabilization Act in this particular bill. After all, “Moving Ahead for Progress in the 21st Century,” is also known as the Highway Act because it’s mostly about transportation. On the surface, that has little to do with pensions. Aha. It’s because decreasing the amount that companies have to contribute to their pensions helped make the Highway Act budget neutral – or at least, it appeared to do so, which in Washington is all that apparently matters. Here’s why. Pension contributions are a deduction from taxable income. So smaller contributions should result in higher corporate taxes. Presto! Indeed, according to JPMorgan, the Joint Committee on Taxation says the pension provisions in the Highway Act will raise taxes of $18.1 billion between 2012 and 2017. So our pensions suffer, but the budget looks better!

There’s one more twist, which is that the increased taxes may not materialize. Moore thinks that healthy companies will continue to fund their pension plans in excess of the minimum, meaning their taxable income will be what it would have been before the bill’s passage. It’s the unhealthy companies who will take advantage of the new rule – and it’s precisely the unhealthy companies that may soon not have any profits to tax anyway, particularly if the economy takes a turn for the worse. Which means that counting on increased contributions from them is, in a word, crazy. Or as Moore calls the whole thing, “A curious example of Washington’s twisted logic and dubious accounting.” Well said.

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.

Even before the initial Journal piece appeared, on April 10, 2008, a research analyst at Citigroup named Scott Peng wrote a report headlined, “Special Topic: Is LIBOR broken?” Peng concluded that Libor could understate actual interbank lending costs by 20 to 30 basis points. Ironically enough, he based his evidence in part on the fact that the Fed itself was providing short-term loans to banks at a higher rate than Libor.   Not incidentally, Peng (whom Mollenkamp cited in his story) wrote the following: “LIBOR touches everyone from the largest international conglomerate to the smallest borrower in Peoria … the functionality and relevance of LIBOR is of primary importance to the global financial system … if LIBOR, now the most popular floating-rate index in the world, loses credibility because it no longer represents true interbank lending costs, the long-term psychological and economic impacts this could have on the financial market are incalculable.”

And even before that, in March 2008, in another report Mollenkamp cited, two economists at the Bank for International Settlements wrote their own report raising questions about Libor. They said that banks might have an incentive to provide false rates to profit from derivatives transactions, and that although the practice of throwing out the lowest and highest groups of quotes was likely to curb manipulation, Libor rates could still “be manipulated if contributor banks collude or if a sufficient number change their behavior.”

In other words, at the time Geithner wrote his “early” memo, it was already known that there was likely a big problem with Libor, that the problem could affect a wide range of borrowers and that the damage from any manipulation could be, as Peng put it, “incalculable.” If you were inclined to be nice, you might call Geithner’s actions “timely.” But that’s about it.

In fairness, Geithner’s lack of follow-through was hardly unique: The Journal noted in its pieces that the British Bankers Association was aware of the problem, and other regulators and law enforcement people could have read the paper and taken action, too. But as followers of the Libor scandal now know, the New York Fed did have access to what seems to be some unique information. On April 11, 2008, just before the Journal story ran, Barclays basically confessed, telling the Fed: “We know that we’re not posting, um, an honest rate.” That wasn’t in Geithner’s “aggressive” memo; Geithner said in congressional testimony that he wasn’t aware of that specific conversation. Say what you will about JPMorgan CEO Jamie Dimon, but when he found out that he should have known something he says he didn’t know, he didn’t call himself  “exceptional.” He said: “We screwed up.”

You could argue that four years later, we’re seeing the results of investigations Geithner helped set in motion.  Maybe. You could also argue, and some have, that the failure to do anything earlier is no big deal, and that a memo is all that was called for, if even that. After all, it’s uncertain what the financial impact of any Libor manipulation was. And the very fact that so many people suspected there was a problem means that those involved, from the perpetrators to the regulators, must be innocent. How can you commit a financial crime in plain sight?

The problem with that line of argument is that many financial crimes are committed in plain sight. The casual acceptance of widely known wrongdoing is almost the definition of modern financial malfeasance. Think about the dotcom era research scandal, in which investment bank “analysts” wrote puffy research pieces so that unsuspecting investors would put their savings into inflated stocks. Lots of people were in on the game. Did that make it right? Or think about the housing bubble. An awful lot of people understood that dubious loans were being packaged up and sold as triple-A securities. That was just the way things were done, and so almost no one questioned it. Again, does that make it right? And while it may turn out that the economic impact of any manipulation of Libor was small, that doesn’t change the fact that people cheated. The cost of that, in terms of lost trust, is indeed incalculable.

If you think more broadly about human history, some of the worst abuses have often occurred in the relative open. What is “exceptional” and “aggressive” is to be able to see that what’s happening is wrong, and to do something concrete to stop it. As human history also shows, that’s unfortunately a lot to ask of someone. But let’s save the extravagant praise for when it’s truly been earned.

PHOTO: U.S. Treasury Secretary Timothy Geithner delivers his testimony regarding the annual report of the Financial Stability Oversight Council before the House Financial Services Committee on Capitol Hill in Washington, July 25, 2012. REUTERS/Jonathan Ernst

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.

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.)

Among its banking brethren, Goldman isn’t unique or even the worst off – Bank of America trades at about 60 percent of book value and Citigroup at just over 50 percent. Analysts question whether these banks can earn their cost of capital. Last month, Philip Purcell, the former CEO of Morgan Stanley – and the architect of the megamerger between Morgan Stanley and Dean Witter – wrote a piece in the Wall Street Journal arguing that shareholders would get better value if the big banks broke themselves up. He chalked the sinking stocks up to the “mismatch” between volatile investment banking and trading businesses on the one hand, and “safer, more client-centric businesses” like asset management and banking and credit cards on the other hand. Others who have called for a breakup of the big banks cite the essential unmanageability of these giant, risky firms.

But Goldman hasn’t suffered the blatant management missteps of its peers, at least from a bottom-line perspective; moreover, it’s hard to see how splitting up is an option for Goldman. Unlike a Citi or a BofA, Goldman lacks the pieces in which to break. Although Goldman is now officially a bank, it doesn’t do much that resembles banking as we know it. True, Goldman does have an asset management business, but it has succeeded despite less-than-stellar performance. A good chunk of its value is precisely because it’s part of Goldman Sachs.

So what’s the problem, and is there a solution? One view is that Goldman has always been run for the benefit of its employees, rather than shareholders – over the years, many of the former have gotten rich, while some of the latter have lost a lot of money – and shareholders have finally wised up. In this view, it doesn’t matter what Goldman earns because ultimately that wealth will be transferred to management, not shareholders, through ever-larger compensation packages. So Goldman should take itself private and stop pretending that shareholders are part of the equation.

But there are also a number of more constructive theories, all of which could be true. One possibility is that the black-box nature of Goldman Sachs is no longer acceptable to investors, in which case Goldman could work to make itself more transparent – a Lucite box! Another is that the ongoing threat of legal liabilities, in particular, the Department of Justice investigation into Goldman’s behavior during the crisis, is weighing down the stock. A third is that given the myriad uncertainties in world markets, of course Goldman’s stock is going to suffer. Market participants say that Goldman is no longer taking risk the way it once did. But as soon as the clouds lift, normalcy – i.e., the risk-taking and the mega-profits of the pre-crash years – will return.

Yet another possibility, though, is that the world has changed, and Goldman either needs to shrink – or show investors how it can reinvent itself. New regulations are one reason. Despite frenzied lobbying, regulations from higher capital requirements to whatever iteration of the Volcker Rule emerges from the murk of D.C. will add cost and lessen opportunities. But the more important reason is that Europe, Japan and North America, which analyst Meredith Whitney wrote in a report accounted for 80 percent of Wall Street’s revenues over the last decade, are all in a massive, lengthy deleveraging process. Yet during that period, over a third of Wall Street’s revenues came from debt capital markets, and in turn, over 40 percent of that came from the issuance of financial debt. Even more, at the big banks, a huge percentage of the debt they sold at the peak was their own. (In Goldman’s case, Whitney says, 40 percent of its total debt capital markets business in 2006 was the issuance of its own debt.) Less debt equals less profit. (Goldman says it doesn’t make money issuing its own debt.)

Goldman gets a bigger chunk of its profits from outside the U.S. and Europe than others do. But while Asia and Latin America are growing quickly, they are still relatively small. And it’s hard to tell how much of Goldman’s derivatives business, which has been a huge chunk of its profits, was tied to the issuance of debt. In a world where debt in the developed world has to decrease, a world where everything can’t be turned into a derivative, maybe the robust return on equity Goldman produced is a thing of the past.

While Goldman people are the first to say that there is no certainty about anything today, the firm – not surprisingly! – rejects the idea that the market wants it to liquidate. You can see the firm’s optimism in its headcount, which is now about 32,000. True, that’s down some 8 percent from last year (and Goldman has cut costs more aggressively than headcount reflects), but it is still up about 9,000 from the end of 2005. Goldman executives have argued that even if Europe – European banks in particular – do need to delever, there could be a silver lining, which is that companies in Europe, which traditionally have relied upon loans from banks, will now instead sell debt in the capital markets, thereby spelling opportunity for firms like Goldman. There’s also an argument that while Goldman’s return on equity of 12 percent in the first quarter (which, in fairness, was a big improvement on the 3.7 percent Goldman posted in 2011) is a fraction of the stunning 40 percent returns it posted at the peak, a 12 percent return on equity, if sustainable, is not so terrible in a zero-interest-rate world.

If you look at the firm over the decades, its real business model has been to be wherever there’s money to be made, to turn on a dime to get there, and to find a way to adapt and prosper no matter what the conditions. But even Goldman admits that in the meantime, investors have to be patient – and patient is one thing that most modern investors are not.

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.

Right now, that roughly $1 trillion in student loans outstanding is paltry compared with the amount of mortgage debt outstanding at the peak of the bubble, which was about $10 trillion. Indeed, at the peak, there were about $2.5 trillion in securities backed by subprime mortgages alone, says Barron’s. And while student loans outstanding have grown rapidly – debt is up ninefold from 1997, according to the College Board’s 2011 “Trends in College Pricing” – that too is small compared with the torrid growth in subprime lending before the collapse.

But taking solace in the face value of the numbers is probably a mistake, just as it was a mistake to look at the size of the subprime market and say the problem was “contained.” (Hello, Ben Bernanke and Hank Paulson!) For one thing, just because the student loan bubble is smaller doesn’t mean there isn’t a bubble. While some of the increase in the overall level of debt has happened because more people are going to college, tuition is growing far more rapidly than inflation or even healthcare spending; in fact, according to Barron’s, tuition and fees at four-year schools grew by 300 percent from 1990 through 2011. Over the same period, broad inflation increased just 75 percent and healthcare costs rose 150 percent. Perhaps more important, education inflation has also exceeded wage growth for decades. Former U.S. Secretary of Education Bill Bennett says that tuition has increased 400 percent in the last 20 years. So by definition, an education is becoming less and less affordable – just as homeownership became less and less affordable as that bubble reached its apex.

Nor does the amount of outstanding debt simply grow as more students attend college. The amount also increases when those who have left school can’t pay, and the balance can mushroom as the interest compounds. Have you read the horror stories about students who graduate with $70,000 in debt that turns into $200,000? Indeed, student loans are sort of like option ARM mortgages, where the amount of the mortgage grew if the borrower chose to pay less interest than was due. And if Congress doesn’t keep the interest rates on federal student loans from doubling on July 1, as they’re supposed to do, the numbers are going to get worse. (Although there’s another way to look at this, which is that allowing interest rates to rise will help prick the bubble before it gets even bigger, just as allowing interest rates to rise in, say, 2004 would have caused pain, but also would have pricked the mortgage bubble.)

Default rates on student loans are both high and hard to measure: According to a recent report by the Federal Reserve, about 10 percent of outstanding loans are past due. But the Times noted that when you include borrowers who are still in school or who have otherwise postponed their payments, just 38 percent of the balance of federal student loans is currently being repaid, down from 46 percent five years ago. Optimists cite a whole host of reasons as to why defaults on student debt aren’t as dangerous for the financial system as defaults on mortgages. Because student loan debt isn’t dischargeable in bankruptcy, historically, people have been unwilling to walk away from it. Indeed, the government eventually collects about 85 cents on every dollar. The average amount of student debt – $23,200, according to the Times – is much smaller than the average mortgage. And while student loans are turned into securities, just as mortgages were, Wall Street hasn’t, so far, created the crazy add-on debt instruments that made the mortgage defaults ricochet through the financial system. (Hello, AIG.) As far as I know, no one is selling credit default swaps tied to student loan debt – at least not yet!

But this time around, it may not be defaults that are the problem. Student debt will reverberate not through the financial system, but rather through the real economy, even if the amount of money that’s lost isn’t enormous in dollar terms. “Hobbled” is the word the New York Times used, and it’s more than apropos: It will hobble not just students, but our entire economy. In an ironic twist, student debt may prevent the revitalization of the housing market, upon which so much of our economic health rests. In his most recent annual report, Warren Buffett said he was bullish on housing because of hormones: As young people form families, they buy homes. But what does it mean for the housing market, especially as baby boomers look to sell their homes, if there’s less demand because the money that might have gone toward downpayments is instead going to student loan payments?

Nor is student debt just a problem for the young. The Washington Post recently cited research from the Fed showing that Americans who are 60 and older still owe about $36 billion in student loans. Many of these people have co-signed for loans with their children or grandchildren to help them afford the tuition. What will it do to our economy if people can’t afford to retire, especially given the strains on Social Security and Medicare? And there are side effects of too much debt that are hard to measure. As someone recently said to me: “Debt is a negative mindset versus a hopeful one.” Will the student with tens of thousands of dollars in debt be as willing or able to take a flyer on her entrepreneurial dream? We’ll never know what the value was of the business that wasn’t started.

There’s also a predatory aspect to today’s boom in student loans that is eerily reminiscent of subprime loans. Attorneys general – who also tried to be vigilant about subprime abuses – from more than 20 states have joined together to investigate for-profit colleges, which account for nearly half of student loan defaults, even though less than 10 percent of higher education students go there, according to the New York Times. The stories are horrifying, just as the stories about abusive mortgage lending were horrifying.

But as bad as the instances of blatant predation are, there’s an even larger, darker context. Students, and their families, are overextending themselves because they’ve been told that an education is the path to a better life, just as many people bought homes at the height of the bubble because they were told that homeownership was the key to a better future. But if education isn’t worth the cost – if people can’t get jobs that enable them to pay back their debt – then they’re being sold another lie. I often think that the worst carnage of the financial crisis wasn’t financial, but rather psychological. People were encouraged to pay for something that turned out to be worthless, and as a result, there’s been a societal breakdown in trust. Will we eventually conclude that the education market was as screwed up as the mortgage market, but only after it’s too late?

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?”

More recently, Simon Johnson, a former chief economist at the IMF, said last November that the decision “by the Bush administration, by the SEC to allow investment banks to massively increase their leverage … in terms of the big mistakes in financial history, that’s got to be in the top 10.”

It is certainly true that leverage at the investment banks zoomed between 2004 and 2007, before the near collapse. And this narrative of the rule change has plenty of appeal — it serves up villains. Stupid SEC people! Greedy bankers! It also suggests regulators were in the pockets of the big banks, and it offers support for the narrative of financial deregulation that many put at the center of the crisis.

There’s just one problem with this story line: It’s not true. Nor is it hard to prove that. Look at the historical leverage of the big five investment banks — Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley. The Government Accountability Office did just this in a July 2009 report and noted that three of the five firms had leverage ratios of 28 to 1 or greater at fiscal year-end 1998, which not only is a lot higher than 12 to 1 but also was higher than their leverage ratios at the end of 2006. So if leverage was higher before the rule change than it ever was afterward, how could the 2004 rule change have resulted in previously impermissible leverage?

The blame-the-2004-rule position made its first appearance in August 2008, when a former director of the SEC’s trading and markets division named Lee Pickard wrote an op-ed in the American Banker arguing that the SEC contributed to the crisis when it changed something known as the “net capital rule” in 2004. The net capital rule, which governs how much capital broker-dealers have to hold and how that capital is measured, is technical, but Pickard made it simple: Prior to 2004, the broker-dealers’ debt had been limited “to about 12 times its net capital,” but thanks to the change, the investment banks were now able to avoid “limitations on indebtedness.”

That October, the New York Times ran a front-page piece by Stephen Labaton entitled, “Agency’s ’04 Rule Let Banks Pile Up New Debt.” Labaton wrote that the big banks had made an “urgent plea” to the SEC that would exempt their brokerage units “from an old regulation that limited the amount of debt they could take on” and would “unshackle billions of dollars held in reserve as a cushion against losses.” This was essentially what the banks demanded in exchange for submitting their holding companies to oversight by the SEC. Previously, there had been no oversight, but the European Union was threatening to impose its own regulations unless the U.S. did so. With the loosened capital rules, billions could then “flow up to the parent company,” enabling increased leverage. Indeed, Labaton wrote, “Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measure of how much the firm was borrowing compared with its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly.” There were 157 comments on the Web version of this piece, most along the lines of remarks by a “Vietnam-era vet” who called the 2004 rule change “the financial equivalent of Patient Zero.”

On Jan. 3, 2009, at the annual meeting of the American Economic Association, Susan Woodward, a former SEC chief economist, highlighted the rule change in a presentation, a slide for which read:  “2004 — SEC eliminated capital rules for investment banks” and “Average I-bank ratios of capital to assets: before 2004: 1 to 12. After 2004: 1 to 33.”

A number of prominent academics who were there went on to repeat a version of Woodward’s claim. They include Robert Hall, who was then the incoming president of the American Economic Association, Ken Rogoff, and Alan Blinder. In the highly regarded book This Time is Different, which Rogoff co-authored with Carmen Reinhart, the authors write that “huge regulatory mistakes” like the “2004 decision of the SEC to allow investment banks to triple their leverage ratios (that is, the ratio measuring the amount of risk to capital) appeared benign at the time.”

Other prominent people who have blamed the SEC’s 2004 rule change for the increase in leverage at the (former) big five investment banks include historian Niall Ferguson; Joseph Stiglitz, who wrote in his book Freefall that “in a controversial decision in April 2004, [the SEC] seems to have given them [the big investment banks] even more latitude, as some investment banks increased their leverage to 40 to 1”); and Nouriel Roubini, who with his co-authors wrote in their book Crisis Economics that “investment banks reacted to this [2004] deregulation by massively increasing their leverage … to ratios of 20, 25 or even more…”

Thus did the “fact” become part of the conventional wisdom about the crisis.

***

Jacob Goldfield, a Harvard physics major turned Goldman Sachs partner (he left in 2000) noticed the claim that leverage had been limited to 12 before 2004, and then soared to 33. He thought it was strange that he hadn’t heard of this when it happened. He’d also noticed what he calls “quite a few” other pieces of conventional, but inaccurate, wisdom about the crisis, so he didn’t take for granted that this one was right. Instead, he checked. He looked at the 2003 leverage of two investment banks and found that it was much higher than 12. (In fact, there’s only one firm whose leverage in 2006 or 2007 was higher than it had ever been before 2004, and that’s Morgan Stanley. Nor was the leverage for the two firms that were hit the hardest by the crisis out of historical bounds when the world went to hell: Bear’s leverage (as measured by liabilities over equity capital) at year-end 2001 was 32, versus 32.5 at year-end 2007, Lehman’s at year-end 2001 was 28.3, versus 29.7 at year-end 2007.)

Halfway across the country, a semi-retired lawyer in Chicago named Bob Lockner began reading about the 2004 rule change, too. Lockner, who specialized in commercial bank capital markets activities, was suspicious because everyone kept citing the holding company leverage — but the rule applied only to the broker-dealer subsidiaries, and so didn’t include any international business, over-the-counter derivatives, or holdings of corporate or real estate loans, for instance. He also noticed that the rule hadn’t actually been implemented in 2004. The broker-dealer subsidiaries of Merrill and Goldman began using it in 2005, but the broker-dealer subs of Bear, Lehman and Morgan Stanley didn’t begin using the rule until their fiscal 2006 years. In other words, while leverage at the holding companies had started to climb in 2004 and 2005, the rule change clearly couldn’t be the reason.

After reading the Wikipedia entry for the “net capital rule,” which mostly cited the New York Times piece, Lockner decided to rewrite it, hoping that an accurate version would force people to acknowledge the old version was wrong. When I ask why he spent his time that way, he chuckles and says: “You mean, why am I insane?”

Lockner’s rewrite of the Wikipedia entry, at least as it existed on Mar. 13, 2012, describes in great technical detail the SEC’s net capital rule and the 2004 changes. But there are a few simple points. There was never any explicit leverage limit at the holding company level before or after the rule change. Even at the broker-dealer subsidiaries, a 12:1 limit didn’t exist. Smaller broker-dealers had an early warning at the 12:1 ratio, and an actual limit of 15:1 — but even these ratios didn’t exist in the way the economists seemed to interpret them, because they were calculated in a way that excluded big chunks of debt. In any event, since 1975, the broker-dealer subsidiaries of the big five investment banks had been using a different method, which had nothing to do with 12:1 or 15:1, to calculate their leverage limit. That method was unchanged in 2004. (Interestingly enough, the holding companies for the big investment banks might actually have made it under the 15:1 limit if you calculate the ratios by excluding the debt that the SEC does.)

There is another, more subtle point. The SEC did change the way the big broker-dealers calculated their net capital in 2004 in a way that could have allowed them to reduce the capital they held (by making it easier for them to meet the minimum requirements). This could indeed have had the effect of increasing the leverage, at least at the broker-dealer level. But it’s not axiomatic that that would result in higher leverage at the holding company — and it’s not even clear what the effect of the rule change was at the broker-dealer level.

One way the broker-dealers could have reduced capital would have been, as Labaton wrote, by paying big dividends to the holding company. But when the SEC changed the rule, it also put in place a new requirement that each of the broker-dealers have $5 billion in liquid capital before the major effects of the rule change; the SEC says that would have made it harder for the broker-dealers to pay out big dividends, and in fact, it required one firm to add capital to its broker-dealer. Overall, the SEC says that capital, as measured before most of the expected impact of the rule change, stayed stable or even increased after 2004. Several people at the broker-dealers at the time also tell me that the new rule was totally inconsequential in how they managed their capital levels

Skeptics may discount what the SEC and the broker-dealers say. But the data does show that over the years, the broker-dealers, contrary to perceptions that they must have wanted their capital to be as low as possible, actually kept much more capital on hand than they were required to hold. For example, in both 2006 and 2007, Bear Stearns had seven times the amount of capital that the SEC required, or more than $3 billion in excess net capital. This might suggest that the amount of capital the broker-dealers kept was boosted by factors other than the SEC’s requirements, like business needs, or rating agency and customer demands.

Various measures of leverage at the broker-dealer level do reach fresh peaks subsequent to the rule change. But it’s not obvious that that’s because of the rule change. The increases aren’t big in all cases, nor do they follow immediately after the firms implemented the new rules, and there’s enormous volatility from year to year, which may argue that the driving factor wasn’t the loosening of a preexisting constraint. Interestingly enough, one measure of leverage at the best-performing firm’s broker-dealer — Goldman Sachs — was higher before the rule change than at any other firm’s broker-dealer after the rule change.

***

The funny thing is that this is a mistake that no one has corrected. Although Erik Sirri, who was then the director of the SEC’s division of trading and markets, rebutted the claim in 2009, the New York Times didn’t cover it. Lockner says he wrote to a handful of economists; only Niall Ferguson responded and was chagrined to find out he was wrong. Of the people I cited earlier, only Blinder, Johnson, Kwak and Susan Woodward responded to my calls or emails.  Blinder now says: “It’s true that very high leverage was a big source of the problem, but the net capital rule does not appear to have changed that much.” (The New York Times hasn’t issued a correction to his op-ed.)  Woodward now says that while she doesn’t think the 2004 change is even on the top ten list of the most important contributors to the crisis, it doesn’t really matter, because “everyone agrees that too much leverage was a key cause.” Pickard, for his part, believes that the rule change hasn’t gotten enough blame yet, and he says that if leverage at the holding companies was higher in the 1990s, then the investment banks must have been playing games with their books.

More recently, Andrew Lo, the director of MIT’s Laboratory for Financial Engineering, wrote a paper analyzing 21 books on the financial crisis. In his paper, he pointed out the fallacy of blaming increased leverage on the 2004 rule change. Although Lo’s paper was picked up by the Economist, even that didn’t spur any of the academics who made the mistake to correct it. Why?

The best reason was voiced by James Kwak, who co-authored the book Thirteen Bankers with Simon Johnson. The book also links the increased leverage at the holding companies to the SEC’s rule change (although Johnson and Kwak never say the leverage was limited to 12:1 beforehand.) In a blog response to Lo’s paper, Kwak argues that Lo is making too big a deal out of this, because the rule change “very well might” have played a role in the increased leverage even if “we can’t tell how much.” In a conversation with me, Simon Johnson, Kwak’s co-author, argued that even if the broker-dealers kept excess capital on hand, well, they might have kept more excess capital had the rule change not occurred. This is indeed possible, although over time, the excess capital that the broker-dealers kept varied wildly, making it hard to see that they were targeting a specific amount of excess. In any event, Kwak and Johnson have a point: What happened at the broker-dealer level is murky and should be better understood. But the problem is that saying the rule change “might” have caused increased leverage just at the broker-dealer level is very different from saying it was an important cause of the crisis (especially since Lehman’s broker-dealer stayed solvent after its bankruptcy — it wasn’t the root of Lehman’s problems). At this point, the burden of proof should be on those who have claimed that the rule change was seminal.

Another reason that was suggested to me is that it’s politically incorrect to challenge the conventional wisdom about the rule change, because doing so might be construed as a defense of the SEC or the investment banks. That’s ridiculous: Facts are facts, and those who supposedly traffic in them should have respect for them. In addition, it’s far from a defense of the SEC to say that the rule change has been misrepresented. It may well have had pernicious effects that aren’t well understood yet. The broader context of the 2004 rule change was that, as Labaton pointed out, the SEC agreed to supervise the investment bank holding companies, and it clearly failed in those responsibilities. While the 2004 rule change offered a lovely explanation for that failure — blind incompetence is easily fixable — the real failings might be harder to fix, especially if we’re not looking for them.

A third reason I was given for why this mistake is no big deal is that because high leverage was surely to blame for the crisis, it’s beside the point whether the 2004 rule change made things worse or not. That’s silly — saying cancer killed the patient and saying the water he drank gave him the cancer are two very different claims. And it’s also dangerous, because if the rule change wasn’t behind the increased leverage at the investment banks, or the broker-dealers, then what was? If our goal is to prevent another crisis, isn’t it important to understand what actually happened? Or as Lo said to me: “If we haven’t captured the killer, then the real killer is still out there somewhere.”

PHOTOS: The U.S. Securities and Exchange Commission logo adorns an office door at the SEC headquarters in Washington, June 24, 2011. REUTERS/Jonathan Ernst; Princeton University Professor of Economics Alan Blinder speaks during a presentation at the American Economic Association Conference in Atlanta, January 3, 2010. REUTERS/Tami Chappell