The Securities and Exchange Commission and the Federal Bureau of Investigation are looking into JPMorgan Chase’s trading debacle — and if you think anything is going to come of that, well, I’m pretty sure that JPMorgan has some derivatives it would love to sell you.

A serious investigation is still necessary. The first lesson of the financial crisis is not that the capital markets were poorly regulated or that the banks were too leveraged or that the government needed better processes for taking over failing institutions.

The first lesson is that when they are in trouble, banks will mislead the world about their financials. And some will lie. Richard S. Fuld Jr. of Lehman Brothers, E. Stanley O’Neal and Charles O. Prince of Citigroup all played down their banks’ exposures before their institutions took vast losses. Were they deliberately misleading? Because of the failures to investigate the financial crisis adequately, we still don’t know.

But we do know that when banks hide their problems, they metastasize and can hurt the economy.

So before we move on to other vital discussions — about tightening the Volcker Rule, preventing the rollback of Dodd-Frank’s derivatives provisions, whether these banks are Too Big to Manage and more — we need to go back to the basics:

What did Jamie Dimon, the bank’s chief executive, and Doug Braunstein, the chief financial officer, know and when did they know it? Were JPMorgan’s first-quarter earnings accurate? Were top JPMorgan officials misleading when they discussed the chief investment office’s investments?

Perhaps JPMorgan was a model of probity, but so far these questions have been given only glancing treatment. The news coverage has largely focused on how the bank took the losses, what went wrong with its risk management and what it’s doing now. The commentary has mostly gone straight to discussing the implications for banking reform.

That’s already a victory for bankers — including Mr. Dimon. The first question on everyone’s mind should be whether any existing laws were broken.

That it hasn’t been asked shows how little true accountability there has been since the financial crisis. No top-tier banker has gone to prison for the many bank failures, the deceptive sales practices or the misrepresentations of the books. As a society, we have thrown up our hands at Too Big to Prosecute financial fraud.

Granted, it’s also because Mr. Dimon is charming. Last week, in his extraordinary conference call, he was refreshingly straightforward and made a big show of contrition. He repeatedly said things chief executives don’t say, calling his bank “stupid” and its conduct “egregious.”

And there has been a measure of internal accountability: JPMorgan cashiered the three top executives responsible for the trading loss.

But we still don’t know enough about the timing of these losses.

The broader public became aware of the trades when Bloomberg News and The Wall Street Journal wrote about the “London Whale” in early April. JPMorgan dismissed concerns then.

Now the bank says that the big losses happened after the first quarter, in late April and early May.

JPMorgan reported its first-quarter earnings on April 13. That’s when Mr. Dimon and Mr. Braunstein played down the problem, including with Mr. Dimon’s now-infamous remark that reports about the trades were a “complete tempest in a teapot.”

JPMorgan was clearly executing a strategy. The bank didn’t want its trader to become a wounded zebra on the savanna, attracting predators. Had the bank owned up to the problem right away, the losses could have ballooned as other investors piled in on the other side to force JPMorgan to let go of its positions at fire-sale prices.

JPMorgan executives spread the word, whispering in the ears of reporters and analysts, that hedge funds on the opposite side of the trade were in trouble. JPMorgan signaled that it wasn’t going anywhere. It had a big balance sheet behind these trades and could hold for a very long time. Its message: Hedge funds, you’re in trouble. Sell now.

“As they started to get some scrutiny, the last thing that they wanted was to admit that the journalists had been right,” said David Murphy, a risk management specialist at Rivast Consulting.

Now we realize the bank was bluffing. And it didn’t work.

Of course, bluffing isn’t illegal. From traders’ and bloggers’ efforts to figure out what JPMorgan’s positions were, it appears that the credit default swap indexes that the London Whale, Bruno Iksil, was speculating in started to have big moves recently. That argues in favor of the idea that the first-quarter earnings were not misstated, the most egregious potential transgression.

But there are some odd aspects. Even on Wall Street, losing $2 billion typically takes a while. The one big “London Whale Trade” — buying and selling credit default swaps on the same index but at different expiration dates — appears to amount to only around $50 billion or $70 billion, and likely accounts for perhaps $600 million to $1 billion at most of the more than $2 billion loss, I’m told.

So there were other trades involved, which have also taken losses. From the losses that have been reported so far, the underlying value of the derivatives contracts was likely to be $250 billion to $300 billion. What were the other trades and when did those losses take place? And were positions being marked correctly?

JPMorgan changed a crucial measure of risk during the quarter. Why? And was that adequately disclosed?

At best, this was a huge management failure. The trades had been initiated months ago and were widely known. Earlier in the year, people inside the bank spoke of Mr. Iksil as “defending his positions.” That carries the implication that he was doubling down, to force the market in the opposite direction. That’s a rookie trading mistake, one presumably approved by his bosses.

It’s only human to have trouble owning up to mistakes. As Mr. Murphy, the risk management specialist, put it: “There’s always management pressure when it’s a big number and it’s material. ‘Are we sure?’ The last thing managers want is a big loss in quarter that then comes back right afterwards. Then they look like total idiots.”

But given the outstanding questions, looking like an idiot is the best-case scenario.

The Securities and Exchange Commission seems to think that it has done a much better job of investigating financial crisis wrongdoing than the Justice Department. And it's true.

But it's like being proud that you're the "Dumb" of "Dumb and Dumber."

A case the commission filed last week epitomizes a lot of what's wrong with the agency, even under the supposed overhaul by its chairwoman, Mary L. Schapiro.

The agency brought a civil case against a tiny, iconoclastic ratings agency called Egan-Jones, run by the outspoken Sean Egan, accusing it of, well, essentially filling out forms wrong.

Before the S.E.C. charges, Egan-Jones was best known for two things: having made some bold calls about shaky credit prospects and having a business model that was different than that of the big boys — Moody's Investors Service, Standard & Poor's and Fitch. Mr. Egan's outfit gets paid by the users of his ratings; the oligopoly gets paid by the issuers whose debt is going to be rated.

You don't need to be a hedge fund quant to see the conflict of interest: the more ratings, the more profits to the ratings agencies, so the temptation is to be extra lenient. And, boy, were they.

Mr. Egan wasn't shy about pointing this out, often through media appearances. To be honest, one wondered how much was showmanship and how much was deep research.

But the world needs his brand of punditry, especially on Wall Street, where the uncorrupted are too afraid to speak out. Mr. Egan has been prescient on some important calls about declining credit prospects, ahead of both the European financial crisis and the American mortgage and structured finance bubble before that.

The S.E.C.'s case against Mr. Egan and his firm concerns a filing made in 2008 seeking special designation to be a "nationally recognized statistical ratings organization." This status confers some rights and special privileges under securities laws, and it's one of the main competitive advantages the credit ratings trinity has.

The agency makes a variety of allegations. For one, Egan-Jones represented in its application that it had 150 ratings on asset-backed securities and 50 ratings on governments, when it hadn't issued any at the time, the S.E.C. says. To the guillotine! (Egan-Jones responds that it was using a different counting method.)

Some allegations are more serious, but only slightly. The agency contends that two Egan-Jones employees had a role in rating issuers while owning securities in those issuers. The firm says these employees had long-standing investments and that it actually brought these violations to the attention of the S.E.C.

All told, the allegations seem especially paltry when compared with the disastrous performance of the ratings agencies that matter — Moody's and S.&P. Egan-Jones's ratings didn't cripple the global economy. Mr. Egan's business model is far less prone to compromise and corruption. The inescapable conclusion is that the S.E.C. is letting Moody's and S.&P. officials walk free while pursuing Mr. Egan on minor technicalities.

This is your S.E.C., folks. It courageously assails tiny firms, and at the pace of a three-toed sloth. And when it goes after its prey, it's because it has found a box unchecked, rather than any kind of deep, systemic rot.

Unfortunately, there's an even worse problem here. The action against Mr. Egan gives the appearance, perhaps inadvertently, that the agency is persecuting a longstanding critic of the ratings agencies. That just solidifies the woeful ratings oligopoly we have today.

Now, the S.E.C. doesn't see it this way, naturally. The agency says that bringing one case doesn't preclude another. And it's true that there have been news reports of investigations into the ratings firms regarding actions that led to the financial crisis, including notices that it plans to bring charges over some ratings.

John Nester, a commission spokesman, said the agency stands up to the big boys. "Our record shows beyond dispute that no institution is immune from S.E.C. charges when we find violations of the securities laws," he said, pointing to, among others, Goldman Sachs, Citigroup, JPMorgan Chase and Bank of America.

Relative to Eric Holder's Justice Department, that record makes the S.E.C. look like the god Shiva, destroyer of worlds. But the S.E.C. has hardly been aggressive about the ratings agencies. It hasn't moved against any top executives of any major ratings firm for actions leading to the financial crisis.

In one of its timorous moments, the agency punted on a case involving Moody's and a questionable rating on a complicated European structured finance product. The S.E.C. determined that it was unclear whether it had jurisdiction because the securities were created and sold in Europe.

Promising leads on other potential wrongdoings by credit rating agencies seemingly go to the S.E.C. to die. A whistle-blower — Eric Kolchinsky, a former Moody's executive who oversaw the firm's collateralized debt obligation ratings — claimed that Moody's inflated ratings on a loan deal called Nine Grade Funding in January 2008 because it had already made a decision that it was going to downgrade the assets that were going into the deal.

Some three years after that allegation was dropped at the door of the S.E.C., there's been no action so far on the deal.

Moody's declined to comment. The S.E.C. does not confirm or deny investigations. Given that the regulator's bark is worse than its bite, Egan-Jones will probably be able to wriggle out of the agency's clutches with a settlement and a fine. Mr. Egan's business will be damaged, but he is likely to still have one.

The help that the S.E.C. has given the oligopoly will last, however. Any small company looking at filing for special status will think twice. While they ponder, Moody's, S.&P. and Fitch will continue to earn fat profits, and their executives walk free.

The path to gaming the Volcker Rule has always been clear: Banks will shut down anything with the word "proprietary" on the door and simply move the activities down the hall.

To look like they were ready to comply with the Volcker Rule, the part of the Dodd-Frank Act that aims to prevent banks from gambling on their own account with money that taxpayers insure, financial firms quickly spun off or shut down their hedge funds, private equity firms and proprietary trading desks.

But the suspicious-minded among us wonder whether it was all that simple. This is the specter raised by the news that a JPMorgan Chase trader in London, made instantaneously notorious thanks to his colorful nicknames ("Voldemort" or "the London Whale," take your pick), was amassing such huge positions in indexes related to corporate defaults that he was distorting the market. (Apparently, it wasn't just one trader but more than a dozen, according to a person at JPMorgan, but the nicknames are too good to let go.)

Bloomberg followed up with a powerful article about how Jamie Dimon, the chief executive of JPMorgan, has transformed the sleepy chief investment office, which takes care of the bank's treasury operation, into a unit that hires former hedge fund portfolio managers and slings around giant sums of money in what walks and quacks like prop trading. The chief investment office seems not to just be risk-mitigating, but profit-maximizing.

The Congressional authors of the Volcker Rule worried about this very thing, and you can trace their concerns through their drafts. The original language of the rule had a broad exception: banks couldn't trade for their own account, but they could hedge to mitigate their risks.

The authors quickly realized that the exemption was absurdly broad. After moving these businesses to other divisions, banks would then argue that their bets were either market-making activities or simply hedges that offset risks.

Such "hedges" could encompass a lot of trades that looked awfully proprietary. A trade could seem to hedge a large business risk, like suffering loan losses if companies they lent to went broke in an economic downturn. But that might just be a bet on companies going belly up.

So Congress tightened the language. It wrote that the hedges had to be specific. When the Dodd-Frank financial reform law came out, the Volcker Rule provision defined "risk mitigating activities" as trades that were "designed to reduce the specific risks to the banking entity in connection with and related to such positions, contracts, or other holdings." No macro-hedging, only micro-hedging. That is the will of Congress.

But then federal regulators got their hands on Volcker and set about interpreting the meaning of Dodd Frank. This has been a Talmudic exercise in reverse: It has taken the clear and simple intent and made it muddy and complicated.

Regulators decided that banks could say that they were hedging for an overall portfolio. And the banks could argue that a hedge was legitimate if it merely had a "reasonable correlation" with the security or position being hedged. It was as if the regulators had not only questioned the basis for the rules of being kosher, but had also served up a cheeseburger — with bacon on top — all very nonkosher.

"One of the great fears was that banks could avoid the rule by simply pretending that their prop trading was somehow their market-making or hedging," a Congressional aide told me. "Congress tightened the language to prevent this, and yet banks still may get away with this under the proposed rules."

The rules aren't finalized, so there's a chance the regulators will make adjustments. The authors of the Volcker Rule raised objections in a comment letter in February. "Banks could easily use portfolio-based hedging to mask proprietary trading," Democratic Senators Jeff Merkley of Oregon and Carl Levin of Michigan wrote in a letter to regulators. "There is no statutory basis to support the proposed portfolio hedging language, nor is there anything in the legislative history to suggest it should be allowed."

The problem of allowing a broad "portfolio hedging" exception is obvious. Follow the logic to its end, and you could expect to find a bank arguing that it needed to hedge its commercial banking business by buying an investment bank and hedge its banking business with an insurance company and so on.

And lo, JPMorgan says exactly what we might expect a bank that knows how the regulators are interpreting Volcker would say: that the trading of its chief investment office is merely hedging.

But the bank is unabashed: "The purpose of this is to hedge the macro risk of the company," a JPMorgan executive explained to me. "It's what we are supposed to be doing, we do it well, we write about it in the annual report and we show it to every regulator," he added.

Alas, it wasn't the regulators who brought this to light. Instead, it took hedge funds on the other side of trades. This has led to a cynical reaction: hedge funds are hardly the epitome of upright regulatory citizens, burning to bring violations of the Volcker Rule to light.

But just because a hedge fund is biased doesn't mean it's wrong. It can be simultaneously true that hedge funds have gotten themselves into a bad trade and that JPMorgan is doing something more than hedging.

And it matters what the banks' trading partners think because the banks invoke them constantly in order to protect themselves from the Volcker Rule. The big banks wrap themselves in the mantle of market-making. Without them, they warn, liquidity — or how easy it is to enter and exit trades — will dry up.

In the case of these JPMorgan trades, however, we can see how a huge position can undermine liquidity. A big bank can become the market. JPMorgan's big position now makes trading in these credit indexes less likely, not more, which could lead to more volatile markets.

So is this legitimate trading? The hedge funds don't really know what's going on at JPMorgan's chief investment office. Nor can the public tell from the bank's disclosures. The only ones who have a chance to get a true picture are the dozens of regulators who are sitting in the bank's office.

But given how bent the regulators are to subvert the will of Congress, it would take an act of extraordinary naiveté to believe they will actually get to the bottom of it.

An annual report from a regional Federal Reserve bank is typically a collection of banalities and clichés with some pictures of local worthies who serve on the board.

And so it is with this year's annual report from the Federal Reserve Bank of Dallas, whose pages are graced by the smiling, stolid portraits of board members who run local companies like Whataburger Restaurants.

But the text is something else entirely. It's a radical indictment of the nation's financial system. The lead essay, which is endorsed by the president of the Dallas Fed, contends that despite the great crisis of 2008, a cartel of megabanks is still hindering the economic recovery and the institutions remain too big to fail.

The country's biggest banks look much as they did before the 2008 financial crisis -- only bigger. They have "increased oligopoly power" and "remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation," Harvey Rosenblum, the head of the Dallas Fed's research department, wrote in the essay.

Having seen the biggest banks make risky bets, crush the economy and get rewarded leaves "a residue of distrust for the government, the banking system, the Fed and capitalism itself," Mr. Rosenblum wrote.

It's one thing for the Occupy movement to point out how bailing out the biggest banks -- with little cost to their executives or shareholders and creditors -- has demolished credibility. It's quite another for top officials in the Federal Reserve system to put it in an annual report.

As for Dodd-Frank's "resolution authority" -- the power to dissolve big financial institutions that Barney Frank famously hailed as a death panel for banks -- well, not so much. "For all its bluster, Dodd-Frank leaves TBTF entrenched," Mr. Rosenblum wrote, using the acronym for "too big to fail."

Yes, Dodd Frank has mechanisms in place to prevent taxpayer bailouts of the largest banks, he concedes. Banks are supposed to have "living wills" that explain how they could be seized and wound down while minimizing the use of taxpayer money.

But the Dallas Fed is deeply skeptical that this would work in real life.

"We know under the current structure that the government would be called on once again," the president of the Dallas Fed, Richard W. Fisher, told me. He has been giving a series of speeches about the continuing problem of "too big to fail."

The biggest banks are like Aspen trees (to borrow a famous, but incorrect, metaphor made by Scooter Libby in a different context): their roots are intertwined and they turn color at the same time. "If you believe the next time the problem will center on one institution and one only, I cross my fingers and am reasonably confident" that regulators will be able to liquidate it in an orderly fashion, Mr. Rosenblum told me. But that one institution would have to be largely in one market, with few lines of business and few connections to other institutions.

Obviously, there's almost no giant financial institution that fits that description. It's more likely that the next crisis will be similar to this one, one with "too many to fail," Mr. Rosenblum contends.

Another problem, the report points out, is that the decision now doesn't rest with the Fed or some institution that has some slight hope of being neutral, but with the Treasury secretary and the president. In other words, saving a big bank now will be even more political than before. Sure, some future president could act courageously, but the Federal Reserve bankers in Texas aren't so naïve as to see that as likely.

Crucially, the Dallas Fed argues that these problems are making the system vulnerable to a future crisis and that the financial oligopoly is undermining the economic recovery and the Fed's efforts to revive growth.

"Monetary policy cannot be effective when a major portion of the banking system is undercapitalized," Mr. Rosenblum wrote in the report. "Many of the biggest banks have sputtered, their balance sheets still clogged with toxic assets accumulated in the boom years."

Unfortunately for our banking regulation system, critics in the regional Federal Reserve banks haven't had much influence on regulatory policy.

One reason is that the regional Fed officials seem to be talking their own book, or can be dismissed as doing so. Outside of New York, Richmond, Va., and San Francisco, the regional Feds oversee only the small and midsize banks that compete with the "too big to fail" banks. The small guys suffer when the big banks are unfairly subsidized by the government, so the regional Feds can be brushed off as merely cheerleading for their team.

Mr. Fisher explained to me that, on the contrary, the Dallas Fed should be heeded because it has experience with "too big to fail": During the savings-and-loan crisis of the late 1980s and early '90s, some of the biggest banks to fail were from Texas.

But another major reason that they are disregarded may be that the rebel regional Fed presidents have been skeptical about the Fed's aggressive and successful monetary policy and overly worried about inflation and the vulnerability of the dollar. That may have undermined their solid case on bank regulation.

Mr. Fisher, the Dallas Fed president, has been one of the fiercest inflation hawks. He has dissented against the Fed's efforts to buy longer-term assets, known as quantitative easing, which was an effort to stimulate the economy. (He has been less worried about inflation more recently, arguing that unemployment is the top problem for the economy.)

"Sound money and sound structure go hand in glove," Mr. Fisher said.

Thomas M. Hoenig, the former president of the Kansas City Fed, also articulated strong, compelling views on bank regulation coupled with a hard-money fever that is discredited in most economic circles. (Mr. Hoenig has been nominated to be vice chairman of the Federal Deposit Insurance Corporation, which -- an economist might say -- is his highest and best use.)

The top bank regulators at the Fed, meanwhile, have embraced unorthodox monetary policies, but have also had scant courage and originality in challenging the current structure of the country's financial system.

Not so with the Dallas Fed. Its report champions "the ultimate solution for TBTF -- breaking up the nation's biggest banks into smaller units."

Hear, hear.

Update (3/28): Yesterday, the House approved the JOBS Act. It has now been sent to the White House for the president's signature.

Finally, the House passed a jobs bill last week. And what a bill it is!

Officially called the Jump-Start Our Business Start-Ups Act, it calls for reopening our capital markets to exciting new start-ups by ridding protections for investors and stripping away disclosure requirements for smaller companies.

JOBS has been repeatedly assailed, but it will bring much-needed help to some of the harder hit sectors of the economy.

John Coffee, a Columbia Law professor, has hailed the bill as "the boiler room legalization act." And rightly so. Boiler room operations were one of the unsung job creators of the 1990s, producing some of America's greatest penny stocks and boom times for yacht makers and coke dealers.

But these small, hard-working firms have run into hard times. Areas of Long Island and Boca Raton, Fla., have still not recovered since the heyday of the Nasdaq. How long must a lost generation of Lamborghini-loving twenty-somethings suffer while their talents for talking quickly go to waste?

Congress is on the case, with Democrats and Republicans working together at last. It's not just the House. The Senate is expected to pass a similar bill this week.

Since the technology stock blowup, the accounting scandals at Enron and WorldCom and the worst financial crisis since the Great Depression, investors have been needlessly wary of putting their savings into fledgling companies offered by Wall Street banks.

The JOBS bill fixes that. Taking advantage of the revolutionary possibilities of the Internet, the bill loosens decades-old investor protections so that companies can directly advertise to those who would like to be separated from their money. It does that by giving broad exemptions for start-ups that want to "crowdfund" by raising small amounts of money over the Internet. I.P.O. pitches next to "Lose Your Belly!" ads. Sounds like a great idea!

Nigeria shouldn't be the only country to benefit from the web. Right here in America, the elderly are increasingly attractive to a variety of entrepreneurial spirits. If JOBS becomes the law, such innovators could flourish.

Let's not forget Wall Street analysts. Once, men and women could make a good living by stamping glowing ratings on companies offering stock to the public for the first time, even if they secretly believed those companies were dogs. You could even become famous, like Jack Grubman or Henry Blodget.

Ever since the cleanup back then by the New York State attorney general, Eliot Spitzer, analysts have lost some luster. With JOBS enacted, Wall Street analysts will once again be able to shill for the companies that their own investment banks are shepherding through the initial public offering process.

And then there are the short-sellers, the type of investor who ferrets out the overvalued companies, the hype stories and stock frauds.

It's been about a year now since Chinese reverse-merger companies collapsed. In that scandal, dozens of those small Chinese companies went public in the United States without having to run the gantlet of the Securities and Exchange Commission's registration rules.

After they blew up by the boatload, the S.E.C. cracked down and tightened its rules.

Since then, short-sellers' pickings have been slim. By allowing newly public small companies to not disclose financial information for years, the bill will provide new targets for short-selling hedge funds.

Clearly, the many critics of the law underestimate what a boon this will be. Sure, it would be better not to have the scams in the first place. But now short-sellers will now be able to use their talents to uncover fraud that might not have occurred without JOBS. Capital will pour into this sector of the economy.

Finally, one shouldn't underestimate how tough things have been for lobbyists promoting financial deregulation. Not in finding work, of course. Legions of civic-minded lawyers have found gainful employment helping banks desperately fight the Dodd-Frank regulatory overhaul.

But these people have suffered no end of social embarrassment. When they go to cocktail parties and say their job is to protect banks from regulations that hurt America, people have been known to laugh.

Now, the lobbyists can point out that even the White House agrees. The Obama administration has backed JOBS and is on the same page as the banks when it comes to the message: Safe, tightly regulated capital markets don't instill confidence in investors, but rather stifle ingenuity and creativity. Expect these same arguments to come up again in the push to revise Dodd-Frank. That's change we can believe in.

And, anyway, trust and confidence are overrated. Wild West markets are more thrilling. If Americans thought otherwise, Las Vegas casinos would have the buy-and-hold room next to the roulette wheels.

Then again, for entertainment, our capital markets just cannot compete with Congress.

Last week, it finally became clear that the Volcker Rule is as good as dead.

The Volcker Rule, named after Paul A. Volcker, the former chairman of the Federal Reserve, is meant to ban financial institutions that are protected and subsidized by the federal government from trading for their own account. That is, it's pretty simple: Traders shouldn't speculate for their own personal gain using the money you and I pay in taxes.

Yet bank lobbyists with complicit regulators and legislators took a simple concept and bloated it into a 530-page monstrosity of hopeless complexity and vagueness.

They couldn't kill the rule. Instead, they are getting Congress and regulators to render it morbidly obese and bedridden.

Of course, that's no accident. The biggest banks, which are in business today only because taxpayers bailed them out, want to protect their valuable franchises.

"Most of the length, complexity and questions are in there because of industry lobbying," said Dennis Kelleher, who runs Better Markets, a financial regulatory reform group. The rule is "the bastard child of the lobbying industry," he said. "You can't demand and insist and lobby for all these rules and exemptions and then complain that it's too long and complex."

The banks are making sure the rule stays incapacitated. By Mr. Kelleher's count, of the substantive responses, 13 were pro-reform, compared with 300 from the industry.

The regulators and legislators deserve some sympathy against such an onslaught. But only so much. Responsibility for the gross inadequacy of the Volcker Rule lies with them. They added in the loopholes and exceptions.

Regulators did so out of vanity. They are confident they will be smart enough to navigate all the complexities. Regulators have already testified that they wanted to carry out the rule in a nuanced fashion. They aspire to distinguish intentional proprietary trading from unintentional cases, a standard that is tantamount to pre-emptive surrender. That will make enforcement all but impossible without a trader stupidly putting something incriminating in an email.

Even at this late hour, regulators still have a choice. The final rule isn't in place. They could radically simplify it. The law could merely state that prop trading is illegal at banks backed by the government, and not explain what the inevitable exceptions and exemptions will be. And regulators could make sure to stress, in public pronouncements, that the penalty will be stiff. If regulators carried that through, banks would scream that the sky would fall -- that they wouldn't know what was legal and what wasn't.

Please.

What would happen is that regulators and financial houses would settle into a situation where only the most egregious violations would be prosecuted, while most acts that came close to the line would pass through. The result would be exactly the intent of the law: to reduce sharply any truly risky activities because lawyers wouldn't be able to find rationalizations in any of the law's language. The Volcker Rule should be a lean and mean single sentence.

O.K., fantasy time is over.

Second-best is to introduce some bright-line rules into this monstrosity. Then Volcker won't be hostage to whichever heavily lobbied regulators happen to be on staff at any given moment.

As it stands, "it's as if we told the banks to stop speeding and required them to have speedometers," said a Congressional official familiar with the rule-making. "But we didn't set the speed limit."

Occupy the S.E.C., a group of reform supporters that wrote a powerful letter about the flaws and proposed remedies of the rule, urges regulators "not to confuse mere complexity for nuance. Simple bright-line rules make the compliance process easier, both for the regulated and for the regulator."

Yes, bright-line rules set up an arms race between the law firms that figure out ways for banks to comply with the letter but not the spirit of the law, and the government cops that are trying to figure them out. That's a race that government can never win outright. But with some enforcement, regulators could prevent the worst risks.

In all their pages of concerns, what is the anti-Volcker crowd most worried about? Nothing convincing.

Banks and their industry groups have mainly argued that the rule would reduce liquidity, or the ease with which a customer can buy or sell an investment. Less liquidity would raise the cost of capital for those seeking it.

Bogus. There is a surfeit of liquidity on Wall Street. It generates fees and short-term gains but little social worth. It's the opposite of useful. It disappears when most needed, as in the "flash crash" of 2010, thus exacerbating collapses.

Trading has risen inexorably in the last couple of decades, but has that resulted in more companies raising cheaper capital? No. Indeed, Professor Thomas Philippon of New York University has found that the financial sector's costs to society have risen, not fallen, in recent decades.

Banks say the rule will hurt their market-making businesses. But as the Occupy letter points out, market-making is a competitive, profitable business. There is no law of nature that requires banks do it.

Regulators could, if they wanted to, ban all market-making by deposit-taking institutions. The Columbia economist Joseph Stiglitz and Robert Johnson of the Roosevelt Institute wrote in their letter to regulators on the rule, "If absolute simplicity is truly what the industry demands, then the regulator should provide that."

Complex structures and high-risk trading should be eliminated, they argue. The rule, they point out, gives the regulators authority to make "any (their emphasis) limitations or restrictions" they want on trading, which includes banning all trading in securities or derivatives.

Despite the decibel level, the banks' case is weak. As Peter Eavis of The New York Times noted on DealBook, the opposition comment letters substitute dire theoretical predictions for specific real-life examples. Surely, the banks have the data. If the data supported their case, why not trot it out?

The reason is that they didn't have to. They won anyway.

As fears mount that Dodd-Frank, the financial overhaul law, is about to be emasculated, it's worth reflecting on the 10-year anniversary of a major regulatory success.

I'm speaking of the mocked, patronized and vilified Sarbanes-Oxley, the law that cleaned up American corporate accounting.

SOX, as it's known, was a response to an epidemic in corporate accounting fraud that swept American business in the late 1990s and early 2000s. Because the 2008 financial crisis dwarfs that earlier round of scandal, it's easy to forget how rotten things were, said Broc Romanek, editor of TheCorporateCounsel.net, a site devoted to securities law and corporate governance. "Everyone had lost faith in the numbers put out by big public companies," he said.

Cast your mind back. The scandals erupted in some of the purportedly best, most recognizable companies in America. Enron and WorldCom were the two biggest names and the two biggest failures. Tyco and Adelphia were in the second tier. But there were appalling accounting disgraces at HealthSouth, Rite Aid and Sunbeam. Waste Management and Xerox barely survived theirs.

Today, there are certainly debates about stocks and their valuations — and some questionable accounting — but no company that finds itself under scrutiny now is anywhere near as large, respected or publicized as those were then.

Something else characterized those dark days: the frauds often lasted and lasted. Investors known as short-sellers, who make money when stocks collapse, waged battles for years over certain companies. Today, accounting disputes are finished before they start. An accounting scandal at Groupon, the online coupon company, came and went in a matter of weeks back in the fall — resolved by the regulators before the company went public.

When SOX was passed, it was attacked — almost exactly like Dodd-Frank is today. Sarbanes-Oxley got "horrible press," said Jack T. Ciesielski, who edits the Analyst's Accounting Observer. People mocked it for requiring companies "to flow chart the keys to the executive washroom," he said. But the result is that accounting at American companies is much cleaner today.

The main criticisms of the law haven't panned out. Corporate earnings have soared, and no company has ever missed a quarterly estimate because it was spending too much on its accounting and internal controls.

Critics railed that it would cost small companies too much, which it may have, though the evidence is debated. They also argued that it would hurt initial public offerings, which it didn't. Yet, there remains vestigial criticism from the right; Newt Gingrich called for its repeal the other day on the campaign trail.

Is Sarbanes-Oxley perfect? Of course not. The financial crisis included accounting problems. The books of the American International Group, Lehman Brothers and Merrill Lynch misrepresented the true state of the companies. The auditors have managed to skirt blame — even more so than other gatekeepers, like the ratings agencies, have. But at its heart, the financial crisis wasn't an accounting scandal. It was a bubble, albeit one exacerbated by some book-cooking.

But the evidence in SOX's favor is that one big dog didn't bark. Even as the financial panic turned into the Great Recession, corporate America weathered the worst of the downturn without a series of major accounting frauds.

SOX required that chief executives and chief financial officers personally sign off on their companies' financial statements. That seems minor. No doubt a Madoff wouldn't be deterred by a little dissembling signature. But blackhearts aren't the typical accounting fraudsters.

At huge corporations, corruption usually develops slowly, incrementally, starting with a minor crossing of the line. At the end of a quarter, a sale is booked before it was actually ordered — to make the numbers for Wall Street. Over time, the fraud builds on itself and it's easier to keep the game going than to clean it up.

Requiring a step where the top dogs actually have to mark the books as their own territory halts that process. It steels their concentration and improves the culture, preventing those initial halting steps toward fraud.

The accounting industry has been improved as well. The new SOX-created industry overseer, the Public Company Accounting Oversight Board, has made inroads. Accountants have done a better job, remembering the devastating collapse of the accounting firm Arthur Andersen in the wake of the Enron debacle.

SOX wasn't the only factor in this cleanup, of course. The accounting trials of the early 2000s made a cultural mark. Kenneth L. Lay and Jeffrey K. Skilling of Enron, the Tyco fraudsters L. Dennis Kozlowski and Mark H. Swartz and Bernard J. Ebbers of WorldCom all had their day in court. All the world, including their executive peers, watched them go from their mansions to the big house.

Is there a lesson to draw here for the prospects of Dodd-Frank? The new law is more sweeping, more pilloried and more complicated. It is concentrated on one industry, which allows for a more unified opposition. Importantly, a round of perp walks and prison terms didn't accompany the law. Quite the contrary, the people responsible for the greatest economic collapse since 1929 have all danced away untouched.

But for all of the criticisms of Dodd-Frank, there has been a societal change in our views. Few can sustain an argument in favor of a gigantic, self-serving and rapacious financial sector. Some kind of financial reform law was — and still is — needed.

If lawmakers don't gut Dodd-Frank, then 10 years from now we just might be reflecting on how safe our financial system is.

Imagine how Mitt Romney would campaign if he actually ran as a private equity executive, dangerous though that may be in this era of the Tea Party and Occupy Wall Street.

Aggressively attacked by a super PAC supporting Newt Gingrich, Mr. Romney stands accused of being a rapacious capitalist intent on destroying jobs for personal gain. Mr. Romney has responded: Au contraire! He argues that his work at Bain Capital, one of the earliest and most successful private equity firms, created jobs by making companies more efficient and successful.

Many people on Wall Street are befuddled. After all, a private equity firm creating jobs is like Adam Sandler winning an Academy Award — it would be nice if it happened, but it sure wasn't the goal.

The goal, of course, is high returns.

If Mr. Romney were really running as a private equity executive, how would he view what his campaign regards as one of the nation's most pressing issues, the national debt?

Right at the top of his campaign's home page, Mr. Romney proclaims, "We have a moral responsibility not to spend more than we take in." The United States' debt is such a problem, it's like an addiction: "The first step toward recovery is admitting we have a problem and refusing to allow any more irresponsible borrowing," his site says.

It's almost as if Mr. Romney never worked in — what's that other phrase for private equity? — oh yes, a leveraged buyout firm. Leverage as in debt, debt and more debt. Debt amplifies the returns of L.B.O. firms. Indeed, they often saddle companies with extra debt precisely so that their investors can cash out faster, a technique Bain deployed under Mr. Romney's watch.

L.B.O. firms certainly never think of debt as immoral. When the borrowing is good, private equity is going to grab the money. When Mr. Romney rails against debt, he is running away from his entire career in business.

So what about the federal government? The 10-year Treasury bond rate is 1.87 percent. Since inflation is higher than that, real rates are actually below zero, meaning that a lender to the United States government will get back less money in 10 years than it started with.

That's right: When the government borrows, its lenders actually lose money. Yet foreigners and Americans, institutions and individuals alike are extraordinarily willing to shovel money at the United States government right now.

Are there private equity executives anywhere in the world who would counsel their companies not to borrow at such extremely low rates? I haven't had the privilege of meeting one. Their mantra is, borrow now, for tomorrow the Mayans might turn out to be right. Few indeed are the companies that could borrow that cheaply and not make some kind of return on essentially free money.

"If debt is available to you historically cheaply, it almost always makes sense to take it," said Shivan Govindan, a private equity executive for the Resource Financial Institutions Group. "Your capital strategy isn't something ideological. You are going to optimize it for the best mix."

So, by the logic of private equity, the United States government should borrow much more right now.

But what about the unsustainability of our debt? If a company has out-of-control costs and is spiraling toward default, it should not borrow more. True, but no company that is truly headed toward imminent default can borrow as cheaply as the American government.

If the United States government is headed toward bankruptcy, lenders are surely not acting that way. Maybe those people are making a good decision; maybe they are deluded. It doesn't matter to the borrower.

Of course, an issue for the United States, as for a company, is whether it could put the money to good use.

"Surely, government investments would have a real return in a 10-year period higher than zero, even with waste and corruption," said Paul L. Kasriel, an economist for Northern Trust. "This means that these investments will boost future real G.D.P. growth, which will boost future tax revenues to service the increased debt."

There will be bridges and roads that we must fix over the next decade. We could put more young people in college, improve elementary school education, train veterans so they can find good jobs or finance exploration of alternative fuels. People will quibble — or maybe, in our polarized culture, fight tooth and nail — over the choices, but most could think of something that would be a good investment.

On a deeper level, the debate over private equity raises questions about using the metaphor of America as a business. That kind of thinking can reduce society to the sum of its revenues and profits, ignoring that much of what we do to provide for the common defense and promote the general welfare cannot or should not be measured, especially in economic terms. We take care of our elderly because it is the right thing to do, not because we expect a return on investment. Shouldn't society promote and protect freedom and human rights? Even when there are times when doing so may be expensive or uneconomical?

There are moral issues that confront our country. Debt isn't one of them.

Does the Securities and Exchange Commission suffer from trialphobia?

Ever since Judge Jed S. Rakoff rejected the S.E.C.'s settlement with Citigroup over a malignant mortgage securities deal, the agency has been defending its policy to settle securities fraud cases. But the public wants a "Law & Order" moment, and who can blame them?

Of course, there was one criminal trial. Federal prosecutors in Brooklyn brought a case against two Bear Stearns hedge fund managers who blew up the firm's internal fund, eventually leading to the demise of Bear. They were acquitted.

But so far, there's been no civil trial in a major case directly related to the biggest economic fiasco of our time: the financial crisis.

The S.E.C. contends that it has received more than $1.2 billion in penalties from financial crisis cases, having accused 81 people and entities, 39 of them chief executives and other senior officers. And it doesn't avoid trials altogether. The agency has averaged almost 14 trials a year from 2008 to 2010, compared with about eight from 2001 to 2003. Finally, in cases that haven't yet gone to trial, the S.E.C. has charged some low-level bankers from big Wall Street firms — but no masters of the universe.

As for the near future, the agency might actually have a financial crisis trial. Right now, it looks as if cases against the mortgage bank IndyMac, the brokerage firm Stifel Nicolaus and the executives who blew up the Reserve Primary money market fund could go to court. But do you see the pattern? None of those is a major investment bank. The S.E.C. is just not hauling in the big boys.

That could change if the S.E.C. sued Citigroup. As Judge Rakoff noted, Citigroup is a "recidivist," repeatedly flouting securities laws. In its settlement with the bank, the agency cited only one mortgage securities deal, but as my ProPublica colleague Jake Bernstein and I wrote, there are many more that look just as rotten.

Yet the reason for putting Citigroup in the dock goes beyond the bank itself. The S.E.C. is not getting big enough settlements out of the largest banks. It's not bringing enough financial cases. It isn't going after the big banks' top executives. It's being way too cautious in its interpretation of its role as defender of the fairness and sanctity of the markets. The frustration, shared by Judge Rakoff and the rest of humanity, is all the greater because the agency rarely, if ever, gets anyone to admit guilt when they settle.

This renders the settlements little more than turning on the light in a kitchen full of roaches. Instead of teaching the banks a lesson, the settlements merely show how the bad actors are scattered everywhere — and the public watches the banks scurry into the pantry to feast some more.

To the S.E.C., this view is profoundly unfair.

The agency's message is, "if you want to resolve a case short of a contested proceeding, come in and be prepared to provide the type of relief we would obtain at the end of a trial," said Lorin L. Reisner, the S.E.C.'s deputy director of enforcement.

"And where that's not available, we'll go to the mat."

On a case-by-case basis, the S.E.C.'s argument for settling is strong. While the public loves a court case, lawyers often believe that trials are failures. They are expensive, time-consuming and capricious, especially in financial cases that are often so complex they challenge even sophisticated juries.

Generally, securities regulators can rack up more enforcement actions by settling. And the agency would do only civil trials anyway; it's the Justice Department that undertakes criminal trials, which probably are a greater deterrent to white-collar crime.

Fair enough. But here's the rub: By taking this doctrine too far, the S.E.C. has undermined its negotiating position.

Agency officials continually advertise how few resources they have, how costly trials are and how irresponsible it is to shareholders to force a trial when a reasonable settlement can be won instead.

Last month, for example, Robert S. Khuzami, the agency's head of enforcement, trumpeted the S.E.C.'s "record-breaking performance during a period of resource constraints."

In doing so, the agency has Beltway blinkers on. Sure, it's speaking to Congress, but Wall Street is also listening. When it complains, even legitimately, about its budget or how costly and difficult trials are, the S.E.C. is inadvertently showing its belly to Wall Street in a sign of submission. It's whimpering that it will shy away from a trial, afraid of draining its coffers.

When it's not signaling its fear about spending money, S.E.C. officials are often talking about how complex financial crisis cases are. In a recent conversation with James B. Stewart of The New York Times, Mr. Khuzami almost sounded as if he were Citigroup's counsel, a role for which he is well suited since he held that role at Deutsche Bank before joining the S.E.C. In that interview, he made Citigroup's case for it. But the bank's lawyers get paid enough and don't need his help.

Above all, the S.E.C. worries about losing. That means it doesn't push cases that would broaden definitions of securities fraud, the ambitious cases that penetrate the gray areas and eliminate murk as a defense against wrongdoing.

In his interview with Mr. Stewart, Mr. Khuzami worried aloud that Citigroup might have made the proper disclosure in its mortgage deal when it mentioned that it was possible the deal might have an adverse impact on its customers. Might have? It absolutely did have a clear adverse impact. If you raise an issue as a mere hypothetical when you know for a fact that it's occurring, isn't that misleading? Shouldn't that be tested? And tested in court, so that a precedent is set?

To overcome its greatest fear, the S.E.C needs to realize that it can win even if it loses. A trial against a big bank could be helpful regardless of the outcome. It would generate public interest. It would put a face on complex transactions that often are known only by abbreviations or acronyms. Litigation would cost the bank money, too. And it could cast the way Wall Street does business in such an unflattering light that even if the bank won, it might bring about better behavior.

A trial would show boldness. And when the S.E.C. found itself at the negotiating table again, it would feel a new respect.

Last week, I had a conversation with a man who runs his own trading firm. In the process of fuming about competition from Goldman Sachs, he said with resignation and exasperation: “The fact that they were bailed out and can borrow for free — It’s pretty sickening.”

Though the sentiment is commonplace these days, I later found myself thinking about his outrage. Here was someone who is in the thick of the business, trading every day, and he is being sickened by the inequities and corruption on Wall Street and utterly persuaded that nothing had changed in the years since the financial crisis of 2008.

Then I realized something odd: I have conversations like this as a matter of routine. I can’t go a week without speaking to a hedge fund manager or analyst or even a banker who registers somewhere on the Wall Street Derangement Scale.

That should be a great relief: Some of them are just like us! Just because you are deranged doesn’t mean you are irrational, after all. Wall Street is already occupied — from within.

The insiders have a critique similar to that of the outsiders. The financial industry has strayed far from being an intermediary between companies that want to raise capital so they can sell people things they want. Instead, it is a machine to enrich itself, fleecing customers and exacerbating inequality. When it goes off the rails, it impoverishes the rest of us. When the crises come, as they inevitably do, banks hold the economy hostage, warning that they will shoot us in the head if we don’t bail them out.

And I won’t pretend this is a widespread view in finance — or even a large minority. You don’t hear this from the executives running the big Wall Street firms; you don’t hear it from the average trader or investment banker. From them, we get self-pity. For every one of the secret Occupy Wall Street sympathizers, there are probably 15 others like Kenneth G. Langone, who, like downtrodden people before him, is trying to reclaim and embrace a pejorative, “fat cat.”

The critics are more often found on the periphery, running hedge funds or working at independent research shops. They are retired, either voluntarily or not. They are low-level executives who haven’t made scrambling up the corporate hierarchy their sole ambition in life. Perhaps their independent status removes the intellectual handcuffs that come with ungodly bonuses. Or perhaps they are able to see Big Money’s flaws because they have to compete with the bigger banks for dollars.

Are these “Wall Streeters”? To civilians, they work on the Street. Bankers at the bulge-bracket firms wouldn’t think they are. But that doesn’t mean they don’t count. They know the financial business intimately.

Sadly, almost none of these closeted occupier-sympathizers go public. But Mike Mayo, a bank analyst with the brokerage firm CLSA, which is majority owned by the French bank Crédit Agricole, has done just that. In his book “Exile on Wall Street” (Wiley), Mr. Mayo offers an unvarnished account of the punishments he experienced after denouncing bank excesses. Talking to him, it’s hard to tell you aren’t interviewing Michael Moore.

Mr. Mayo is particularly outraged over compensation for bank executives. Excessive compensation “sends a signal that you take what you get and take it however you can,” he told me. “That sends another signal to outsiders that the system is rigged. I truly wish the protestors didn’t have a leg to stand on, but the unfortunate truth is that they do.”

I asked Richard Kramer, who used to work as a technology analyst at Goldman Sachs until he got fed up with how it did business and now runs his own firm, Arete Research, what was going wrong. He sees it as part of the business model.

“There have been repeated fines and malfeasance at literally all the investment banks, but it doesn’t seem to affect their behavior much,” he said. “So I have to conclude it is part of strategy as simple cost/benefit analysis, that fines and legal costs are a small price to pay for the profits.”

Last week, in a Bloomberg Television event, both Laurence D. Fink, the chairman and chief executive of the mega-money management firm BlackRock, and Bill Gross, the legendary bond investor, evinced some sympathy for the Occupy Wall Street movement.

Over the last several decades, “money and finance have dominated at the expense of labor and Main Street, and so how can one not sympathize with their predicament?” Mr. Gross said, speaking of the 99 percent. “To not have sympathy with Main Street as opposed to Wall Street is to have blinders.”

It’s progress that these sentiments now come regularly from people who work in finance. This is an unheralded triumph of the Occupy Wall Street movement. It’s also an opportunity, to reach out to make common cause with native informants.

It’s also a failure. One notable absence in this crisis and its aftermath was a great statesman from the financial industry who would publicly embrace reform that mattered. Instead, mere months after the trillions had flowed from taxpayers and the Federal Reserve, they were back defending their prerogatives and fighting any regulations or changes to their business.

Perhaps a major reason why so few in this secret confederacy speak out is that they are as flummoxed about practical solutions as the rest of us. They don’t know where to begin.

Over the next year, maybe that will change. Things are going to be tough on Wall Street. Bonuses will be down. Layoffs are coming. Europe seems on the brink of another financial crisis. Maybe from that wreckage, a leader will emerge.

When the architects of the Dodd-Frank regulatory overhaul flinched from the most effective solution — breaking up the banks so that none would be too big to drag down the financial system — they forced regulators of the derivatives market into a cumbersome and potentially dangerous workaround.

Those regulators are feverishly making lots of important, arcane rulings that are being followed only by insiders. They are replacing an opaque system prone to failures with a new, huge Rube Goldberg-like system that may reduce global financial risk. Or it may not. Nobody knows, not least the regulators themselves.

The Commodity Futures Trading Commission, led by Gary Gensler, last month approved rules that would require derivatives clearinghouses to open their membership to firms that have as little as $50 million in capital. A clearinghouse is a central body through which trades take place. It is supported by its financial firm members. For instance, if JPMorgan Chase enters into a derivatives transaction with Goldman Sachs, their deal would go through a clearinghouse, which is on the hook for the trade if one of those banks fails.

The big banks that dominate derivatives trading resisted letting in smaller firms, arguing that doing so would make the clearinghouses vulnerable. They have a point: A clearinghouse with a bunch of undercapitalized members would be more prone to failure, unable to pony up when one side of a trade defaults, and we would be back where we started.

And who had lobbied for this? One of those smaller brokerage firms, MF Global, then run by Jon S. Corzine. Of course, MF Global went belly up because of its aggressive bets and high leverage.

Oops. That disaster makes it easy to conclude that the Commodity Futures Trading Commission is going about trying to reform the derivatives markets all wrong.

But excluding the small fry is dangerous as well. If clearinghouses restricted their membership to only the biggest and best-capitalized firms, the markets would more or less look like they are today — an oligopoly.

Derivatives trading is dominated by the likes of JPMorgan, Goldman Sachs and Deutsche Bank. We now have a financial system where the failure of one megabank can jeopardize the world financial system, and having clearinghouses run by only the “too big to fail” firms merely replicates that fundamental problem.

“If you want to restrict access to just the larger organizations, you don’t solve the problem that clearinghouses are there to solve,” said Nicholas Dunbar, the author of "The Devil’s Derivatives" (Harvard Business Press), a history of the creation of these markets.

So both options are bad; letting in small guys is dangerous, but so is keeping them out.

Another insoluble problem is that of the One or the Many. If there were only one giant global clearinghouse for all derivatives, it might have enough capital to survive a panic in any one corner of the derivatives market. But if a general financial crisis forced many members to default, then it really would be too big to save. No country, not even the United States, would allow such a gargantuan institution to be domiciled on its home turf.

Instead we have an explosion of clearinghouses. We have clearinghouses for different asset classes. We have competing clearinghouses. We have clearinghouses in the United States, Europe and Asia. Dodd Frank implicitly supports this “let a thousand flowers bloom” approach.

That leads to another concern. Clearinghouses create an impression there’s some underlying capital to protect them, either in the entity itself or among the members. But a multiplicity of small ones is dangerous, according to Frank Partnoy, a professor of law and finance at the University of San Diego. The fragmentation means that safety is likely to be an illusion.

“There is less money” in each tiny clearinghouse, he explained. It virtually guarantees that if there’s a panic in one area of the world, the clearinghouse that backs it won’t have enough capital.

The regulatory changes could make things worse in another way, said David Murphy, principal of the risk management firm Rivast Consulting and a former head of risk at the trade group International Swaps and Derivatives Association. Here, it’s worth knowing a little about how banks minimize risks as they trade derivatives.

The underlying amount of derivatives, called the “notional value,” is in the hundreds of trillions. The biggest dealers, like JPMorgan, have tens of trillions of notional value on their books. What we are worried about is counterparty risk: What happens if one of the banks on either side of a trade fails?

As an example, the investment bank Robbin & Steelin has a portfolio with another investment bank, Engulf & Devour. Robbin goes through an exercise to figure out the following:

If Engulf fails, how much would Engulf owe us and what collateral do we have against that?

And how much would it cost us to replace those positions, to restore our offsetting hedges?

That, with a few steps in between and a lot of fancy math, is how those trillions of “notional” amounts shrink to a much smaller “net” figure, in the billions.

But under the clearinghouse regime, the banks will have to split up those gargantuan portfolios. Let’s say Robbin and Engulf had two trades with each other, a European derivatives trade worth $200 and an American derivatives trade worth $180. It has a net value of $20, with Engulf posting that amount in collateral with Robbin.

Now the trades move to clearinghouses. The European trade goes to a European clearinghouse. The American trade goes to an American clearinghouse. The parties need to post larger amounts of collateral. If, say, the European clearinghouse fails, one bank is exposed and now has a much bigger exposure.

Will that bank have received adequate collateral from the clearinghouse? Maybe, but maybe not.

But the bank may have to go out into the market to offset its exposure — possibly a more disruptive move than it would have been under the previous regime.

It’s possible that the netting effects from other trades with the clearinghouse will serve the same function. But it hasn’t been adequately studied.

One possible result of all of this is that there will be less derivatives trading and more collateral going back and forth. That’s bad for bankers, but good for the rest of us.

Given the weak hand that regulators have, however, it seems more likely that the collateral will just be inadequate. It’s easy to see regulators and trading partners falling for the illusion of safety that clearinghouses provide.

“The scary part,” said Mr. Murphy, the risk expert, “is that I’m pretty certain that clearing is being imposed without anyone actually knowing whether it actually reduces counterparty risk or not.”

One sure thing in this morass of uncertainty: We will find out.

Back when the Financial Crisis Inquiry Commission was doing its work, I would check in periodically with someone who worked there to find out how it was going.

"Good news!" my source would joke. "We got the guy who caused it."

That is the way I felt last week when the Securities and Exchange Commission announced that it had, well, agreed to a measly $285 million settlement with Citigroup over the bank having misled its own customers in selling an investment it created out of mortgage securities as the housing market was beginning its collapse.

In addition, the S.E.C. accused one person -- a low-level banker. Hooray, we finally got the guy who caused the financial crisis! The Occupy Wall Street protestors can now go home.

After years of lengthy investigations into collateralized debt obligations, the mortgage securities at the heart of the financial crisis, the only individuals the S.E.C. has brought civil actions against for involvement in those transactions are half a dozen small-timers. But compared with the Justice Department, the S.E.C. is the second coming of Eliot Ness. No major investment banker has been brought up on criminal charges stemming from the financial crisis.

To understand why that is so pathetic and -- worse -- corrupting, we need to briefly review what went on in C.D.O.'s in the years before the crisis. By 2006, legions of Wall Street bankers had turned C.D.O.'s into vehicles for their own personal enrichment, at the expense of their customers.

These bankers brought in savvy (and cynical) investors to buy pieces of the deals that they could not sell. These investors bet against the deals. Worse, they skewed the deals by exercising influence over what securities went into the C.D.O.'s, and they pushed for the worst possible stuff to be included.

The investment banks did not disclose any of this to the investors on the other side of the deals, or if they did, they slipped a vague, legalistic disclosure sentence into the middle of hundreds of pages of dense documentation. In the case brought last week, Citigroup was selling the deal, called Class V Funding III, while its own traders were filling it up with garbage and betting against it.

By the S.E.C.'s own investigations of and settlements with Goldman Sachs, JPMorgan Chase and Citigroup, and by reporting like my ProPublica work with Jake Bernstein and early stories by The Wall Street Journal, we know that these breaches were anything but isolated. This was the Wall Street business model. (Goldman, JPMorgan and Citigroup were all able to settle without admitting or denying anything, which, of course, is part of the problem.)

Neither the Citigroup settlement nor any of the others come close to matching the profits and bonuses that these banks generated in making these deals. And low-level bankers did not, and could not, act alone. They were not rogues, hiding things from their bosses.

Last week's S.E.C. complaint makes clear that the low-level Citigroup banker that it sued, Brian H. Stoker, had multiple conversations with his superiors about the details of Class V. At one point, Mr. Stoker's boss pressed him to make sure that their group got "credit" for the profits on the short that was made by another group at the bank.

Pause, and think about that. The boss was looking for credit, but as far as the S.E.C. was concerned, he got no blame.

The S.E.C. did not respond to a request for comment, so we are left to wonder what explains its failure to reckon adequately with the pervasive problems. Contrary to expectations, the embattled and oft-assailed agency has done almost everything right with structured finance investigations, taking aim at abuses related to C.D.O.'s and other complex deals.

The S.E.C. has also devoted adequate resources to the issue. It put together a special task force on structured finance, sending the proper signal of the agency's priorities both internally and externally. The task force is staffed by bright people, an invigorating mix of young go-getters and experienced hands. Those people have understood for years what was wrong with the C.D.O. business on Wall Street.

O.K., so what is it? Risk aversion.

Based on the major cases the S.E.C. has brought, a pattern has emerged. It is making one settlement per firm and concentrating on only the safest, most airtight cases. The agency's yardstick seems to be, who wrote the stupidest e-mail? Mr. Stoker of Citigroup wrote an incriminating e-mail that recommended keeping one crucial participant in the dark. Goldman's Fabrice Tourre, the other functionary the agency has sued, wrote dumb things to his girlfriend.

But the S.E.C is not the G-mail G-man. It is the securities police. Imprudent e-mailing is not the only way to commit securities fraud.

Maybe the agency hopes that private litigation will take up the slack. It cannot investigate and wring a prosecution or settlement out of every corrupt deal. Instead, it has long aimed to plant a flag and let private litigants take care of the rest.

But private litigation has failed. One problem is that the defrauded institutions often committed their own sins. In a monstrous daisy chain, C.D.O.'s bought pieces of other C.D.O.'s. These investments were run by management companies. They might have been the victim in one C.D.O., but complicit in the predations of another.

Other victims, like large financial institutions and money managers, do not want to sue because it could reveal their own compromised behavior. Or they would be revealing to customers that they had simply been taken by other, smarter bankers. You cannot very well convince people that you are a good steward of their money if you are simultaneously complaining that the Wall Street sharpies fleeced you.

And private litigation has changed in the last decade and a half. The Private Securities Litigation Reform Act of 1995, which was meant to make class-action lawsuits harder to bring, has had a spillover effect beyond those cases, according to plaintiffs' lawyers. Courts have raised the bar for securities fraud cases, even where the act does not apply. The rules color how judges look at financial disputes.

So the S.E.C. has the wrong approach.

This is a matter of will and leadership. Its chairwoman, Mary L. Schapiro, while deserving credit for pushing investigations of structured investments, is sending the signal that she does not want to lose. Her agency is meekly willing to get token settlements when the situation calls for Old Testament justice.

Someday, the S.E.C. will have to go up against a top executive who has resources to fight, and who was too sophisticated to put anything rash in writing. This seems to be our fate: our bankers took reckless risks, but our regulators take none.

Clarification (11/09): A sentence in this story referred incompletely to actions taken against individuals. It has been updated to show that the agency has sued four other people in addition to the two bankers originally referred to in that sentence.

By almost any measure, Morgan Stanley is fine.

Look at this impressive rundown of the bank’s critical numbers and ratios compiled by Paul Gulberg, an investment-banking analyst with the independent research firm Portales Partners.

Morgan Stanley has much more capital and lower leverage than it did at the height of the financial crisis, which I like to think of as 9/08. It has almost $60 billion in common equity, compared with $36 billion before September 2008, and its ratios are stronger. Its trading book — which is volatile and where any bank can take sudden, large losses — is smaller than it was. Morgan Stanley has more long-term debt and higher deposits, both of which stabilize its finances. The bank has more cash available in case there’s a crunch and a smaller amount of Level III assets, which don’t have an independently verifiable value and so must be estimated by the bank. Hedge funds have parked a smaller amount of assets at Morgan Stanley. That’s good because in the financial crisis, they pulled them from the bank.

Yes, Morgan Stanley by any measure is a safe and solid investment bank. Except for one: The amount of trust people have in the whole financial and political system. It’s just about zero.

That’s why the bank’s shares are down 42 percent this year. That’s why all the big bank stocks have double-digit dips.

True, they start their next round of quarterly reporting in a matter of days. Morgan Stanley is scheduled to report its third-quarter earnings on Oct. 19, and its earnings may calm fears temporarily.

But the essential problem will still be there, a slow burn beneath the global financial system that flares up at the worst moments. Banks don’t have faith in other banks, investors are deeply scarred and wary, and nobody believes that the governments around the world could grapple with the magnitude of the problems, even if they wanted to.

Three months ago, the Belgian bank Dexia passed the European stress tests. By that measure, it was fine. Then it collapsed.

This weekend France, Belgium and Luxembourg swooped in to save Dexia and pledged to figure out how to recapitalize European banks as a whole.

So investors had a moment of euphoria on Monday: Governments will save institutions!

While they probably won’t hesitate to wipe out equity holders in failed financial institutions and will perhaps force the value of bondholders’ investments to be trimmed, they will do everything they can to protect counterparties so that the system doesn’t melt down.

That’s the hope, at least, and it has a rational basis. Almost universally, regulators and political leaders believe that letting Lehman fail in the fall of 2008 was a disastrous mistake. Its downfall cascaded throughout the global financial world, collapsing money markets, terrifying lenders to banks and accelerating the implosion of multiple financial institutions.

So investors and policy makers, burned by the recent crisis, are all supposed to be acting more prudently and forcefully.

Yet, the moment one examines almost any detail of the global financial system, faith falters once again. Take the uncertainty about the derivatives markets. Morgan Stanley has a face value of $56 trillion in derivatives. That’s really nothing. JPMorgan Chase has more — amounting to the G.D.P. of large countries — a face value of $79 trillion in derivatives. If something goes wrong with just one-tenth of 1 percent of those trades, it’s kablooie.

Now those are gross numbers. Many people would dismiss those totals as ridiculous and misleading. Anyone who brings them up is merely displaying ignorance. The banks’ derivatives portfolios are full of off-setting trades that net out at a smaller number.

Derivatives can be dismissed as a popular bugaboo, but they really are just a symbol of the larger problem. A litany of daily stories reveals all kinds of reasons that banks don’t trust each other. To take just one news item, almost at random: Bloomberg News reported the other day that a Danish bank was refusing French sovereign debt as collateral.

Nobody really knows how much exposure the American banks have to the European financial and political crisis, with the Treasury Department minimizing the issue while other outlets raise the specter of catastrophic problems.

So trust, naturally, is the casualty. “If you get in a period of stress, everyone starts questioning whether the hedges will hold up and whether the collateral is good enough,” said Mr. Gulberg, the banking analyst.

Surely no bank would be so reckless as to accept dodgy collateral these days. It would hold out for something unassailable, like, say, Triple A mortgages on American homes. Wait, scratch that. It would accept sovereign debt, perhaps from some European realm that has been around for centuries. Whoops, no, no. Well, O.K., maybe United States Treasuries — and we’ll agree to ignore that one of the country’s two major political parties was willing to plunge the United States into default to achieve its aims.

So there’s concern about the collateral. But what about the hedges? Of course, they wouldn’t hedge with some bank like Dexia, which at year-end had $700 billion worth of loans, undrawn commitments, financial guarantees and the like. Some financial institutions have to be on the other side of Dexia’s commitments. Some might even be those supposedly strong and prudent banks that were supposed to have learned so much from the financial crisis. Did Morgan Stanley learn its lesson from the crisis?

You begin to see the problem.

As a draft of the Volcker rule has made the rounds in the last several weeks, it has alternatively caused fits of despair and cries of exultation. And that’s just among the proponents of the regulation.

Then came news that the Swiss bank UBS lost $2.3 billion thanks to a rogue trader. Of course, it’s terrible for the bank, and the last thing we need right now is another fragile financial institution. But for Volckerites, the timing couldn’t be better. It comes just when the rule’s champions are trying to preserve the draft’s strongest measures and buttress the weaker clauses.

Such is the perpetual state of emotional confusion these days for believers in banking reform and other hopeless pessimists. It’s satisfying to be right about the risks. But that is overwhelmed by the horror of seeing their predictions about the instability of the global financial system come true.

Regulators have been toiling away to write the specific provisions of the Volcker rule, which is intended to prevent banks trading for their own account and is named after Paul A. Volker, the former chairman of the Federal Reserve. The rule was a back-door and second-best way of re-instating Glass-Steagall, the Depression-era law that separated commercial banking with its mom-and-pop depositors from investment banking with its reckless traders.

Turns out that bank lobbyists didn’t just fall off the turnip truck. They knew the consequences a robust rule would have and went to work in the arcane and shadowy rule-making process to carve out exceptions that you could drive trucks through, turnip or Mack.

Reports about the draft show how confused even the architects and close observers of the regulation are. The Wall Street Journal suggested that the draft contained such huge loopholes about what banks could label hedging that traders would “have license to do pretty much anything,” according to Robert Litan of the Kauffman Foundation.

By contrast, a Bloomberg article this week suggested that the rule might limit reckless speculation by overhauling the way traders are compensated to base their pay on the fees banks charge for the products they create, rather than on the profits generated by trading positions based on those products.

Then there is the exception for market making. Banks are allowed, under the Volcker rule, to take positions in securities and other investments to help facilitate smooth trading. But the banks need to hedge that exposure as best as they can.

Of course no hedge is perfect. That allows a trader, who might think he knows more than a client, to shade his hedge a little bit one way or another. After all, if he’s right, the bank makes more profit. More profit means higher bonuses (under the current way of doing business).

Allowing the market-making exception could leave a gaping hole in the law. The former banker and author Satyajit Das, who has a new critical book about finance called "Extreme Money: Masters of the Universe and the Cult of Risk” (FT Press), says that proprietary trading has simply moved over to market-making desks. He told me that he was recently consulting with a bank when a lawyer in the room said, “With that exception, I’d be embarrassed if I couldn’t excuse a trade.”

Which brings us to UBS’s Kweku Adoboli and his perfectly timed blowup.

Mr. Adoboli was apparently trading in the service of clients, which traditionally is thought of as market making. He was, according to a person familiar with the trading, working in an area of the bank that structured equity trades for clients—say, an investment that mimics the performance of a group of European stock market indexes. And he was supposed to hedge the bank’s positions.

So far, that’s OK. Banks are allowed, under the Volcker rule, to serve clients and make markets, and they are supposed to hedge.

UBS says that the Volcker rule has nothing to do with Mr. Adoboli’s situation. “The Volcker rule was intended to address perceived risks with banks’ proprietary trading activities, not the type of alleged fraudulent activity (which is subject to criminal investigation) recently uncovered at UBS’s trading desk in London. That is a very important distinction,” a spokesman said.

Sure, fraud is fraud.

But it’s a bit more complex than that. As drafted, the rule has an interesting clause. Permitted market-making activities cannot involve “high-risk” assets or trading strategies. The draft language defines this as an asset or a trading strategy that would “significantly increase the likelihood that the banking entity would incur a substantial banking loss or would fail.”

So, was this “high risk”? Almost anyone on Wall Street would say this is plain-vanilla stuff.

Yet the bank lost billions, its stock took a hit and the chief executive walked the plank. Seems to qualify as high risk to me. Either that, or even plain-vanilla trading is too prone to blowups for comfort.

It’s all the more so when traders are compensated for gains in their trading. Mr. Adoboli doesn’t appear to have made any illicit money directly from his scheme. Nor did Jérôme Kerviel, the Société Générale rogue trader.

But illegal money is not the motivation. Traders on market-making desks are often paid handsomely in a manner indistinguishable from prop traders—by bonuses based on how much profit they make the bank. Mr. Adoboli was a lower-level employee at UBS. Such employees have an incentive to try to take more risk because when they make more, they get bonuses and their bosses get bigger bonuses.

The draft of the Volcker rule has language to address this issue. Regulators can look to see if the compensation looks more like that of prop traders as a signal that yes, walking and talking like a duck does make one a duck.

So, supporters of the Volcker rule again get to feel their patented mix of contentment and trepidation. The good news is that tough language is in there. And UBS has reminded all of us (as if we needed it) why such strict rules are needed.

Now the moment of unease: Given these powers, will regulators use them?

Jesse Eisinger will appear with former New York Gov. Eliot Spitzer and ProPublica reporter Jake Bernstein on Oct. 11 at the Tenement Museum to discuss financial reform and the financial crisis. For more information, visit http://www.propublica.org/events.

Some people stay sharp in their old age by doing crossword puzzles. Some play memory games or Scrabble or cut back on the heavy drinking.

That’s minor league stuff. If you really want to give your brain a workout to stave off the ravages of mental decline, I recommend trying to read bank financial statements.

In my last column, I wrote about how many bad residential mortgage loans the big banks had on their balance sheets, using numbers from a site called Bankregdata.com, which does the punishing work of wading through regulatory filings, known as call reports, and aggregating the data.

Take Wells Fargo. About $41.3 billion, or 19.5 percent, of its $212 billion worth of residential first-mortgage customers were either late in paying or had been classified as “nonperforming,” according to the site.

This was in line with calculations by the Office of the Comptroller of the Currency, which estimates that about a fifth of residential loans on bank balance sheets nationwide are delinquent or in the process of being written off.

Turn to Wells Fargo’s filings with the Securities and Exchange Commission for a full picture, according to Wells. It’s a happier, alternate universe in which $15.6 billion, or 7 percent of $223 billion, of first-mortgage loans are tagged late or “nonaccrual,” a charmingly opaque euphemism for bust.

Two helpful representatives from Wells Fargo gave me a raft of reasons to disregard the call reports and trust the SEC filings. Their main argument is that the federal figure includes a bucket of loans Wells wrote down when it bought Wachovia in 2008.

When Wells Fargo bought Wachovia, it set aside a huge reserve for those loans—mostly pick-a-pay deals, where the borrower could choose to make a minimum payment, with the downside that the rest of the monthly amount owed was tacked onto the outstanding balance. The loans aren’t performing well, but they are doing better than Wells expected back then, which makes investors even more confident that the bank will eventually kick some of that reserve back to the bottom line.

In addition, the representative pointed out, the call figure was an analysis that added up different figures from several bank divisions. But Wells has some divisions that don’t file call reports but nevertheless make a modest number of mortgage loans. (All big banks are holding companies with multiple subsidiaries.)

(Disclosure: The pick-a-pay loans were made by Golden West Financial, which was sold to Wachovia in 2006 by Herb and Marion Sandler, the principal financial backers of ProPublica.)

To be fair, banks do file mountain ranges of disclosure documents. They report to the SEC (which protects investors), the Federal Deposit Insurance Corporation (which insures borrowers), the OCC (which regulates banks) and the Federal Reserve (which also regulates banks with slightly different responsibilities).

Day after day, they push out news releases that run to dozens of pages. They prepare reams of special presentations for investors, the most recent of which from Wells ran to 51 pages, on top of a 41-page news release. The SEC filing from the quarter was 162 pages.

The numbers and presentation differ slightly in all of them and often differ from other banks’ presentations, stirring a struggle among outsiders to compare apples and bananas. No professional admits this publicly, but many investors and analysts privately acknowledge that they can’t fully track the data gushing each quarter from the nation’s banks.

Even if they could somehow reconcile all the numbers, analysts would still be significantly in the dark. In many instances, banks’ financial disclosures are drawn from estimates that only management teams are privy to. Even the simplest of concepts—how much capital a bank has—is a number based on countless calculations that, let’s face it, are not much better than guesswork.

So, it is all the more important that we trust bank management and regulators to make sure the numbers we see truly reflect their financial condition.

Wells is one of the four biggest banks in America. After the financial crisis, it vaulted into this top echelon of gigantic institutions, along with JPMorgan Chase, Bank of America and Citigroup. In this group, Wells has the greatest exposure to residential real estate, more recently infamous as the single-worst asset class in America.

For many reasons, some not particularly rational, Wells seems to be scrutinized less by investors and the media. One is that Warren E. Buffett holds a large stake in the bank, the financial equivalent of a Good Housekeeping seal of approval. Wells is based in San Francisco, far from the madding crowd of American finance and media.

Wells, for its part, has historically displayed disdain for investors and Wall Street, in some regards an appealing attribute. While some of its competitors have tried to wheedle their way into analysts’ hearts, the San Francisco bank refused to engage on even the most basic level. Not until last year did its management deign to take questions on conference calls after earnings reports.

A Wells Fargo representative told me that the bank’s disclosure was “best in class” and listed the enormous amount that it provides.

The bank still falls short of other big banks in disclosure, according to investors and analysts I’ve spoken with. It doesn’t break out the reserves it has made by asset class, unlike Bank of America, making it particularly difficult to understand how much it is reserving for bad residential real estate loans. It doesn’t separate its business lines in the detail that the other banks do.

Then there are its nonperforming loans. For its residential mortgages, it doesn’t classify them as nonaccrual until they are 120 days past due, instead of the more typical 90 days. The effect is to make the numbers look better.

The crucial figure, over time, is the loss rate, the bank representative said. And since the Wells portfolio—not counting the bad Wachovia loans—has been performing consistently well for many years now, investors should believe that the bank is doing something right, and better than its competitors with its mortgage portfolio.

Yet housing prices continue to fall, the economy is weaker than expected, and we are flirting with another financial crisis, as Europe gets its revenge on us for having exported our calamity to their continent in 2008. Wells isn’t likely to remain immune to that. “Trust but verify,” Ronald Reagan used to say of the Soviet Union. Not a bad idea.

Last week, our financial Superman, the mild-mannered Midwesterner Warren E. Buffett, swooped in again to save another bank, the financial markets, the American economy and just maybe our precious way of life.

Mr. Buffett's purchase of $5 billion worth of Bank of America preferred stock (on his usual generous terms, including long-lasting warrants to buy common stock at an attractive price) immediately stiffened the upper lips of chattering investors and pundits. Bank of America's chairman hailed it as a "vote of confidence" in the bank. It was also celebrated as a signal that the worst was over in the rout recently experienced by the American financial sector.

For the moment, that all seems right: Bank of America's stock is up 17 percent from the Aug. 25 announcement, and stocks of the other three major American banks—JPMorgan Chase, Citigroup and Wells Fargo—are also up.

But as the news is digested, it could set off the opposite effect. The Buffett investment just might turn out to erode, not increase, confidence. And not only for Bank of America, but for the banking sector as a whole.

Mr. Buffett's investment reveals something both infuriating and scary. Bank of America has not been talking straight about its need for capital.

"You cannot have the largest bank in the country saying, 'We don't need the money,' and then paying this kind of price to Warren Buffett for capital they say they don't need," said Daniel Alpert, who runs the investment firm Westwood Capital. "Industrywide, it's a potential boomerang because we think, ‘Why should we believe any of these guys when they say they don't need the money?' "

"We've been through a massive crisis in 2007 and '08 where executives of major financial institutions tried to hide their insolvency," he added. "They said, ‘No, no, a thousand times no, we're fine.' And then they were gone."

Sure, Mr. Buffett reportedly approached Brian T. Moynihan, Bank of America's chief executive, who initially rebuffed the investment offer—suggesting that Bank of America didn't really need capital. Even so, Mr. Moynihan's reticence didn't last long. And if the bank truly didn't need capital, why make such an expensive deal that could dilute other shareholders?

The more investors think about it, the more Mr. Buffett's announcement will intensify, not allay, their fears about Bank of America's capital position. Indeed, Mr. Buffett is making something more resembling a loan than an equity investment. His $5 billion doesn't fully count in the important measure of capital that regulators look at, called Tier 1.

That is perhaps why Bank of America's money-raising has not stopped with Mr. Buffett. On Monday, the bank sold about half of its stake in China Construction Bank for more than $8 billion. And over the last year, Bank of America has been jettisoning multiple businesses to raise cash and shore up its capital.

Prudent, yes, and we can hope the bank's management has learned a lesson about credibility. Last year, Mr. Moynihan suggested that the bank would be able to raise its dividend after it passed the Federal Reserve's second round of stress tests. No such luck. That plan was blocked, rightly, by the Fed, whose exams revealed, among other perils, Bank of America's overexposure to the sickly real estate sector.

Yet Mr. Moynihan and Bank of America persisted, with analysts expecting the bank to come back in the middle of the year to push the Fed to revisit the dividend issue. So much for that now.

Still, even with these moves, some investors and analysts do not think the bank's actions will be sufficient and that it will have to sell common shares to raise capital.

Bank of America disagrees. Yes, the stock has "an overhang" thanks to economic and legal uncertainty, but "we understand that and are working very aggressively to address that," said Jerome F. Dubrowski, a spokesman. "We have more than enough capital to run our business" based on current rules, he said.

The bank has clearly explained to investors and regulators how it will reach compliance with the new rules ahead of schedule, he added. The Buffett opportunity was too good to pass up, Mr. Dubrowski said: "There's only one Warren Buffett. We are very happy to have him, but it wasn't driven by capital."

Yet Bank of America investors had whipped themselves into a panic in August because of the giant legal liability faced by the bank. The Buffett investment does not remove that, let alone any of the bank's other millstones.

Not only does the bank still face billions in legal settlement costs from Countrywide Financial, but it also has to buy back billions in faulty mortgages. Bank of America's questionable foreclosure practices continue to drag it down, and in addition it faces Securities and Exchange Commission investigations into the actions of its subsidiary, Merrill Lynch, in the lead-up to the financial crisis. Bank of America acquired Merrill in 2008, under heavy pressure from the Federal Reserve and the Treasury Department.

The big problem, however, is not the unknown legal costs, but the exceedingly well-known exposure to real estate, both home mortgages and home-equity lines of credit.

The bears will return, armed with a soft economy and the declining housing market. As they do, what is to stop them from jumping from bank to bank?

Compared with Bank of America, Wells Fargo has more exposure to real estate and less capital. The bank classifies about 19 percent of its residential mortgage loans as either delinquent or nonperforming, a number similar to that of Bank of America. Wells Fargo says it's fine, but where have we heard that before?

Of all the big American banks, JPMorgan Chase, perhaps surprisingly, has the highest proportion of bad mortgages, at about 24 percent, according to Bankregdata.com. Citigroup is lowest at less than 14 percent. But JPMorgan's balance sheet is more solid than that of any of the country's other megabanks.

Even if the major banks do not experience additional capital crises, the Fed plans to keep interest rates low for years. That will almost certainly depress bank lending rates, squeezing profits.

That is, if the banks lend at all. In one of the most important business lines for Bank of America and the other Big Three banks, residential mortgages, the banks are pricing themselves out of the market, offering uncompetitive rates. The mortgage market remains shattered.

Why aren't the banks lending? They fear potential future litigation, for one. And they claim there is not enough demand from high-quality borrowers. But if they had conviction that the economy and housing markets were recovering, those concerns would ebb.

So, if bank leaders are not exhibiting confidence, why should the rest of us?

Correction (9/1): This column referred incorrectly to the investment's impact on the bank's capital. Of the $5 billion, $2 billion will count in the measure of capital called Tier 1, under the current capital standard known as Basel 1. The column erroneously said that none of the $5 billion would count as Tier 1 capital.

Update, September 22, 2011: Yesterday, Standard and Poor’s downgraded the credit ratings for seven Italian banks, shortly after downgrading Italy’s sovereign credit rating. As Jesse Eisinger explains in this column, Italian financial weakness could have serious consequences for the U.S. banking system.

In early 2010, top officials at the Federal Reserve began to wonder: How would United States banks hold up through the European debt crisis? Investors were fleeing Greece and Ireland and starting to get nervous about Portugal and Spain, spreading contagion.

The conclusion from the stress tests that resulted was heartening to supervisors at the regulator, according to a person who was directly involved in the exercise: American banks didn't have too much exposure to Portugal and Spain, so the contagion would not be a problem.

Unless it hit Italy.

"At the time, the results made us a bit relieved; our focus was on Ireland and Greece," said this person, who spoke on condition of anonymity because the Fed has a policy of not discussing supervisory actions. "But if Italy goes, God help us all."

American banks had not only a small exposure to Italian government bonds, but a larger one to Italian banks and companies. If the European debt crisis spread to Italy, it could cause another global financial catastrophe. Only this time, global regulators might have fewer weapons to combat it. The Fed declined to comment on its analysis.

And that is why last week was so terrifying, scarier than either the stock market drop or the Standard & Poor's downgrade of the United States credit rating: Debtholders had abandoned Spain and Italy.

At one point on Friday, Italian bonds were trading at more than 400 basis points higher than Germany's, a signal of panic. Italy has a huge debt load. If investors began to focus on that, it wasn't clear what might stop the run.

The European Central Bank intervened this week, buying Spanish and Italian government bonds. On Monday, the panic eased in Europe, with Italian and Spanish interest rates falling. The French and Germans announced that the European Financial Stability Facility (clearly named by Dr. Seuss) would be able to buy those government bonds when it was up and running in late September.

By Wednesday, the fears were back, as French banks got hit especially hard. The problem is that Europe has tried repeatedly to fence off the problem, only to have it escape again to wreak havoc. Greece and Ireland have each been through several rounds of failed bailouts and extensions. If they are bankrupt, and not simply victims of investor panic, then someone, somewhere will have to take losses. And if Spain and Italy start to go down, those losses threaten the global economy.

European banks are on the front lines, vulnerable because they are more thinly capitalized than their American counterparts. Europe has conducted stress tests, just as the Fed has, but they haven't instilled confidence, in part because they didn't subject most sovereign debt holdings to any loss estimates.

The tests did require vast disclosures, however, so that investors and analysts could delve into the numbers and conduct their own analyses.

If European banks go down, what will happen to American banks? Investors and analysts seem unconcerned. American banks disclose some of their exposure to specific countries, but the information isn't up-to-date, and the figures depend on opaque estimates of how well hedged the banks are. Analysts differ on the amounts at risk.

According to a note from the research firm CLSA on July 13, Citigroup had $12.7 billion in Italian holdings, much of it government-related, while JPMorgan Chase had $12.2 billion. According to a note from BernsteinResearch, JPMorgan had "less than $20 billion" in exposure to Portugal, Ireland, Italy, Greece and Spain combined. But that was going in the wrong direction, up from "less than $15 billion" at the end of 2010, when one might expect the banks to be paring exposure.

These aren't large numbers, less than 1 percent of these gigantic banks' balance sheets. And banks wouldn't take 100 percent losses on their investments in the event of a default.

Unfortunately, we simply don't know whether the analysts are right. Neither the Fed nor the Securities and Exchange Commission has forced United States banks to make as detailed disclosures as the European stress tests did of its banks. So, it's a matter of having to trust the banks and the regulators.

Which brings us back to the exercise the Fed undertook last year. Two Fed officials ordered up the analysis: Daniel K. Tarullo, the board member who oversees matters of bank supervision; and Patrick Parkinson, the head of banking supervision, who is reported to have undergone a conversion from an Alan Greenspan antiregulation acolyte to a believer in strong oversight. Clinton D. Lively, a number-cruncher who recently left the New York Fed, was one of the officials who played a major role.

Disturbingly, before the financial crisis of 2008, the Fed, which is the most important bank regulator and is charged with keeping the banking system safe and sound, couldn't really do this kind of analysis, according to former Fed officials. It might have asked banks for the data on their exposures to specific countries, but it couldn't play out a chain of events very easily. What if the central bank wanted to know what would happen to United States banks if the euro fell 20 percent in a short period? The Fed didn't have the tools.

Now it does, thanks in part to the efforts of Mr. Lively and others. The assessment came with its own pitfalls. At time the Fed was gathering the data, a rumor started in markets that the Fed was worried about two Spanish banks. Some European banking supervisors became nervous about the Fed's efforts and voiced those concerns.

Unfortunately, the biggest problem is whether the data truly reflects all the risks. That continues to be a matter of intense debate within the central bank. Given the complexity of the trading arrangements within the global financial system, it's far from clear that the banks have a handle on their own exposures. As we learned in 2008, hedges that seemed solid on Monday disappear on Tuesday.

Nevertheless, it's good to know that the Fed isn't flying blind.

What was made can be unmade.

JPMorgan Chase and Wells Fargo may have venerable names, but they and the pseudo-venerable Citigroup and Bank of America are all products of countless mergers and agglomerations.

There is no rule of markets that requires a financial system dominated by four cobbled-together, lumbering behemoths.

Lawmakers and regulators have failed to remake our system with smaller, safer institutions. What about investors?

Big bank stocks have been persistently weak, making breakups that seemed politically impossible no longer unthinkable.

Bank of America’s recent quarterly earnings were so weak that investors and commentators wondered whether the bank should sell off Merrill Lynch, the investment bank for which it foolishly overpaid at the height of the crisis. Bank of America trades at half of its book value (the stated value of its assets minus its liabilities), an indication that investors view its asset quality and prospects just a notch below abominable, as Jonathan Weil of Bloomberg News pointed out last week.

For Bank of America, the question is whether it will have to raise capital. Selling shares at such depressed prices would be costly. Regulators won’t push for it. They just gave stress tests to the biggest banks and merely restricted the bank from paying out a dividend. The logical solution is that Bank of America shed business lines in a bid to improve its prospects in the eyes of Wall Street.

Citigroup’s stock, revenue and earnings have lagged for a decade.

“Look, if you can’t compete in the major leagues for over a decade, it’s time to go back to the minors,” said the always outspoken Mike Mayo, an analyst with CLSA. His chronicle of ruffling bank management feathers, “Exile on Wall Street” (Wiley), will be published in the fall.

JPMorgan Chase is as well managed as any gargantuan bank can be. But if you look at its businesses, it’s hard to see any area where it is clearly the best, something even its own executives concede. Not in credit cards, where the premier name is American Express. Not in money management, where you might offer up T. Rowe Price. Investment banking—Goldman Sachs (the last quarter notwithstanding). Back-office transactions, State Street.

Yet even JPMorgan is merely trading at book value. Put another way, the market regards the value that JPMorgan provides as a financial services conglomerate as zilch. How well do all of JPMorgan’s divisions work together? In presentations to investors, JPMorgan executives show how much revenue they gain from existing clients. But these measures are hardly unbiased. Executives have an incentive to defend their empires. Who is to say that a certain division of JPMorgan wouldn’t have won that business anyway? And nobody measures how much a bank loses through conflicts of interest.

Even in the face of investor pressure, there are forces that would hold bank breakups back. Mainly pay.

“The biggest motivation for not breaking up is that top managers would earn less,” Mayo said. “That is part of the breakdown in the owner/manager relationship. That’s a breakdown in capitalism.”

Institutional investors—the major owners of the banks—are passive and conflicted. They don’t like to go public with complaints. They have extensive business ties with the banks. The few hedge fund activist investors who aren’t cowed would most likely balk at taking on such an enormous target.

Also, there are reasons to think that smaller banks wouldn’t necessarily make the system safer. A wave of small bank failures can have systemic effects, as was the case in the Great Depression. Focused companies like Washington Mutual and Bear Stearns failed in the recent crisis, worsening it.

Making a nuanced argument, John Hempton, a blogger, investor and former regulator in Australia, says that it’s better for shareholders—and societies—to have large banks with lots of market power. That makes them more profitable and leads them to take less risk, making them safer and more enticing for investors.

Another oft-trotted-out argument against breakups: The United States needs global banks to service its giant, multinational corporations and to preserve our position in world markets.

Color me unconvinced. When a giant corporation wants to do a major bond offering or a big company goes public, the banks, despite their size, don’t want to shoulder all the risk themselves, preferring to share the responsibility.

If the stocks continue to lag for quarters upon years, these arguments will seem less convincing, while institutional reluctance will begin to erode.

Investors don’t care about size, they care about performance. It’s undeniable that smaller banks are easier to manage. And they are easier for regulators to unwind—and therefore less terrifying to trading partners—when they fail.

One of the most remarkable aspects of the debate about overhauling the financial system after the great crisis was the absence of serious contemplation of breaking up the largest banks.

It’s not a perfect solution. Banks responding to investor pressure would react haphazardly. But it’s a good start.

The most pronounced development in banking today is that executives have become bolder as their business has gotten worse.

The economy is clearly weaker than expected, and housing prices are falling throughout the land, eroding bank asset values. Yet regulators are on their heels in Washington as bankers and their lobbyists push back against the postcrisis regulations, even publicly condemning the new rules.

In a well-covered exchange, Jamie Dimon, JPMorgan Chase's chief executive, challenged Ben S. Bernanke, the Federal Reserve chairman, about the costs and benefits of the Dodd-Frank rules. More attention has been paid to the banker's audacity, but the response of the world's most powerful banking regulator was more troubling. Mr. Bernanke scraped and bowed in apology without mentioning the staggering costs of the crisis the banks led us into.

So this is a good occasion to step way back to understand just how good the banks have it today.

The federal government, in ways explicit and implicit, profoundly subsidizes and shelters the banking industry. True since the 1930s, it is much more so today. And that makes Mr. Dimon no capitalist colossus astride the Isle of Manhattan, but one of the great welfare queens in America.

The protection is so well established that we barely notice it anymore. The government supervises bank activities and guarantees deposits. When people walk into a bank, they assume it is as safe as their local supermarket.

Banks are also the mechanism through which we express economic policy, especially as fiscal stimulus has been eliminated as an option. The result is that the government pays a "vig" to banks in order to reach its policy goals.

When the Federal Reserve lowers interest rates to help buoy the economy during a slowdown, banks are the first beneficiaries. As the Fed lowers short-term rates, banks borrow cheaply and lend out for a lot more, making any new lending highly profitable (assuming the banks make good loans). This is classic monetary policy, and supported nearly universally. But let's not pretend that it isn't a boon to banks.

Some think bolstering banks' fortunes is a major goal, not a side effect.

"The Fed not only wants to stimulate the economy but also to recapitalize the banks, and this is a stealth technique to do it," said Herbert M. Allison Jr., a former investment banker who has turned banking apostate in a new white paper called "The Megabanks Mess," published as a Kindle Single. The reason "banks aren't doing more lending is that they still hold a lot of troubled assets that tie up equity."

Then there are the more subtle subsidies and protections. Take regulatory forbearance. In 2009, regulators gave banks a gift on their commercial real estate loans. They allowed banks to look primarily at whether the loans were current, rather than at whether the underlying value of the property had declined. Of course, given the commercial real estate collapse, this had the effect of protecting banks from write-downs.

Banks and regulators say this is justified because an underwater borrower isn't necessarily going to default. True, but it's hard to see how those borrowers -- and therefore the banks -- are better off for the crash in their collateral.

Commercial real estate is the least of it. The government is profoundly subsidizing the housing market, too. Hardly a loan gets made today by a bank that isn't guaranteed by either Fannie Mae, Freddie Mac or the Federal Housing Administration. There is no subprime mortgage business outside of the F.H.A. When banks make mortgages and sell the credit risk to the government, they make a quick, safe profit.

The first effect of these policies, for better or worse, is to keep a floor under the housing market. But it also helps banks that own trillions in real estate assets that the government is propping up.

Another way taxpayers coddle the biggest banks is by implicitly guaranteeing their derivatives business. JPMorgan, widely viewed as safe and well managed, is a huge beneficiary here. It had $79 billion worth of derivatives on its books in the first quarter. Even if it's hedged, prudent and has thin margins, it's still going to throw off a nice chunk of profits.

Institutions on the other side of these trades wouldn't enter contracts without believing that they have some underlying protection — protection that comes from the government.

"No sensible person would put a nickel on deposit in the normal course given the enormity and opacity of the derivatives portfolios," said Amar Bhidé, a former trader and business professor at the Fletcher School. "It's entirely a function of deposit insurance and the implicit guarantee that the JPMorgan counterparties have."

The government's actions in the financial crisis only cemented that certainty. Counterparties and investors that were previously not guaranteed, like holders of money market funds, were protected at every turn.

This bailout never ended. "In effect, we nationalized the biggest banks years ago," Mr. Allison said. "We implicitly guaranteed them. The taxpayers are still the ultimate owners of the risk in those banks -- they just don't get equity returns for that ownership."

So when taxpayers hear a bank chief, like Jamie Dimon, complaining, it's worth keeping in mind that his 10-figure paycheck is largely coming courtesy of us.

Goldman Sachs appears to be trying to clear its name.

The compelling Permanent Subcommittee on Investigations report on the financial crisis is wrong, the bank says. Goldman Sachs didn’t have a Big Short against the housing market.

But the size of Goldman’s short is irrelevant.

No one disputes that, by 2007, the firm had pivoted to reduce its exposure from mortgages and mortgage securities and had begun shorting the market on some scale. There’s nothing wrong with that. Don’t we want banks to reduce their risk when they see trouble ahead, as Goldman did in the mortgage markets?

Nor should shorting itself be seen as a bad thing. Putting money behind a bet that a stock (or bond or commodity or derivative) is overpriced is necessary for the efficient functioning of capital markets. Short-sellers can keep prices from getting out of whack and help deflate bubbles.

The problem isn’t that Goldman went short and reduced risk — it’s how.

To establish many of its short positions, the Senate report says, Goldman created new securities, backed them with its good name, and then strung together misleading statements to its customers about what it was actually doing. By shorting the way it did, the bank perverted the market instead of correcting it.

Take Hudson Mezzanine, a $2 billion collateralized debt obligation created by Goldman in 2006. In marketing material, the firm wrote that “Goldman Sachs has aligned incentives with the Hudson program.”

I suppose that was technically true: Goldman had made a small investment in the C.D.O. and therefore had an aligned incentive with the other investors. But the material failed to mention the firm’s much larger bet against the C.D.O. — a huge adverse incentive to its customers’ interests.

Goldman told investors that the Hudson assets had been “sourced from the Street,” which most investors would understand to mean that Goldman had purchased the assets from other broker-dealers. In fact, all the assets had come from Goldman’s own balance sheet, the Senate report found.

In his April 2010 testimony to the Senate, Goldman’s chief executive, Lloyd C. Blankfein, argued that Goldman was merely making a market in these securities and derivatives, matching willing and sophisticated buyers and sellers. But Goldman was acting like an underwriter, not a market maker.

As the underwriter, Goldman threw its marketing muscle behind Hudson Mezzanine and other C.D.O.’s. When the bank’s salespeople ran into trouble selling the securities, they begged for help from the executives who created them. One requested material to give to clients about “how great” the sector was. One needed the aid to get a client to invest, to be “THERE AND IN SIZE,” according to e-mails cited in the report.

Sometimes, Goldman took advantage of the opaque markets. According to the Senate report, Goldman executives had extensive concerns about the prices of its 2007 Timberwolf C.D.O. Goldman sold the C.D.O. securities anyway, often at higher prices than it had them recorded on its books. In summer 2007, Goldman marked some Timberwolf assets at 55 cents on the dollar, but sold similar securities to an Israeli bank at 78.25 cents at the same time, according to the report. Oh, well, tough luck!

For decades, Goldman’s famous mantra was to be “long-term greedy” and a central element of that was putting customers first. In these C.D.O.’s, the bank’s customers were “only first in the same way that on Thanksgiving, the turkey is first,” a former C.D.O. professional told me.

Goldman declined to address these specific disclosures from the report. A spokesman maintained the firm fulfilled its obligations to buyers of these kinds of C.D.O.’s, which were made up of derivatives. The customers were large and sophisticated investors who knew that one side had to be long while the other was short. And they knew, or should have known, that Goldman might be on the other side.

“It was fully disclosed and well known to investors that banks that arranged synthetic C.D.O.’s took the initial short position,” a spokesman wrote in an e-mail.

True, but few thought that the bank that had created and hawked the C.D.O.’s expected them to fail.

Goldman’s techniques harmed the capital markets. Goldman brought something into the world that didn’t exist before. Instead of selling something — thereby decreasing the price or supply of it — and giving the market a signal that it was less desirable, Goldman did the opposite. The firm created more mortgage investments and gave the world the signal that there was more demand, for C.D.O.’s and for the mortgages that backed them.

By shorting C.D.O.’s, Goldman also distorted the pricing of the underlying assets. The bank could have taken the securities it owned and sold them en masse in a fairly negotiated sale, though it likely would have gotten less for them than it was able to make by shorting the C.D.O.’s it created.

Because of Goldman’s actions, the financial system took greater losses than there otherwise would have been. Goldman’s form of shorting prolonged the boom and made the crisis that followed much worse.

Goldman executives surely hope to change the subject from the firm’s specific actions to a more general discussion of how much and when it shorted. We shouldn’t let them.