JPMorgan Chase's surprise announcement on Friday that it had accidentally dropped $2 billion down the derivatives sewer returns the issue of Wall Street regulation to the front of the political debate and raises the question of why, five years after a massive financial collapse, we haven't prevented banks from risky trading.
Though regulatory reform seemed like a no-brainer after the 2007, any hang-'em-high sentiment was first diverted by a need to salve serious economic wounds, which turned discussion onto the size and nature of stimulus packages rather than increasing regulation. Then along came the Tea Party, which viewed as treasonous any word containing letters that could be used to spell government, and suddenly the idea of regulation of any kind was anathema to midterm voters. Somewhere in there, Congress passed the Dodd-Frank regulatory bill, which was so defanged by the time it was completed that many wondered if it would have any bite on the financial system at all.
JPMorgan's massive loss takes us right back to the early days of the financial collapse, before we digressed into conversations of stimulus and austerity, and to some of the same questions: are extreme banking losses part of the normal ebb and flow of a risk-based economy, or sheer recklessness? And either way, does the government have a role in preventing them?
Alex Pareene wants answers from Jamie Dimon, JPMorgan' CEO. Under Dimon, JPMorgan steered clear of the dangerous trades that felled so many of its competitors—even Obama praised his performance as distinct from the recklessness of Wall Street—and in turn Dimon has used his relative spotlessness to argue against financial regulation, in particular against the Volcker Rule, which would prohibit proprietary trading of the type that just tripped up JPMorgan. Dimon has appeared somewhat chastened by his bank's stunning loss, especially the degree to which they didn't see it coming, and he seems to understand that his bank's mistake will play right into the narrative of financial regulation. But he has yet to see that his company's behavior not only firms up the argument for regulation but threatens the existential justification of banks as stewards of economic growth:
I’d also like Mr. Dimon to have to explain whether he knew he was about to have to admit to losing billions of dollars when, on May 3, he complained about the “discrimination” faced by bankers. Dimon also argued a few days later that the economy would’ve added twice as many jobs in the last 24 months if it weren’t for a “constant attack on business” from various unnamed hippies and government bureaucrats. I would like to know how many jobs were created when JPMorgan accidentally lost some unknown amount of money that is likely to end up being more than $2 billion? Also did Dimon lie during his first-quarter earnings call last month, or did he have no idea what sort of things his chief investment office was up to (even after their actions were reported in the press)? If he didn’t have any idea, shouldn’t he maybe step down to run a smaller bank, where he can keep a closer eye on everything? Dimon said initially that the stuff that lost all the money wouldn’t have violated the Volcker Rule, even though it plainly violates the spirit of the Volcker Rule but also he’s not sure if the bank broke any laws? Jamie, I think maybe you should consider retirement; this bank is too complicated for you.
Pareene's snark actually hits on a main point. One of the problems uncovered by the 2007 economic collapse was "Too Big To Fail." Dodd-Frank partially corrected this by increasing capital requirements, meaning a bank like JPMorgan can lose $2 billion without needing a taxpayer bailout (though banks in 2007 were losing much more than that). But without limiting the size of banks themselves—and, indeed, by increasing the capital requirements, actually increasing the monetary holdings of banks—financial reform failed to correct the TBTF problem, leading to what one blog called "Too Big To Manage." In short, Pareene is right: JPMorgan might literally be too big for even a sagacious leader like Dimon to successfully apply risk management.
Via Economist's View:
JP Morgan claimed to have great risk management systems—and these are widely regarded as the best on Wall Street. But what does the "best on Wall Street" mean when bank executives and key employees have an incentive to make and misrepresent big bets—they are compensated based on return on equity, unadjusted for risk? Bank executives get the upside and the downside falls on everyone else—this is what it means to be "too big to fail" in modern America.
Paul Krugman agrees, arguing that banking regulations fill the gap between human error—which a competitive system of rewards and punishments like capitalism takes into account—and risk management of extremely complex financial units, the failure of which has seismic consequences:
Just to be clear, businessmen are human—although the lords of finance have a tendency to forget that—and they make money-losing mistakes all the time. That in itself is no reason for the government to get involved. But banks are special, because the risks they take are borne, in large part, by taxpayers and the economy as a whole. And what JPMorgan has just demonstrated is that even supposedly smart bankers must be sharply limited in the kinds of risk they’re allowed to take on.
JPMorgan's mistake is important because it so clearly and visibly crosses the line between acceptable risk and reckless risk, in a way that emphasizes the size of banks as a key factor in the inability to keep banks on the right side of that line. The "trust us" argument breaks down right here: it's not only that bankers can't be trusted to manage risk, but that the banking industry is systemically structured as to make that level of risk management unfeasable.
Krugman is skeptical that JPMorgan's loss will result in any tightening regulations:
It’s clear, then, that we need to restore the sorts of safeguards that gave us a couple of generations without major banking panics. It’s clear, that is, to everyone except bankers and the politicians they bankroll — for now that they have been bailed out, the bankers would of course like to go back to business as usual... I expect Wall Street to be back to its usual arrogance within weeks if not days.
This is the main obstacle to financial regulation. Despite their trashing of the global economy just five years ago, Wall Street still factors centrally into the American narrative of economic prosperity, a narrative that looks askance at government regulation (seen here as a hindrance) of the market even as the excesses of that market are so clearly shown to be disastrous.
It is this paradox that so hobbled attempts at financial reform during Obama's administration. Politico has a rundown of the political difficulties made for Obama by the losses incurred at JPMorgan: Obama was unable to pass meaningful banking reform, due both to using his political capital to pass the stimulus and health care, and because he was partially beholden to the very industries that he would have to punish through regulation. This combination meant the Obama administration "mostly just let the process play out, which is the same as handing it over to Wall Street and the lobbyists," a Democratic staffer said, making it "much harder for Obama to run as the sheriff who cleaned up Wall Street."
The Politico piece overplays the political costs to Obama—anybody who's been paying even the slightest bit of attention knows that financial regulation was tried and gutted—though it does note that Obama caught a break in getting a Wall Street-ish opponent in Mitt Romney. And given the president's recent populist turn, it's unlikely that he'll suffer much anti-Wall Street sentiment.
But the pressing need for financial regulation stands. The Volcker rule is an attempt to fill the gap of which Krugman spoke by limiting the types of dangerous trading in which banks can engage, thus putting a harsh restraint on the level and kind of risks banks can take, no matter how much they feel they can handle it. It makes both banking mistakes and banking arrogance simultaenously impossible by institutionalizing the fact that there is too often no difference between the two. There still remains the Too Big To Fail problem, which has led more and more economic observers to call for banks to be broken up (the very hybridity of the name JPMorgan Chase sums this problem up well).
Thanks to the nature of his opponent, Obama has all the pieces he needs to make the push for meaningful financial reform that he was either unable or unwilling to make three years ago. Will he make the case? And will Wall Street, reeling from a fresh example of its own disastrous excess, stand in his way this time?
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