Putting the JP Morgan Loss In (Real) Perspective

Ever since JP Morgan’s announcement of a $2 billion loss on Thursday from what might or might not be a hedging transaction, advocates for financial reform have used the news as a basis for calls to strengthen rules currently in the works, most notably the Volcker rule.  This is not the least bit surprising, given both the nature of politics and the fact that Jamie Dimon has been the most vocal opponent of such reforms, insisting that they’re unnecessary and so costly as to make American banks uncompetitive.  So it’s really a given that reformers and pundits are not going to waste an opportunity to hit back when Mr. Dimon announces losses from egregious sloppiness that are multiple times his own estimates of the costs of Volcker rule compliance. 

Perhaps just as predictably, less reform-minded commentators are now fighting back.  Notably, Jonathan Macey has a piece in today’s WSJ arguing that we should keep the JP Morgan losses in perspective.  Says Macey:

The truth is that nobody should care about J.P. Morgan's loss—nobody except J.P. Morgan stockholders and a few top executives and traders who will lose their bonuses or their jobs in the wake of this teapot tempest. The three executives with the closest ties to the losses are already out the door.

After the $2 billion in losses, J.P. Morgan still had $127 billion in equity. This means that J.P. Morgan could lose another $100 billion and creditors would still have an equity cushion that could absorb 10 times the losses that the bank suffered on this trade. . . .

Thus, far from serving as a pretext to justify still more regulation of providers of capital, J.P. Morgan's losses should be treated as further proof that markets work. J.P. Morgan and its competitors will learn from this experience and do a better job of hedging the next time. They will learn because they have to: In the long run their survival depends on it. And in the short run their jobs and bonuses depend on it.

Yes, of course the losses are small change given JP Morgan’s size and, of course, politicians are opportunists.  Moreover, I’ll even grant Macey’s basic position that markets typically work better than governments.  More to the point, I’ve been quite vocal on this blog about the limitations of the Volcker rule, along with many other Dodd Frank reforms.

But, this “let’s put the JP Morgan loss in perspective” tale making its rounds the past few days quite misstates both the concerns of the proposed Volcker rule and what is worrying about the JP Morgan losses.  The rationale behind the Volcker rule became embodied in a “too big to fail” and “no government bailouts” narrative, perhaps because those were winning spin points for Obama and because those rationales are easier for the general public to grasp.  But the real rationale of the rule was really about subsidies: depository institutions receive a variety of federal subsidies, including underpriced federal deposit insurance and liquidity assistance.  The sense of most Volcker rule proponents (or at least the more thoughtful ones) is that these federal subsidies, designed to provide stability to such institutions, should not then be leveraged into risky trading activities that bear no relation to traditional banking services.  I’ve discussed my own views on this before: the Volcker rule’s goals are noble in theory, but I’m not persuaded the rule will be at all workable.  And, as I discussed in this earlier post, the JP Morgan loss – rather than illustrating the need for the Volcker rule -- demonstrates the many hurdles to successful implementation. 

But we should be straight about the purposes of the rule. 

Yes, markets typically work.  Maybe if we allowed them to work for banking entities we wouldn’t need to worry about JP Morgan’s risk profile.  But we don’t . . . so we do.  

Comments

[James Pannabecker]

I'd like to think Dimon learned from this event. Among other things, though, I'm concerned that the transaction illustrates that banks (and product designers) still don't understand the complicated nature of the derivatives transactions in which they're engaged. Do they really understand and have they identified the risks of what they're doing? Is $2B the tip of an iceberg?

[Adam]

I think this proves the point, that 'Wall Street' has not learned. Dimon and his cohort are like children who don't learn a lesson.

I realize this is not exactly the same. My point is - as a parent - I see this man as an irresponsible child. He doesn't care about the $2 billion loss. He wouldn't really care if it was $20 billion. Because on getting the news he'd turn to Washington and ask for a handout.

Newsweek recently had an article about the fact that unlike the Bush I Administration that criminally prosecuted bankers following the S&L debacle, there's been a lot of showmanship but no follow-through by the Obama Administration.

The truth is that for bankers like Dimon who were ultimatelu responsible given their sophistication, there have been no consequences. And as any parent will tell you, bad behavior will be repeated.

The true fault of President Obama, which he cannot pass off to his predecessor is what he has failed to do to punish the bankers responsible for actions contributing to the Great Rescession. In other words, even if for argument's sake, George W Bush's de-regulation was the cause of the Great Rescession, Barach Obama's failure to punish wrongdoing is the worse merely because it taught people like Dimon that they can get away with their shenanigans.

[Kim Krawiec]

There's some speculation in the press today, James, that there may be more losses -- they don't know, of course, but it is a reasonable story. I may blog more about that later today if I have time.

You may have seen, Adam, that a few folks are calling for more stringent measures, such as breaking up large banks or returning to Glass-Steagall, in the wake of this news. That's probably not the same as what you have in mind with "punishment" (which I take to be a call for individual accountability) but it is more harsh than Dodd Frank. I doubt that any of these proposals will have traction, absent another 2008-like episode.

[Adam]

I did. I heard Robert Reich speak to this on NPR, calling for Glass-Steagall to be brought back.

I do think some individual accountability is necessary. I do not believe that calling Dimon down to a congressional hearing and reading him the riot act is useful at all. What did HE authorize or not is not, I think, a practical exercise.

If Congress or anybody wants to get at the root of the problem, which is what was being done, what was approved, who approved it and who was executing it and when were these authorizations and executions happening, then the people Congress should be speaking with are below Dimon.

IMHO let Dimon sit in his comfy NY office wondering and worrying when the FBI comes to get him. By giving his a platform to swear out yet one more mea culpa, Congress does nothing more than play into Dimon's hand.

[Kim Krawiec]

"I do not believe that calling Dimon down to a congressional hearing and reading him the riot act is useful at all. "

On this we are in complete agreement (as any sane person should be). But the pols must have their few moments on tape giving Dimon a tongue-lashing to prove that they're not all soft on the banks. Yada yada.