Why We Regulate

One of the characters in the classic 1939 film “Stagecoach” is a banker named Gatewood who lectures his captive audience on the evils of big government, especially bank regulation, “As if we bankers don’t know how to run our own banks!” he exclaims. As the film progresses, we learn that Gatewood is in fact skipping town with a satchel full of embezzled cash. As far as we know, Jamie Dimon, the chairman and C.E.O. of JPMorgan Chase, isn’t planning anything similar. He has, however, been fond of giving Gatewood-like speeches about how he and his colleagues know what they’re doing, and don’t need the government looking over their shoulders. So there’s a large heap of poetic justice, and a major policy lesson, in JPMorgan’s shock announcement that it somehow managed to lose $2 billion in a failed bit of financial wheeling-dealing. (source: Paul Krugman – NYTimes – 14/05/2012)

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 government to get involved. But banks are special, because risks they take are borne, in large part, by taxpayers and 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. Why, exactly, are banks special? Because history tells us that banking is and always has been subject to occasional destructive “panics,” which can wreak havoc with economy as a whole. Current right-wing mythology has it that bad banking is always result of government intervention, whether from Federal Reserve or meddling liberals in Congress. In fact, however, Gilded Age America, a land with minimal government and no Fed, was subject to panics roughly once every 6 years. And some of these panics inflicted major economic losses. So what can be done? In the 1930s, after the mother of all banking panics, we arrived at a workable solution, involving both guarantees and oversight. On one side, scope for panic was limited via government-backed deposit insurance; on other, banks were subject to regulations intended to keep them from abusing privileged status they derived from deposit insurance, which is in effect a government guarantee of their debts. Most notably, banks with government-guaranteed deposits weren’t allowed to engage in the often risky speculation characteristic of investment banks like Lehman Brothers. This system gave us half a century of relative financial stability. Eventually, however, lessons of history were forgotten. New forms of banking without government guarantees proliferated, while both conventional and newfangled banks were allowed to take on ever-greater risks. Sure enough, we eventually suffered the 21st-century version of a Gilded Age banking panic, with terrible consequences. 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 politicians they bankroll, for now that they have been bailed out, the bankers would of course like to go back to business as usual. Did I mention Wall Street is giving vast sums to Mitt Romney, who has promised to repeal recent financial reforms?

Enter Mr. Dimon. JPMorgan, to its and his credit, managed to avoid many of the bad investments that brought other banks to their knees. This apparent demonstration of prudence has made Dimon the point man in Wall Street’s fight to delay, water down and/or repeal financial reform. He has been particularly vocal in his opposition to the so-called Volcker Rule, which would prevent banks with government-guaranteed deposits from engaging in “proprietary trading,” basically speculating with depositors’ money. Just trust us, the JPMorgan chief has in effect been saying; everything’s under control. Apparently not. What did JPMorgan actually do? As far as we can tell, it used market for derivatives, complex financial instruments, to make a huge bet on the safety of corporate debt, something like the bets that the insurer A.I.G. made on housing debt a few years ago. The key point is not that the bet went bad; it is that institutions playing a key role in the financial system have no business making such bets, least of all when those institutions are backed by taxpayer guarantees. For the moment Mr. Dimon seems chastened, even admitting that maybe the proponents of stronger regulation have a point. It probably won’t last; I expect Wall Street to be back to its usual arrogance within weeks if not days. But the truth is that we’ve just seen an object demonstration of why Wall Street does, in fact, need to be regulated. Thank you, Mr. Dimon. 


Acerca de ignaciocovelo
Consultor Internacional

5 Responses to Why We Regulate

  1. Professor Uziel Nogueira says: The Jamie Dimon/JPMorgan Chase’s fiasco has two readings. First, the 2008/9 financial crisis is alive and well. Second, the financial system is still in charge of the economic system; if it is healthy and regains strength, the economy will recovery.

    The question is: Does anyone really BELIEVE an trust the financial system?

    The problems of the US economy go much deeper than short term weak demand and high unemployment. It is a CRISIS of CONFIDENCE at the core of a complex and unmanageable banking system. If the problem is not fixed for good, it will become a problem that will stall growth and employment.


  2. Investors are shunning the stock market, and who can blame them? As serial bubbles have burst, faith in the market has been rewarded with shattered retirements. At the same time, trust has been destroyed by scandals and — as demonstrated by the reckless trading at JPMorgan Chase — the slow, uncertain pace of financial reform. There has been less buying and selling of stock, and there have been huge outflows of investor dollars from domestic stock mutual funds, as detailed recently by The Times’s Nathaniel Popper. If the trend continues, the result could be a less robust market, with fewer companies opting to raise money by issuing shares and fewer investors willing to put their retirement savings into stocks. Policy makers should pay attention.

    Evidence suggests that investors are not merely reacting to tough conditions, but rather are staying away because they do not trust the market.

    Restoring trust is crucial to restoring the market. American stocks have doubled in price since the market hit bottom three years ago. But trading in the United States stock market has not only failed to recover since the 2008 financial crash, it has continued to fall. In April, average daily trades stood at 6.5 billion, about half their peak four years ago. By comparison, after the market busts of 1987 and 2001, trading recovered within two years. In fact, going back to 1960, trading had never declined for three consecutive years, let alone four and counting (…..)


  3. (…..) “Paul Volcker by his own admission has said he doesn’t understand capital markets,” Dimon told Fox Business in February. “Honestly, he has proven that to me.” At a private dinner in Dallas last month, the New York Times’ Gretchen Morgenson recently reported, he called Volcker’s criticisms “infantile.” Volcker didn’t merely want to reinstate prudential standards that would effectively lower the big banks’ profits. He was also a relic of banking’s boring past, having worked as an economist at a bank (Chase Manhattan) and later managed the Federal Reserve at a time when commercial banks were forbidden from investing their depositors’ money by the terms of the 1933 Glass-Steagall Act (which, until its repeal in 1999, spared the nation from the convulsions of a Wall Street collapse). Rumpled and unglamorous, Volcker personified banking before big money gave it glitz. He implicitly threatened to drag it back to the days when Wall Streeters occasionally had to hail their own cabs. Now, Dimon has confirmed the wisdom of both the Volcker rule and Glass-Steagall. Precisely because JPMorgan may be the best run bank, and Dimon the most risk-sensitive CEO, their failure to grasp that their hedge on their hedge on their investment in corporate bond indexes exposed them to major losses and couldn’t readily be unwound makes the case that today’s financial innovations are too complicated for even the smartest bankers and too risky to be entered into with depositors’ funds. Indeed, Dimon’s debacle calls into question several fundamentals of modern financial capitalism — globalization among them. Like AIG, JPMorgan Chase is a New York-based company whose miscreant and highly profitable investment unit was located in London. In theory, modern communications should obviate any problems that might create. In practice, it’s clear that transatlantic oversight — by the companies themselves and by regulators — was less than diligent. Jamie Dimon remains a big deal. He still runs America’s biggest bank. But if Dimon’s bank and others like it are not to periodically blow themselves up — taking the economy down with them — they’ll have to be made smaller, safer and less dashing. They’ll have to become boring again, as they were in the days when the U.S. economy — one Bedford Falls after another — thrived.


  4. (…..) Without a strong Volcker Rule, taxpayers — via deposit insurance and bailouts — will continue to be on the hook for risky trades that boost bankers’ pay when things go well but that can wreak havoc on the financial system and broader economy when they blow up. Mr. Dimon and his lobbyists even persuaded regulators to include a loophole in the proposed Volcker regulations known as “portfolio hedging.” It would allow banks to continue to engage in vast and complex trading, ostensibly to hedge broad financial and economic risks facing the bank. The law permits banks to make offsetting trades tied to specific investments but the loophole could let banks do proprietary trading under the guise of hedging. The banks will keep pushing the limits. An effective Volcker Rule must require that any hedge be strongly tied to the investments being hedged — and require bank officers to certify that hedges meet all regulations and have not been put in place to generate speculative gains. Violators must face stiff penalties. And because hedging is often done with derivatives, the Volcker Rule must be coupled with new transparency rules and stiff capital requirements for derivatives trades. For anyone who forgot what happened during the financial meltdown, the JPMorgan debacle should leave no doubts about the need for tougher regulations. The banks cannot be allowed to keep to their risky business as usual. The country cannot afford it.


  5. The trading losses suffered by JPMorgan Chase have surged in recent days, surpassing the bank’s initial $2 billion estimate by at least $1 billion, according to people with knowledge of the losses. When Jamie Dimon, JPMorgan’s chief executive, announced the losses last Thursday, he indicated they could double within the next few quarters. But that process has been compressed into four trading days as hedge funds and other investors take advantage of JPMorgan’s distress, fueling faster deterioration in the underlying credit market positions held by the bank. A spokeswoman for the bank declined to comment, although Mr. Dimon has said the total paper trading losses will be volatile depending on day-to-day market fluctuations. The Federal Reserve is examining the scope of the growing losses and the original bet, along with whether JPMorgan’s chief investment office took risks that were inappropriate for a federally insured depository institution, according to several people with knowledge of the examination. They spoke on the condition of anonymity because the investigation is still under way. The overall health of the bank remains strong, even with the additional losses, and JPMorgan has been able to increase its stock dividend faster than its rivals because of stronger earnings and a more solid capital buffer. Still, the huge trading losses rocked Wall Street and reignited the debate over how tightly giant financial institutions should be regulated. Bank analysts say that while the bank’s stability is not threatened, if the losses continue to mount, the outlook for the bank’s dividend will grow uncertain. The bank’s leadership has discussed the impact of the losses on future earnings, although a dividend cut remains highly unlikely for now. In March, the company raised the quarterly dividend by 5 cents, to 30 cents, which will cost the bank about $190 million more this quarter. A spokeswoman for the bank said a dividend cut has not been discussed internally. At the bank’s annual meeting in Tampa, Fla., on Tuesday, Mr. Dimon did not definitively rule out cutting the dividend, although he said that he “hoped” it would not be cut. John Lackey, a shareholder from Richmond, Va., who attended the meeting precisely to ask about the dividend, was not reassured. “That wasn’t a very clear answer,” he said of Mr. Dimon’s response. “I expect that shareholders are going to suffer because of this” (…..)



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