Even if your only source of news is FOX and Friends, you must certainly have heard by now that the nation’s largest bank, JP Morgan Chase, suffered a loss of at least $2 billion–and likely much more–in a botched credit derivatives trade. The trade, which spurred an all but dog-and-pony show investigation by the FBI and renewed lip-service on Capitol Hill for strengthening Dodd-Frank‘s Volcker Rule and swaps regulations, involved a corporate bond hedging strategy gone horribly wrong. A London based trader for JP Morgan assembled a huge portfolio of derivative credit default swaps and sold them off to investors based upon the trader’s wrong-headed belief that corporate bonds owned by JP Morgan would perform well. The market believed otherwise, and the once “well-intentioned” hedging strategy blew up in the face of JP Morgan chief Jamie Dimon and the rest of the masterly minds who also carry keys to the executive washroom. Losses began to mount, and rather than accept the losses commensurate with the oft-cited free market’s value of the underlying assets and derivatives, Dimon chose instead to attempt to call off the dogs by whining to the federal government yet again. Dimon, long the golden-boy of Wall Street for his perceived risk management acumen, suffered a scathing blow to his egregious ego.
Barack Obama is fond of referring to Dimon as one of Wall Street’s best and brightest.
JP Morgan is one of the best-managed banks there is. Jamie Dimon, the head of it, is one of the smartest bankers we got and they still lost $2 billion and counting,” the president said. “We don’t know all the details. It’s going to be investigated, but this is why we passed Wall Street reform.
I don’t know which claim in this sentence is the most absurd. First, if Jamie Dimon is one of the smartest bankers we’ve got, who is the worst? Good grief. If you have a potential loss looming into the many billions of dollars on a unnecessary and risky bet that was permitted to spiral out of control on your watch, you’re not a genius. If you beg Congress to limit the rules that could potentially prevent the loss from taking place in the first place, you’re an idiot whose hubris has digested whatever tiny amount of good sense you had remaining. You are by no stretch of the imagination to be held out as some captain of finance worthy of the respect of the common man and bankers alike. If you insult those who are attempting to promulgate rules to prevent you–yes you–from destroying the economy and sending millions back to the unemployment lines and soup kitchens, you are a sociopath incapable of understanding the profound effect your actions have on other human beings. You’re just another banker Mr. Dimon, and there are hundreds of thousands of people within fifty miles of Wall Street capable of stepping into your shoes and replicating your results in an instant. I only wish Barack Obama understood that simple fact. Let me backpedal a bit. In fairness, I am sure that he does understand, he just isn’t willing to act upon this knowledge.
Second, there isn’t going to be any investigation. More than four years following the onset of the recent recession-depression, not a single executive–let alone an expendable fall guy–of any of the large Wall Street investment banks has seen the inside of a jail cell. While the Department of Justice has admonished the American public to “just wait” for the hammer do be dropped upon the heads of those who cost millions their jobs, retirements, and pensions, we are told that Wall Street South will be undertaking yet another “investigation.” I won’t hold my breath.
Essentially, the brilliant Mr. Dimon placed the very same family of bets that led to financial collapse. Perhaps he felt that JP Morgan’s relative solvency throughout the crisis granted him the free reign to act similarly without consequences.
For one thing, JPMorgan was known as the best manager of risk on Wall Street. That’s largely because the company made it through the financial crisis mostly unscathed. But it turns out that even the best manager of risk can slip. This trade, in fact, echoes the financial crisis: They bet on something unlikely as if it were impossible. That’s what all those banks did when they bet almost everything on the belief that the housing market never goes down everywhere all at once. It’s a reminder that even “good” banks make this kind of mistake. And remember, JPMorgan made this mistake less than four years after the fall of Lehman Brothers, so this came at a time when the lessons of the crisis were still fresh, and when regulators were watching closely.
The only guarantee that taxpayer money will not be put at risk again due to similar and much larger miscalculations in the future is to again separate the deposit institutions from the investment and speculative institutions. Dodd-Frank is famous for being over eight-hundred pages long with several thousands of additional pages to be produced by the various regulators charged with promulgating additional rules at its direction. No number of pages of byzantine regulation will prevent the unscrupulous likes of Jamie Dimon and others whose egos have been hyper-inflated by ridiculous compensation and consistent government bending to their will from carving out a path through the best intentions of regulators en route to over-leveraged gambling and placing at risk the financial system and the savings of taxpayers. This rather intuitive fact is ultimately what led legislators in the 1930′s to pass the Glass-Steagall Act, a Depression era law which strictly separated investment banking from depositor banking. While there was consternation during the debate surrounding the act and the act was not perfect–in fact the sponsor, Senator Carter Glass, even moved to repeal the act shortly after passage–its framework averted a widespread banking sector collapse for more than seventy years.
Ironically enough, as the banking sector chipped away at the regulations included in Glass-Steagall over the years from 1933 through 1999, when it was repealed in its entirety, it was JP Morgan that pushed for one of the largest non-traditional banking expansions of the act.
In January 1989, the Fed Board approves an application by J.P. Morgan, Chase Manhattan, Bankers Trust, and Citicorp to expand the Glass-Steagall loophole to include dealing in debt and equity securities in addition to municipal securities and commercial paper. This marks a large expansion of the activities considered permissible under Section 20, because the revenue limit for underwriting business is still at 5 percent. Later in 1989, the Board issues an order raising the limit to 10 percent of revenues, referring to the April 1987 order for its rationale.
In 1990, J.P. Morgan becomes the first bank to receive permission from the Federal Reserve to underwrite securities, so long as its underwriting business does not exceed the 10 percent limit.
JP Morgan and other large banks spent the better part of a century unraveling Glass-Steagall. Since its complete destruction in 1999, we have seen the steep deterioration of ending standards as well as the greatest expansion of leveraged investing and derivatives trading in the modern world. The result was the 2008 collapse of the world economy. Many, including Massachusetts Senate candidate and economics professor Elizabeth Warren, have called for the reinstatement of Glass Steagall in its entirety, believing that minor fixes such as the Volcker Rule are inadequate.
Well, I’m going to put it this way. The Volcker Rule would help. We don’t know exactly the nature of these trades. But if the question is is the Volcker rule enough, or do we need more, look, I’m somebody who believes we really should have boring banking. That banking should be — the part that’s about savings accounts and checking accounts and our money system — should be separated from the kind of risk-taking that Wall Street traders want to take. That was originally what the Glass-Steagall Act was about, it was repealed in 1999. There was an effort to get it into Dodd-Frank in the 2010 bill. That effort failed. I think we really do need that kind of separation. We need to go back to boring banking. The people who want to take risks need to take risks with their own money and do it somewhere else.
The banking sector spent nearly $500 million on efforts to repeal the Glass-Steagall Act. Initially the banks lobbied to be permitted to enter the bond and securities markets, followed by a loosening of the standards prohibiting banks from underwriting commercial paper and mortgage-backed-securities. Many of the regulatory changes occurred over the objection of Paul Volcker, the then Federal Reserve Chairman and continued nemesis of the reckless investment banking sector.
In the spring of 1987, the Federal Reserve Board votes 3-2 in favor of easing regulations under Glass-Steagall Act, overriding the opposition of Chairman Paul Volcker. The vote comes after the Fed Board hears proposals from Citicorp, J.P. Morgan and Bankers Trust advocating the loosening of Glass-Steagall restrictions to allow banks to handle several underwriting businesses, including commercial paper, municipal revenue bonds, and mortgage-backed securities. Thomas Theobald, then vice chairman of Citicorp, argues that three “outside checks” on corporate misbehavior had emerged since 1933: “a very effective” SEC; knowledgeable investors, and “very sophisticated” rating agencies. Volcker is unconvinced, and expresses his fear that lenders will recklessly lower loan standards in pursuit of lucrative securities offerings and market bad loans to the public. For many critics, it boiled down to the issue of two different cultures – a culture of risk which was the securities business, and a culture of protection of deposits which was the culture of banking.
The banking sector also objected to efforts to reinstate Glass-Steagall during the debate over the 2010 Dodd-Frank bill. It had after all spent millions of dollars and several decades dismantling the legislation and gaining access to your savings deposits and loans, and the deposits and loans of businesses and groups as a source for leveraged gambling and “creative” debt offerings and derivatives. It wasn’t about to allow the clock to be turned back to a time when banks did well and the financial sector was a rather hum-drum yet effective and profitable industry. Let me be clear, there is no need for creativity in finance. There is no need for the best and brightest mathematicians and physicists to waste their significant true brilliance concocting new means through which to extract exponential wealth from wealth. Banking is not inherently complicated, as the century following Glass-Steagall illustrated. Efforts to reinstate Glass-Steagall do in fact have significant support, but not enough support to overcome the most powerful lobby in Washington D.C.
Without a return to a full separation of commercial banks from investment banks, we are doomed to repeat the events of 2008, no matter now well intentioned and even how well written the thousands of pages of regulations drafted in an effort to avoid this basic truth. If brokerage houses wish to cook up a witches brew of financial instruments, leveraged bets, derivative trades, mutual funds, credit default swaps, and hedges, they should be free to do so. They should not however be permitted to do so using the deposits and ordinary loans of individuals and small businesses. The recent debacle at JP Morgan illustrates the inherent inability of the investment and finance sector to refrain from engaging in extraordinarily dangerous activities. Obama himself admitted that had a smaller less solvent institution engaged in similar behavior, the government may have had to step in–”You could have a bank that isn’t as strong, isn’t as profitable making those same bets and we might have had to step in. That’s exactly why Wall Street reform’s so important.”
Unfortunately the reform he backed did nothing–and will do nothing–to prevent the government from having to step in when, not if, his scenario plays out. However, if the brokerage or investment house is completely separate from the bank–not a subsidiary or affiliated entity–it can be allowed to rise and fall without intervention. After all, as Obama points out but does not for one second believe, these titans of finance are brilliant minds who are certainly capable of generating trillions of dollars employing their creativity exclusive of making use of our savings and mortgage notes as collateral. Certainly a failure of a large investment house would cause a minor crash in the economy, but the government would not be forced to step in because depositors’ funds would not be placed in harms way. The government would not be held hostage by the financial sector under threat that it will refuse to make loans to individuals and small businesses, because it will no longer be in the business of doing so.
Just one week ago Jamie Dimon called the concerns of those like Paul Volcker who believe that too-big-to-fail banks continue to present a threat to the economy and to the proper functioning of basic financial transactions “infantile and nonfactual.” When I was a child I would often attempt to push my mother over the edge by callously and purposefully engaging in the very behavior she had just admonished me against. I would then be subjected to a lengthy lecture on the childishness of my actions, followed by severe punishment. It was not until several years later that I realized how utterly pubescent my behavior had been. The banking sector and its stockpile of Harvard and Wharton graduates on the other hand, not four years removed from the worst financial collapse since the Great Depression, could not help itself but to sneak into the backyard and play with matches after it had just burned down the family home. In their case a timeout will not do, they need to be completely separated from the rest of us, for everyones’ safety. No separation – no peace.