Does JPMorgan's Multi-Billion-Dollar Trading Loss Justify More Regulation?

JPMorgan Chase recently announced that its London office suffered a $2-billion trading loss from a flawed hedging strategy, with the losses expected to get worse.  In a conference call, CEO Jamie Dimon said, "The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought. ... There were many errors, sloppiness and bad judgment."

This trading debacle has led to frantic, knee-jerk calls for more regulation.  AFL-CIO President Richard Trumka says that JPMorgan's trading loss shows "that financial regulation is more needed now than it ever was."  According to Representative Barney Frank (D-Massachusetts), "[w]hen a supposedly responsible, well-run organization could make such an enormous mistake with derivatives, that really blows up the argument, 'Oh, leave us alone, we don't need you to regulate us.'"  And Paul Krugman argues that "we've just seen an abject demonstration of why Wall Street does, in fact, need to be regulated."

So JPMorgan Chase loses billions of dollars from a flawed hedging strategy; therefore, we need more regulation?  Sorry, but I do not see the connection.

JPMorgan lost its own money.  No depositors lost money, and taxpayers are not on the hook for the loss.  The only people hurt by this are JP Morgan's investors: its stock was down almost 10 percent the day after the announcement, and its credit rating was downgraded.

What is the problem here?  A company made a bad decision, and it suffered the consequences.  That is how business is supposed to work.  (If JP Morgan, however, misled its shareholders -- and it is unclear if they did -- that may justify a class action lawsuit.)

JPMorgan has previously criticized parts of the 2010 Dodd-Frank financial reform bill, claiming that the new regulations would cost the bank $400 million to $600 million.  Frank points out that "JP Morgan Chase -- entirely without any help from the government -- has lost in this one set of transactions five times the amount they claim financial regulation is costing them."  Are we to believe that because JP Morgan lost money on a bad trade, that means they should not mind losing an additional $400 million to $600 million due to Dodd-Frank?

One part of the Dodd-Frank bill that won't go into effect until 2014 is the so-called "Volcker rule," named after former Federal Reserve chairman Paul Volcker.  The Volcker rule will prohibit banks from making proprietary trades -- that is, trades with their own money for their own profit.  Senator Jeff Merkley (D-Oregon) says the JP Morgan debacle "is a textbook illustration of why we need a strong Volcker rule firewall."

But why should banks be prohibited from trading for their own profit?  They are in business to make a profit.  Trading is not a crime.  Hedging is not a crime.  Speculating is not a crime.  Trading, hedging, and speculating are the cornerstones of a thriving, liquid market.  These activities should not be prohibited -- for banks or for anyone else.

But many politicians and intellectuals argue that banks are overextending themselves.  Senator Carl Levin (D-Michigan) says JP Morgan's losses are "the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making."  President Obama says, "You could have a bank that isn't as strong, isn't as profitable managing those same bets and we might have had to step in.  That's why Wall Street reform is so important."  And Krugman argues, "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."

Taxpayer guarantees, however, along with bailouts are precisely what encourage such risky behavior.  If big banks know the government will bail them out if they fail, why not roll the dice?

Levin adds, "If they get away with this kind of bet, then we're going to be right back in the soup again.  We're going to end up either facing economic disaster, a depression, or having to bail out banks again."

The idea that we had to bail out the banks in 2008 or that we will "have to" bail out banks again is precisely the problem.  We do not have to -- nor should we.  Banks should be free to trade, hedge, and speculate -- and if they take too much risk and fail, then let them fail. 

We do not need more regulation, and we do not need to prohibit banks from proprietary trading.  What we need to prohibit are taxpayer guarantees and taxpayer-financed bailouts.

Michael Dahlen is a freelance writer. His articles have appeared in Skeptic, Liberty, and The Objective Standard. His web site is www.capitalism-vs-biggovernment.net

JPMorgan Chase recently announced that its London office suffered a $2-billion trading loss from a flawed hedging strategy, with the losses expected to get worse.  In a conference call, CEO Jamie Dimon said, "The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought. ... There were many errors, sloppiness and bad judgment."

This trading debacle has led to frantic, knee-jerk calls for more regulation.  AFL-CIO President Richard Trumka says that JPMorgan's trading loss shows "that financial regulation is more needed now than it ever was."  According to Representative Barney Frank (D-Massachusetts), "[w]hen a supposedly responsible, well-run organization could make such an enormous mistake with derivatives, that really blows up the argument, 'Oh, leave us alone, we don't need you to regulate us.'"  And Paul Krugman argues that "we've just seen an abject demonstration of why Wall Street does, in fact, need to be regulated."

So JPMorgan Chase loses billions of dollars from a flawed hedging strategy; therefore, we need more regulation?  Sorry, but I do not see the connection.

JPMorgan lost its own money.  No depositors lost money, and taxpayers are not on the hook for the loss.  The only people hurt by this are JP Morgan's investors: its stock was down almost 10 percent the day after the announcement, and its credit rating was downgraded.

What is the problem here?  A company made a bad decision, and it suffered the consequences.  That is how business is supposed to work.  (If JP Morgan, however, misled its shareholders -- and it is unclear if they did -- that may justify a class action lawsuit.)

JPMorgan has previously criticized parts of the 2010 Dodd-Frank financial reform bill, claiming that the new regulations would cost the bank $400 million to $600 million.  Frank points out that "JP Morgan Chase -- entirely without any help from the government -- has lost in this one set of transactions five times the amount they claim financial regulation is costing them."  Are we to believe that because JP Morgan lost money on a bad trade, that means they should not mind losing an additional $400 million to $600 million due to Dodd-Frank?

One part of the Dodd-Frank bill that won't go into effect until 2014 is the so-called "Volcker rule," named after former Federal Reserve chairman Paul Volcker.  The Volcker rule will prohibit banks from making proprietary trades -- that is, trades with their own money for their own profit.  Senator Jeff Merkley (D-Oregon) says the JP Morgan debacle "is a textbook illustration of why we need a strong Volcker rule firewall."

But why should banks be prohibited from trading for their own profit?  They are in business to make a profit.  Trading is not a crime.  Hedging is not a crime.  Speculating is not a crime.  Trading, hedging, and speculating are the cornerstones of a thriving, liquid market.  These activities should not be prohibited -- for banks or for anyone else.

But many politicians and intellectuals argue that banks are overextending themselves.  Senator Carl Levin (D-Michigan) says JP Morgan's losses are "the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making."  President Obama says, "You could have a bank that isn't as strong, isn't as profitable managing those same bets and we might have had to step in.  That's why Wall Street reform is so important."  And Krugman argues, "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."

Taxpayer guarantees, however, along with bailouts are precisely what encourage such risky behavior.  If big banks know the government will bail them out if they fail, why not roll the dice?

Levin adds, "If they get away with this kind of bet, then we're going to be right back in the soup again.  We're going to end up either facing economic disaster, a depression, or having to bail out banks again."

The idea that we had to bail out the banks in 2008 or that we will "have to" bail out banks again is precisely the problem.  We do not have to -- nor should we.  Banks should be free to trade, hedge, and speculate -- and if they take too much risk and fail, then let them fail. 

We do not need more regulation, and we do not need to prohibit banks from proprietary trading.  What we need to prohibit are taxpayer guarantees and taxpayer-financed bailouts.

Michael Dahlen is a freelance writer. His articles have appeared in Skeptic, Liberty, and The Objective Standard. His web site is www.capitalism-vs-biggovernment.net

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