Originally published in the Financial Times
Let’s stipulate that the $2bn trading loss at JPMorgan resulted from a strategy that was, in the words of chief executive Jamie Dimon “flawed, complex, poorly reviewed, poorly executed and poorly monitored”.
Mr. Dimon (full disclosure: a friend of mine) was wise to flog himself before he could be flogged by others, even though his self-flagellation is unlikely to halt the broad and well-founded criticism of the bank’s failed risk management.
But as the piling on continues, we should devote at least equal time to making this a “learnable” moment. In that spirit, here’s what I think I’ve learned:
First, as best can be discerned, the loss was incurred not in the pursuit of hedging but in pursuit of risk. Specifically, in the credit default index positions that were ultimately responsible for the loss, the bank was apparently not buying insurance against risky loans that it had made; it was providing insurance to others.
If ultimately confirmed, such a strategy would likely be deemed a violation of the pending Volcker rule prohibiting naked bets with a bank’s capital and a reminder that as difficult as implementing the rule has proven to be, limitations on how depositors’ money is used are necessary and prudent.
Second, while JPM doubtless has legitimate business reasons for refusing to make public the details of its misstep (its massive positions still need to be unwound), as a quasi-public institution, it needs to be as transparent as possible as quickly as possible. We need to make the most of this learnable moment.
Third, we shouldn’t forget that in the vast magnitude of the global financial system, this was small beer. For one thing, offsetting the $2bn loss (which Mr Dimon acknowledged could eventually be more) was at least $1bn of profits from other, similar activities.
More importantly, even at $2bn, the loss represents only about 20 per cent of JPM’s pre-tax profit in the first quarter of 2012 alone and a bit more than 1 per cent of its equity market value.
So this loss never endangered JPM or its depositors, let alone any other banks or financial institutions. We need to accept without panicking that a bank –particularly one as large and as well capitalised as JPM – may from time to time lose $2bn in a non-systemic misstep. Far more was lost by banks from old-fashioned corporate loans turning sour during each of the last two recessions. Banking has always involved risks and always will.
Fourth, to those who say Wall Street never pays for its mistakes, please take note of JPM’s shareholders (many of them employees), who saw $14bn lopped off the value of their holdings in Friday’s trading.
Meanwhile, the executive in charge of the botched operation and two of her colleagues are expected to resign Monday. Knowing Mr. Dimon, I wouldn’t be surprised if further departures follow.
Finally – and perhaps most consequentially – we need to be careful about how this event affects the remaining steps in the implementation of Dodd-Frank and other post-crisis regulatory measures.
With the takedown (at least temporarily) of Mr Dimon’s outsized reputation, Wall Street’s last credible voice against excessive regulation has now been effectively silenced.
But that should not mean that foes of banks be allowed to rampage untrammeled. For example, eliminating any ability of banks to hedge would substantially impede their ability to undertake prudent risk management and would therefore have the paradoxical effect of either increasing the possibility of unexpected losses or reducing the banks’ willingness to lend or both.
In taking down JPM’s equity value by vastly more than its projected losses from its bad bet and those of other banks by smaller amounts, the market is clearly concerned that Washington will mete out a severe punishment indeed to Wall Street.
By all means, pile on Mr Dimon, who will likely be harder on himself over such a big misstep than most of his critics. But at the same time, let’s keep calm and carry on, because to react too violently in a way that damages the most important capital market in the world could be as costly as the reverse.