Oops! Lost another couple of billion from “Safe” derivatives — JP Morgan

Jamie Dimon, head of JP Morgan, had a difficult to admission to make.  Give him credit for not sugar coating or hiding it.  The risk mitigation unit of JP Morgan — the group trying to make safe bets to counter the risks taken in other, more active profit-seeking sectors of the bank — had just lost $2 billion in the last five weeks on hedging derivatives.  In what Dimon called “errors, sloppiness, and bad judgement,” the hedging bets went awry.   This is just to remind us, as debate continues on the Volker Rule limiting banks’ risk-taking, that bankers are only human and would benefit from what are in effect rules of the road to provide stop signals and speed limits on their driving.  The idea that just because banks seek profits they will always make the right, rational decisions and are perfectly capabale of managing their own risks without regulation?  Oh yes, that is what brought us the market collapse and great recession we’re in; and apparently the madness has not yet stopped.

Not to blame Morgan — in a market where profit is king and there are no rules beyond what banks place on themselves, there will always be traders tempted to push the envelope.  The only thing limiting risks or preventing excess losses would be barriers to trading or capital cushions that are not yet in place.

Let’s not fool ourselves that any rules will be a perfect solution — traders will always be looking for new instruments and methods to increase their profits.  But at least we should start with the presumption that certain rules for the safety of bankers and their clients are in everyone’s interests, and we need to find sensible bargains on rules.  Without that presumption — if the starting point is that no rules at all are best — we will swing from one extreme to the other, from inadequate regulation that leads to crises to over-reactions that burden companies with too much regulation and red tape.

We are in that over-reaction phase now, with Sarbanes-Oxley (in reaction to Enron’s fraud and collapse) and the Volker rule (in reaction to the Lehman collapse) burdening or threatening corporate action.  Yet the reaction of the business community has been to push all the way back to the “no regulation is best” and decry “job-killing regulations.”   Actually, it is the absence of regulation that is job-killing in the same manner that running an Indy 500 with no rules or caution flags, or a championship football match with no referees, would lead to efforts to win that result in people being killed — or in financial markets, in major companies going bust.

Cass Sunstein of the Obama administration is an advocate of smart regulations that nudge people in a beneficial direction without constraining their choices.  Let’s focus on getting the balance of regulation right– no regulation is not better than reasonable regulation;  unless you like watching billions of your and investors dollars drop down the drain every time someone shows a bit of “sloppiness” in their work.

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About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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