Thanks to disastrous trades made by "the London Whale," JPMorgan lost more than $2-billion (U.S.) and, for a brief, shining moment, CEO Jamie Dimon lost his customary brash arrogance. In a performance worthy of a shamed Japanese executive, he apologized profusely.
Mr. Dimon's theatrics were, of course, designed to ward off regulations – known as the Volcker Rule – that would ban banks from making speculative trades using funds plucked from insured depositors' accounts. A ban on proprietary trading, as it is called, would ensure that the taxpayer would not be left on the hook for trades gone so wrong that they would wreck the bank.
To be fair to Mr. Dimon (even though it is fashionable not to be fair to any banker), a $2-billion-plus loss is pocket change for a bank of JPMorgan's size and ample capital base. If anything it showed that JPMorgan's risk management was better than average. The trading loss reduced the bank's capital cushion from 8.4 per cent of risk-weighted assets to 8.2 per cent (under the new Basel III rules). No big deal.
But that's not the point. The point is that when you play in the great derivatives casino, the loss could have been of bank-busting proportions. Could JPMorgan have survived a $20-billion loss? Maybe, but maybe not. The gruesome strings of bank collapses, bailouts and nationalizations since 2008 show you that banks can fail when they get on the wrong side of big trades and investments.
In spite of Mr. Dimon's apologies and pleadings, the loss is not just an argument in favour of the Volcker Rule; it is an argument to roll back the clock to the Glass-Steagall era, when commercial banking (taking deposits and making loans to companies) was separated from investment banking (selling securities and providing liquidity by making markets for those securities).
Glass-Steagall came into effect in 1933, during the dark days of the Depression, and wasn't fully dismantled until the Bill Clinton administration in the late 1990s. By then, the bank lobbyists had finally convinced the White House and Congress that allowing banks and investment banks to act as one was essential for market efficiency and American banking supremacy and was no more risky than crossing the street on a green light.
We all know what happened next. Trades done by the investment banks went from legitimate hedging, that is, protection from losses, to rank speculation, that is, hunting for instant blockbuster profits. It worked a lot of the time, allegedly justifying banker bonuses the size of sub-Saharan nations' GDP.
But sometimes it didn't work and banks, or parts thereof, blew up when some hotshot went into a panic and doubled up on his bets in a desperate (and usually hidden) attempt to overcome losses. Jérôme Kerveil of Société Générale and Kweku Adoboli of UBS come to mind.
JPMorgan's disaster no doubt will put some momentum behind the Volcker Rule. But the rule is already an incomprehensible, loophole-ridden mess running some 300 pages and regulators are still struggling to figure out the difference between hedging and gambling (the rule would allow the former, not the latter). A fine balancing act is required. If the regulations are too tight, the banking activities that are essential to lubricating the economy will shut down; too loose and every bank would come equipped with a built-in grenade.
So why not go back to Glass-Steagall? It worked for decades. If it were to return, banks would take deposits and turn them into loans. The system presumably would not prevent the banks from allowing investment banks to bundle those loans into securities. The investment banks would do what investment banks should do, which is to make markets and trade using their own capital.
While we're at it, why shouldn't investment banks revert to private partnerships? In the good old days, some investment banks, such as Goldman Sachs, were partner-owned affairs, much like law firms. When their own bucks were on the line, they naturally avoided excessive risks.
Then Wall Street decided that playing with public shareholders' money was much more fun and in came the initial public offerings. Since stock market companies are under enormous pressure to make fat returns for shareholders, a culture of high-risk betting came into vogue. That created enormous profits at times, but also enormous losses. Just ask JPMorgan investors, who have seen their shares drop to about $34 from $40 since the London Whale's bets turned toxic.
Will either the Volcker Rule, as it was originally intended, or a new Glass-Steagall get implemented?
Don't count on it, for the simple reason that drafting legislation in the United States is now corrupted by the 2010 Supreme Court decision to allow special interest groups to spend without restrictions in federal elections.
This has allowed big business, from oil companies to banks, to contribute as much as they want to whom they want. Watch any candidate opposed to the Volcker Rule or a potential Son-of-Glass-Steagall get flooded with riches. Favours, of course, would be repaid accordingly.