What JPMorgan $2B Loss Means

Since last Thursday heads have rolled at JPMorgan in the wake of a $2 billion investment loss. Biggest head among them is highly regarded 30-year veteran Ina Drew, JPMorgan’s Chief Investment Officer (CIO).

At the surface a 2% loss on a bad investment seems innocent enough. Its recoverable without threatening insolvency for a bank like JPMorgan.

But the frightening reality is it exposes a systemic problem that still persists within the financial system that could easily trigger a repeat of the Great Recession of 2008.

The Glass-Steagall Connection

The reason JPMorgan was able to make the speculative investment that led to a $2 billion loss is because the portion of the Glass-Steagall Act of 1933 that made such investments illegal was repealed in 1999 under President Bill Clinton.

The Great Depression of the 1930s was caused by banks making speculative investments with depositor funds. When highly speculative deals went sour the banks lost their depositor’s money. That led to the stock market crash of 1929, then to runs on banks, then bank closures and finally the Great Depression.

Among many other good things, Glass-Steagall made it illegal for banks to be in the investment business and it protected depositor funds by creating the FDIC.

After 1999, however, banks once again could gamble in the stock market. It took them just 8 years to create the 2nd largest economic crisis in U.S. history by making speculative investments in home mortgages.

The Great Dodd-Frank Failure

The other reason JPMorgan was able to make the speculative investment that led to a $2 billion loss is because the Dodd-Frank Wall Street Reform Act of 2010 that was touted to fix the root cause of the Great Recession didn’t fix it.

Dodd-Frank made mostly peripheral changes to convey the appearance the problem had been fixed. Among the most important, it created a bailout fund that banks must pay into to foot the cost of future systemic failures.

It’s sorta like a super FDIC for banks that uses bank money instead taxpayer money to pay for the bailouts. In 2008 taxpayers funded the bailouts with TARP. Fortunately, that has since been recovered.

It had some eye candy consumer protections included to make it look good to voters during the middle of the 2010 election cycle. It was signed into law by President Obama on July 21, 2010.

The reason Dodd-Frank didn’t have real teeth is that it’s primary authors  (Tim Geither, Lawrence Summers, Barney Frank, Chris Dodd) had a vested interest in covering up their own culpability in causing the Great Recession. An explanation is beyond the scope of this article, but it was roughly like having the wolves protect the hen house (the hens being bank depositors and taxpayers).

The Volker Rule Won’t Cut It

Paul Volker

Much ado has been made in the news that the Volker Rule will really fix the problem when it is fully implemented in two years. It is part of Dodd-Frank.

The bottom line, though, is that the Volker Rule still allows speculative investments by banks. It will only implement a series of murky government oversight rules to limit risky bank investments.

It is a far, far cry from reinstating Glass-Steagall.

A surprisingly lucid article about the Volker Rule appeared in the Huffington Post just after the public comment period on it ended:
The Volker Rule: Return to Sender
– Robert Kuttner, Huffington Post, 2/26/2012

Conclusions

JPMorgan’s $2 billion speculative investment loss is a gaping wound that clearly reveals that the root cause of the Great Recession of 2008 still exists.

A further complication is that JPMorgan’s speculative investments didn’t happen in the United States. They were made in London. That leaves open the unanswered question whether or not those investments can be regulated under U.S. law.

That aside, it was a mistake to repeal the speculative investment portion of Glass-Steagall in 1999 and Dodd-Frank, with its convoluted Rube Goldberg Volker Rule, doesn’t fix it.

Until the simple, straightforward rule from Glass-Steagall is reinstated, the United States will remain in danger of a repeat of 2008.

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About azleader

Learning to see life more clearly... one image at a time!

Posted on May 14, 2012, in Business, culture, economics, Life, National, news, Opinion, Politics, TARP, Thoughts. Bookmark the permalink. 6 Comments.

  1. You insult Mr. Rube Goldberg. 😉

  2. You should dig deeper on the Dodd-Frank legislation that still allows a commercial bank to speculate, I mean, hedge. The Obama administration waived its implementation for another two years, even though the legislation said Dodd Frank was to take place in July 2012. Today, Obama is in NY City doing a fund raiser at Black Rock, a major investment Wall Street firm. Wall Street has bought off both parties. I agree–reimpose Glass Steagal immediately.

    • Yeah… yeah… that’s right… hedge, not speculate. lol!!!

      I’m not exactly sure all the specific Dodd-Frank oversight rules have been completely finished yet and don’t even know where to look for them. The Act itself is vague on a lot of details.

      It is VERY interesting that Obama is doing a Blackrock fundraiser. Blackrock could be the most important financial institution in the United States that nobody has ever heard of. It played a huge roll saving the U.S. economy during the credit crunch of 2008.

      Blackrock’s CEO was on Fareed Zakaria’s show GPS – the Global Public Square on Sunday. On it he said he is supporting Obama for President.

      Isn’t that special? 😉

  3. Excellent article. I think that you brought up many good points. The one that stuck with me the most is that many of the investments made in this case were made in London and therefore could be outside of US regulation.

    One of the biggest reasons that the banks cited -in the late 90s- for the repeal of Glass-Steagall, was that they were losing market share to less regulated banks in other countries.

    I think that there are two lessons here. One: the market needs regulation to be healthy. 2. In an increasingly globalized world, there needs to be an international regulating/ governing institution to ensure that the playing field is level for all countries and banks. Without Glass-Steagall the US will remain in danger of a repeat of 2008. However, to be truely effective the implementation of the act may need to be international.

    • I saw in the Financial Times this morning they specifically said the questionable transactions occurred specifically through London trades and not directly through the NYSE. If that be true then it seems doubtful to me that the trades could be under U.S. jurisdiction.

      That supports your suggestion the world might need a sorta international Glass-Steagall provision.

      The deals were done by a guy named Bruno Iksil… known as “The London Whale”. In poker circles a rich, easy mark who loses a lot gambling is also known as a whale. 😉

      In the NYT today they implied JPMorgan was free wheeling by increasing its risky investments from $76B to $356B since 2007. But I think they picked up most of that from their forced acquisition of Washington Mutual which went insolvent over that stuff.

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