By now many of us have learned of JPMorgan Chase’s $100 billion derivatives bet that has turned into a $3 billion and counting loss. Proving that Wall Street banks are still acting like gambling casinos, JPMorgan bet 15 percent of its balance sheet on risky credit default swap contracts tied to corporate bonds (“What JP Morgan Chase Forgot About 2008,” by Robert Lenzer, Forbes).
JPMorgan’s trades appear to have violated the so-called “Volcker Rule.” The Volcker Rule greatly restricts proprietary trading by federally insured institutions. JPMorgan will probably argue that it was simply engaged in “hedging” activity, an essentially defensive strategy, not trading activity. That is how the big Wall Street banks have planned to circumvent the Volcker Rule (See “JPMorgan’s soap opera makes it clear that Wall Street is detached from reality,” Steven Pearlstein, Washington Post).
According to Pearlstein, it shows that Wall Street needs to be put on a short leash, and it raises a number of hard questions, such as:
How could JPMorgan’s risk management models be so flawed as to allow such a position to exist for so long. (The main culprit had enough of a track record in making outsized, risky bets to be dubbed as the “London whale.”)
Why did Jamie Dimon dismiss press warnings about the $100 billion position as a “tempest in a teapot?”
How could this happen under the noses of 70 federal regulators, who were then examining JPMorgan’s trading activities and risk management models?
Why do politicians and regulators, when considering how to oversee and regulate Wall Street banks, allow themselves to be lobbied and influenced by those same banks seeking to water down or eliminate the regulations?
What good comes from big banks speculating in credit derivatives markets?
“Why do these markets exist in the first place. What useful social or economic purpose do they serve?”
According to Pearlstein, two Federal Reserve Bank researchers concluded that, contrary to the argument that credit default swaps lower borrowing costs: “We find no evidence that the onset of [credit default swap] trading affects the cost of debt financing for the average borrower.”
Why should we care? Matt Taibbi’s answer to that is: “because J.P. Morgan Chase is a federally-insured depository institution that has been and will continue to be the recipient of massive amounts of public assistance. If the bank fails, someone will reach into your pocket to pay for the cleanup. So when they gamble like drunken sailors, it’s everyone’s problem.” (“Jamie’s Cryin: Dimon, J.P. Morgan Chase Lose $2 Billion,” by Matt Taibbi, Rolling Stone).
This episode confirms the extensive risk our whole economy is exposed to as a result of Wall Street’s gunslinger mentality. Absent effective regulation and enforcement, expect more of these episodes in the future.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.