Normally, government should not concern itself with a business’
operations, but when taxpayer money and the public welfare are at
risk, it has a responsibility to investigate. That was the premise
of Senate Banking Committee Ranking Member Richard Shelby’s
(R-Ala.) opening remarks during a recent hearing where JPMorgan
Chase Chairman and CEO Jamie Dimon answered questions about
trading losses totaling over $2 billion sustained by his firm
late this spring.
As Shelby noted, Congress was concerned that the incident may
illustrate a threat to the financial system and to the economy as a
whole. Multiple federal agencies, including the FBI, are
investigating. And many commentators have been
pointing to the losses as evidence that more financial industry
regulation is needed.
However, before they rush to impose more rules, lawmakers need
to consider three key questions. Was this a case of systemic risk?
Were taxpayers at risk? Does this episode indicate a market failure
or illustrate a need for greater regulation? The answer to all of
these questions turns out to be “No.”
As Dimon explained in his opening statement, JPMorgan Chase had
created a small division within its Chief Investment Office (CIO),
to manage risk and guard against a possible “systemic event”—such
as a bank failure—by overseeing a “synthetic credit portfolio” of
derivatives.
However, as Shelby noted, at least some employees within this
division had multiple conflicting mandates, to use trades to not
only manage risk but also turn a profit, which they referred to as,
“the icing on the cake.” In short, changes in risk modeling and a
lack of managerial oversight along with human error put the
division in a bad position.
JPMorgan Chase appears to have reacted the best way it could. As
trading losses mounted, Dimon chose to publicly disclose the
episode on May 10. At the hearing, Dimon said that even with the
losses fully accounted for, JPMorgan Chase expects to report
billions of dollars in earning for the second quarter 2012. He also
noted that the firm has replaced the leadership of the CIO,
comprehensively reviewed risk management procedures, and
implemented revisions universally. Its Board is currently
conducting an independent investigation as well.
JPMorgan Chase’s enormous size—it loaned well over $1.5 trillion
to businesses and entrepreneurs in 2011—helped it weather this
storm. The losses were easily absorbed by cash reserves and did not
affect the many other areas of its business. There was never any
possibility the Federal Deposit Insurance Corporation would need to
step in, never mind require a taxpayer bailout. Likewise, no
systemic risk was posed. The bank sustained the hit as well as any
organization could be expected to.
The decline of the firm’s stock price reflects concern about
managerial judgment and procedures, not its diversified, rather
conventional business model. That the bank lost money is a sign
that market discipline still holds some relevance in the
post-meltdown, bailout-era financial sector. We have a profit
and loss system, as Milton Friedman always emphasized.
This was a big deal to JPMorgan Chase, obviously, but it should
not be the concern of the government. The most troubling aspect of
the hearing was the detailed, technical nature of the frankly
unqualified Senators’ questions about the firm’s practices, Dimon’s
knowledge and decision-making processes, the intricacies of
structured finance, and the operations of the CIO. Micromanaging
any industry, never mind financial services, creates uncertainty
that impairs its basic functioning. And in any case, lawmakers’
should not be trying to read CEOs’ minds.
Jamie Dimon and his team have already managed, analyzed, learned
from, and moved beyond their business’ private crisis. That process
was well underway before anyone outside the company knew what was
happening. The Senate, the regulatory agencies, the FBI, and
government in general are behind the curve. All they can do at this
point is unnecessarily interfere.
