JPMorgan Chase’s $2 billion loss on a derivatives bet gone bad says one thing clearly: Paul Volcker isn’t so dumb after all.
JPMorgan Chief Executive Officer Jamie Dimon went out on a limb in saying that he knew more about financial markets than Volcker, the former Federal Reserve chairman who championed the rule restricting banks’ trading risks.
“Paul Volcker by his own admission has said he doesn’t understand capital markets,” Dimon told Fox Business earlier this year. “He has proven that to me.”
Now it’s Dimon who looks like he doesn’t understand capital markets. Bloomberg News is reporting today that the loss occurred after traders in the London-based chief investment office changed a key betting strategy. Dimon wasn’t immediately told about their shift in strategy and didn’t know the magnitude of the losses until after the company reported earnings April 13, an executive told Bloomberg.
That’s how capital markets work. Traders win enormous fortunes if they bet right, and they aren’t forced to pay back their salaries and bonuses if the bets go bad. So when they see opportunities, they seize them. They don’t always wait for clearance from the top, especially if they think risk managers will try to stop them.
Making matters even worse for Dimon, he initially dismissed the problems in London as “a complete tempest in a teapot” after they were revealed by Bloomberg News in April. It’s one thing to miss a problem; it’s much worse to continue missing it after it has been brought to the public’s attention.
Having bragged that JPMorgan had controls in place to prevent this sort of thing, Dimon is left having to concede that it didn’t after all. He had no choice but to admit that the bank had “egg on its face” and to acknowledge that the episode “plays right into the hands of a whole bunch of pundits out there.”
Yet after all that, Dimon hasn’t budged in his opposition to the Volcker Rule.
Dimon is right about one thing: The Volcker Rule in the Dodd-Frank Act is unwieldy because it is devilishly difficult to determine whether a trade violates it or not. The objective is to restrict banks’ trading except for carrying out customers’ orders or hedging—that is, reducing risk by putting on one trade to offset another. (There are some exceptions.) Dimon complained to CNBC earlier this year: “If you want to be trading, you have to have a lawyer and a psychiatrist sitting next to you determining what was your intent every time you did something.”
But the need for a risk-reducing rule something like the Volcker Rule is obvious. Banks have a special obligation to avoid risk because their failure can drag down the entire economy. JPMorgan is able to borrow cheaply because lenders understand that the federal government will not let it default. In fact, it has been officially declared “too big to fail.” In return for the trampoline of taxpayer dollars—once implicit, now explicit—JPMorgan and other too-big-to-fail banks have no choice but to accept some constraints on their freedom of action. Even if that means smaller bonuses for high-flying traders and their (sometimes) out-of-touch bosses in the corner office.