US lawmakers have renewed calls for federal agencies to toughen up on financial regulation after revelations JP Morgan lost US$2 billion on a bad bet.
Previously a leading voice in the finance industry’s push for looser financial regulation, JP Morgan’s loss reportedly stemmed from dealings within the firm’s ‘Chief Investment Office’, where London-based trader Bruno Michel Iksil took a risky position in the credit derivatives market.
While the department is reportedly supposed to manages house exposures, it is believed rather than just hedge, JP Morgan’s CIO regularly took views on the markets and engaged in activities similar to a prop trading desk.
Until the revelation, JP Morgan had been seen as one of the more stable and responsible survivors of the global financial crisis, and chief executive Jamie Dimon had been a harsh critic of the Dodd-Frank Act and other reforms to the financial system. But many now believe any high moral ground JP Morgan may have had has crumbled.
“The strategy we had was badly vetted. It was badly monitored. It should never have happened,” Dimon said of the US$2 billion loss in an interview on NBC on Sunday. “This is a very unfortunate and inopportune time to have had this kind of mistake. We hurt ourselves and our credibility. We’ve got to fully expect and pay the price for that.”
It is not yet understood whether regulatory constraints such as the Volcker Rule ban on prop trading or the Basel III increased minimum capital requirements would have protected JP Morgan against the loss, but to many lawmakers, the point is moot.
“The argument that financial institutions do not need the new rules to help them avoid the irresponsible actions that led to the crisis of 2008 is at least US$2 billion harder to make today,” said Congressman Barney Frank, ranking member on the House Financial Services Committee. “This regrettable news from JP Morgan Chase obviously goes counter to the bank’s narrative blaming excessive regulation for the woes of financial institutions. JP Morgan Chase – entirely without any help from the government – has lost in this one set of transactions, five times the amount they claim financial regulation is costing them.”
Too little, too late?
US federal agencies are presently looking towards a 21 July implementation date for Volcker and Basel III is designed to gradually introduce higher capital and liquidity standards over the next decade. But one industry insider who spoke to theTRADEnews.com’s sister site aiCIO said regulation was not adequately dealing with counterparty risk.
“Capital rules have been tightened up, but by the time they come into effect it will be 10 years down the line – this is too long a process, and the banks are resisting all the way,” the head of distribution at a large global custodian told aiCIO.
Elizabeth Warren, a Democratic Senate candidate and the former chair of the Congressional Oversight Panel for TARP – the Troubled Asset Relief Program – has called on Dimon to resign from his position on the New York Federal Reserve’s board of directors.
Warren, a Harvard Law School professor, said the loss showed Wall Street was still taking “risky gambles” of the kind which led to the global financial crisis.
“We need to stop the cycle of bankers taking on risky activities, getting bailed out by the taxpayers, then using their army of lobbyists to water down regulations,” Warren said.
Not so capital rules
Barely a week before JP Morgan’s revelation, the Securities and Exchange Commission, the US securities watchdog, had already indicated long-held concerns over certain risk management rules for brokers.
After five years of silence on proposed amendments to a 1975 regulation, the SEC earlier this month reopened the public comment period for proposed amendments to its net capital rule, which regulates how broker-dealers should meet financial obligations to customers and creditors.
The SEC said amendments would address several areas of concern regarding the financial requirements for broker-dealers and update financial responsibility rules. In 2007, the SEC issued the proposed amendments to tighten the rules but the agency did not act on them. Given “economic events” and “regulatory developments”, the SEC now believes the rules need amending.
In 2004 the rule was changed to allow major brokerages to reduce the amount of money set aside as net capital – in some cases by up to 30%. But some commentators believe this let investment banks increase their leverage, contributing to the 2008 global financial crisis.
At the time of the relaxing of the rules, then-SEC market regulation director Annette Nazareth said Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns – which was acquired by JP Morgan to save it from collapse at the behest of the US government – had expressed keen interest. At the time, Nazareth described the banks as “all very well-capitalised firms”.
But because the amendment to the net capital rules applied to the largest brokerages, SEC Commissioner Harvey Goldschmid warned, “If anything goes wrong, it’s going to be an awfully big mess.”