On Meet the Press yesterday, JPMorgan Chase chief Jamie Dimon epitomized what’s wrong with America’s approach to the financial crisis. The American media and political elite remain obsessed with personalities, looking for heroes and villains instead of focusing on what we really need: the dispassionate rule of law that would allow free markets to flourish. Meet the Press is for politicians, and Dimon performed like a model one. He spoke in short sentences and apologized directly: “I was dead wrong,” he offered, for having made a “terrible, egregious mistake.” Specifically, last Thursday, JPMorgan announced a $2 billion trading loss on a derivatives bet.
Theoretically, anyway, such a loss should be a matter between the bank and investors, not TV fodder. Yet Dimon’s business—too-big-to-fail banking—is no ordinary business. Washington’s willingness to subsidize failure means that Dimon’s job is as much political risk management as financial risk management. Because JPMorgan depends on Uncle Sam’s backing, one of Dimon’s key constituencies is politicians and government regulators. And one way to charm regulators—and the voters who elect the politicians—is through a killer interview.
In October 2008, the Bush administration, not normally a fan of government expropriation, forced nine big banks, including Dimon’s, to accept $125 billion in TARP money. The banks were deemed so important that they had to take the money to protect them against failure, whether they wanted it or not. Since then, the banks and the government have stayed bound together. President Obama’s Dodd-Frank financial reform law, enacted two summers ago, has tied the two sides closer still. The problems that led to the financial crisis, remember, included investors’ perception—honed over two decades of smaller-scale bailouts—that big banks were too big to fail. Dodd-Frank has given such banks an official title: “systemically important financial institutions.”
Another problem that led to the financial crisis was that, over the years, politicians and regulators determined that banks had become so good at risk management that they no longer needed to abide by consistent rules—fixed limits on borrowing, for example, so that banks could fail without leaving behind so much unpaid debt that they endangered the economy. Instead, banks could largely do what their executives wanted, as long as regulators believed, on a case-by-case basis, that they knew what they were doing.
In the aftermath of the JPMorgan mess, politicians and reporters have been invoking the Dodd-Frank law’s “Volcker Rule.” Named after Paul Volcker, the Federal Reserve chairman from the Carter and Reagan eras, the rule prohibits banks whose customers benefit from taxpayer-backed deposit insurance from engaging in “proprietary trading,” or speculation. But the Volcker Rule isn’t a rule at all: it prohibits behavior that has no set definition. Twenty-two months after Dodd-Frank became law, regulators have delayed enforcing the rule because they still cannot figure out what proprietary trading really is. Consider how JPMorgan lost all that money: creating derivatives that let it sell billions of dollars’ worth of protection against the risk that some corporate securities would default. That sure doesn’t sound like a good idea. Banks, because they’re lenders, are already at risk if people and companies default in droves.
But does selling such synthetic “insurance” constitute proprietary trading? Michigan Senator Carl Levin, who helped draft the Volcker Rule language, says it does. Bank officials have argued that such behavior is hedging, which would be okay under Dodd-Frank.
Real rules could govern Wall Street, but politicians must give regulators the backing to create and enforce them. Rather than worry about the Volcker Rule, politicians and reporters should be focusing on derivatives rules. One reason that Washington had to bail out the financial system four years ago was that financial firms such as AIG had taken on virtually infinite risk through the derivatives markets. Through derivatives, AIG could “sell” protection against other companies’ defaults with almost no cash down. Lo and behold, that’s what JPMorgan Chase was doing, too. Regulators should demand that traders—whether big banks or tiny hedge funds—put a set amount of cash down behind such bets, curtailing the amount of potential unpaid debt in the financial system. Regulators should also require that traders execute such transactions on open clearinghouses and exchanges—so that markets can determine which bets are going well and which aren’t, and clearinghouses can demand more money from traders to cover their losses. Such rules empower market signals, not regulatory micromanagement, to control risk. If such rules were in place, it’s unlikely Dimon would have visited the White House 18 times in three years, as he would have had no way to manipulate a restriction that, after all, applied to everyone.
The best way to stop bailouts is to limit borrowing and demand transparency. When markets know that financial firms have put a cash cushion behind their bets—and where the risk behind such bets lies—they’re unlikely to pull their money out of the financial system en masse, necessitating a government rescue. The Volcker Rule, by contrast, adds no such protection against future taxpayer rescues; all it does is unleash regulators to debate, in private, the definitions of risk.
Dodd-Frank gave regulators the authority to impose real rules on derivatives, and the regulators have done so. But lobbyists demanded and secured exceptions, which could eventually prove the rule. With such loophole-ridden reform, America has hardly set a good example for Europe, which lags even further behind in enacting derivatives rules. In fact, JPMorgan Chase may have executed the derivatives deals from London because the bank perceived London as a looser environment. Moving this activity around the world so that financiers can play inconsistent rules against one another does nothing to help the struggling Western economies.
The media and the politicians, however, would rather discuss people than arcane issues like financial rules. Look at how politely—almost obsequiously—NBC’s David Gregory treated Dimon. Gregory asked Dimon: “Here you are, Jamie Dimon, you’ve got a sterling reputation. . . . How does a guy like you make this mistake? If this happened at JPMorgan Chase . . . what about all the other banks out there? If somebody else made a mistake like this, would we be again talking about too big to fail and taxpayer bailouts?” Then, when asking delicate questions about potential criminal liability, Gregory unconsciously switched from “you” to “the bank.” Lowly regulators will hardly be more willing to take on Dimon and his colleagues.
Focusing on one man represents bailout thinking. Policymakers continue to be distracted from the rules needed to protect the economy from the consequences—including corporate failure—of the bad decisions that individuals can make. Nearly four years after the financial crisis began, Washington seems to have learned almost nothing.