JP Morgan and regulation
So, does the debacle at JP Morgan mean banks should be more regulated?
In Business Week, Henry Blodgett answers “yes”—because, despite the fact that Morgan’s CEO Dimon is one of the best and smartest of the bunch, the situation has grown so mathematically complex, and the incentives are all in favor of risky investments:
…[T]he gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as “weapons of mass destruction.” And those weapons have gotten a lot more complex in the past few years.
…Wall Street’s incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else””the government or shareholders””covers the downside.
As for the remedies—as Hamlet would say, “Ay, there’s the rub.” We don’t want the cure to be worse than the disease, and the law of unintended consequences is ever in operation.
Blodget suggests the following:
(1) increase banks’ capital requirements
(2) re-institute Glass-Steagall
(3) have a plan for dealing with similar events: “by stepping in, seizing the bank, firing management, zeroing out shareholders, haircutting bondholders, and then injecting new SENIOR capital (fully protected) and re-floating or selling off the firm. This will allow the entity to keep operating, and it will stick the losses where they belong””with the idiots who bought the bank’s stock or loaned it money. Meanwhile, the systemic threat will be eliminated.”
I’ve written about the first point (complexity) years ago, for example here and here. I also wrote about the second suggestion, here. And that’s not because I was so smart, but because it was a very common suggestion at the time.
Nothing was done, and I don’t think it’s because Congress is so stupid or so corrupt, although there’s quite a bit of both around. It’s because of that pesky law of unintended consequences again. There are arguments against restoring Glass-Steagall. And although I happen not to find those arguments all that convincing, many very smart people do, and I don’t know who’s right.
Do you?
I thought Dodd-Frank was going to solve all the problems and prevent such risky behavior going forward. No? Well, what about those beefed up regulatory agencies with on-site ’round the clock monitoring–not so much?
JP Morgan has the financial capacity to absorb this loss and there will be no need for the government to step in to cover it. Nevertheless, the hand-wringers and opportunists are pouncing on a perceived chance to further regulate the industry; despite eighty years of failed, ever-increasing regulation, and repeated financial crises. It’s time for more market discipline and less regulation; starting with the phase out of deposit insurance. But, of course, that will never happen.
From what I can tell all those calling for ‘more regulation’ actually seem to think that the government can craft a regulation (and miraculously enforce it) along the lines of:
“You cannot lose any money”.
Stupid is as stupid does.
chase didn’t lose my money so i don’t give a crap.
and i don’t think the government should give a crap either.
only the shareholders should give a crap.
me and feds do not have a dog on that fight.
the core problem is the fact that the fed is giving banks free money to play with, and this makes them take crazy risks.
as long as taxpayers are NOT on the hook, we should not give a crap.
let them fail.
without failure there is no moral hazard and things will only get worse.
If (3) (“have a plan for dealing with similar events: by stepping in, seizing the bank, firing management, zeroing out shareholders, haircutting bondholders, and then injecting new SENIOR capital (fully protected) and re-floating or selling off the firm. This will allow the entity to keep operating, and it will stick the losses where they belong–with the idiots who bought the bank’s stock or loaned it money.”) is instituted, Glass-Steagall, IMO, would be unnecessary. When one’s job and own money are at risk it does tend to change behavior.
Regulation and subsidies distort and hide risk. Eliminate both and let them fail or succeed on their own merits.
“So, does the debacle at JP Morgan mean banks should be more regulated?
In Business Week, Henry Blodgett answers ‘yes’–because . . . the situation has grown so mathematically complex . . . .”
The federal govt can’t even reconcile income minus outflow yet Henry Blodgett believes that it can successfully regulate the mathermatically complex? In what universe?
The purpose of regulation is declaration and observation. How stupid. The ony way big money interests are defeated is communism. In which case, the government becomes big money interests. So, it’s much better to let competing big money interests control each other.
This is a very complicated issue. There are no simple, easy solutions. It gets down to the nub of the matter…namely what is the role of government exactly?
I’m sure everyone agrees that a legitimate role of government is to have laws, a police force, courts, jails, prisons that keep people from killing each other. The benefit of this is people can live in communities without being concerned for their safety.
But is it a legitimate role of government to regulate financial activity so that people can be protected from ravenous wolves who can destroy the economy and if that’s a legitimate role of government, CAN the government provide such protection?
I consider myself to be a “pragmatic libertarian”. The libertarian in me says “Don’t regulate financial activity…let the market punish wrong doers.” But the pragmatic part of me knows that some private organizations have become so big and large that inappropriate, greedy, or incompetent activities by them can hurt the entire community financially.
Part of the problem is that investment banks have been allowed to go public and investment activities involving large risk have not been separated from the usual banking activities. I can assure you that if J. P. Morgan was still a partnership where trading was done with the partners’ money instead of the shareholders’ money, such risks would NOT be taken.
I dislike large companies every bit as much as I dislike large government. I left one (IBM) where I had a promising career and was considered to be on the fast track into upper managment to start my own small software company for that very reason.
Anyone who thinks a large company isn’t as dangerous as large government has another think coming. And large companies affect our daily lives as much or more than large government.
So what’s the answer to all this? Hell, I don’t know. Sometimes I think the Amish have the right idea. Rely primarily on yourself, living a simple life that doesn’t depend much on any big thing.
texexec wrote: “some private organizations have become so big and large that inappropriate, greedy, or incompetent activities by them can hurt the entire community financially.”
I agree. I suggest that the solution is not allowing them to grow super-large and become a hegemony in the first place. That what the Sherman Anti-Trust Act was supposed to solve. Q: When have we last seen real anti-trust action? A: 1984 with the breakup of AT&T. Result: a private phone industry and the creation of international cellular networks. Does anyone think that AT&T with its union-heavy workforce would have permitted the development of a private telephone industry had it not been broken up?
THERE’S NO LOGICAL REASON TO HATE LARGE COMPANIES.
COMPANIES CAN’T COMPEL YOU TO DO ANYTHING.
‘
ONLY THE GOVT CAN.
AND ONLY A LARGE GOVT CAN AID BIG COMPANIES OR BIG CRONIES.
THE SOLUTION IS SMALLER GOVT THAT IS LESS INVOLVED AND THEREFORE HAS FEWER FAVORS IT CAN DOLE OUT AND FEWER NEGATIVE CONSEQUENCES TO ITS REGULATIONS.
reliapundit,
Large companies may not be able to “force” one to do something, but when a market becomes a hegemony dominated by very few mega-companies they dictate the terms of of what you CAN do. They reduce your choice from one-of-many to a simple yes or no (do it our way or don’t do it at all).
We have seen this time and time again. There was a time when the auto market in the U.S. was “owned” by the big three (and they produced shoddy products). There was a time when the communications industry was essentially controlled by AT&T; as Lilly Tomlin’s comedy sketch intoned “We don’t care. We’re the phone company; we don’t have to.” The oil companies still control (or play an oversized role in) the machinations of the oil market; Rockefeller’s Standard Oil is not that far away from becoming a reality once-again.
Likewise, I don’t want to see Google, or Microsoft or any tech company (or the govt) become so powerful that they can dictate the terms of the internet.
There is every reason to fear big companies with their impersonal bureaucracy and thirst for market power as there is to fear big govt with its thirst for tax revenue and social power. They are one and the same.
You said it better than I could, T. Amen.
Federal deposit insurance has precluded runs on banks for decades. It is self funding via charges to banks. Let the high rollers and big gamblers take a hit when they screw up, but the little account holder has to be protected if we want people to put money in banks.
T and texexec,
I agree mostly, but sometimes a company like Microsoft does some good by setting standards (imperfect, to be sure) that allow computers to be used by many rather than remaining the playthings of software geeks. The same is true of companies like Amazon. We have to be sure that when they get big enought to be abusive, there is someone with enough clout to challenge them. Absolute monopolies are not good.
I agree, expat. Some things can only be done by large companies. For example, it’s doubtful that automobiles could be made by small companies with low cost.
I do wish that shareholders of large companies would do a better job of policing the actions of management and boards. Unfortunately, most of the time, board members are selected by a few insiders.
As long as banks, hedge funds, etc. are playing with their own money, they can take all the risks they wish. Its a different matter when they are playing with the money of their depositors; MF global is a case in point. However, when government (and the FED) nudge, nudge lets them know they are TBTF and that they will be bailed out; we have a very serious problem. The tragedy since 2008 is our children and grandchildren bailed them out. F*%& ’em. Let them fail, including GM, Chrysler, California, Illinois, Greece, Portugal, Spain, and DC.
The answer is easy. Read Karl Denninger’s Leverage and start following his blog at market-ticker.org. The solution he favors is called One Dollar Capital along with Stop the Looting and Start Prosecuting.