I was debating someone earlier who took the following position:
“All this uproar around JPMorgan’s big loss is unwarranted. Sure, investors lost a bunch of money on a bad, sloppily-managed bet. But that’s the point: investors, not taxpayers, lost money. If anything, this shows that Dodd-Frank type reforms are not necessary.”
The Romney campaign made a similar argument the other day.
To which I say: nonsense.
First, a deal involving derivatives of this magnitude, where the inherent risk was so poorly understood, could easily have generated losses multiples higher than the ones we’re learning about now – losses that are growing, btw.
But the more important reason why it’s nuts to go to the “reform-is-irrelevant” place is that at the heart of Dodd-Frank is something I’ve written about a lot here: deeper capital reserves. To their credit, JPM had enough of a capital cushion on hand to absorb a large loss like this. But that’s no accident. It’s a direct outcome of Dodd-Frank’s capital reserve requirements and the subsequent actions by large banks to build up their reserves in anticipation of the new rules.
The fact of inadequate reserves – overleveraged banks whose bets couldn’t be covered by their capital on hand – was a major factor in the crash, and if anything, this episode reminds us just how important it is to get this right going forward.
To suggest the opposite – that this somehow shows reform is not necessary – is like saying sure, we crashed the car into a wall but the airbags deployed and only the passengers, not any bystanders, were hurt. Therefore, we don’t need airbags.