Article

The Volcker Rule Must Be Strengthened

JPMorgan’s Misplaced $2 Billion Bet Reveals Dangers to Taxpayers

Travis Waldron parses the evidence of why risky proprietary trading is the root of the bank’s big loss, something taxpayer-insured bank deposits should not be backstopping.

The well-publicized losses at JPMorgan last week make it even clearer now that a strong Volcker Rule is imperative if we want to ensure that our financial industry will never again jeopardize the health of the entire American economy. (AP/ Scott Iskowitz)
The well-publicized losses at JPMorgan last week make it even clearer now that a strong Volcker Rule is imperative if we want to ensure that our financial industry will never again jeopardize the health of the entire American economy. (AP/ Scott Iskowitz)

Recent bombshell news that JPMorgan Chase & Co. is losing billions on an alleged “hedge” was terribly timed for those on Wall Street who have been trying to water down a rule prohibiting risky trading by federally insured banks. But it’s well timed for ordinary taxpayers who should never again have to make up for that risky trading by bailing out our nation’s banks when too many of their trades go wrong.

At a time when opponents of financial reform were succeeding in watering down financial regulations included in the 2010 Dodd-Frank Wall Street Reform Act, JPMorgan’s losses give regulators a reason to re-examine and strengthen rules protecting taxpayers and the American economy.

The JPMorgan case spotlights one of Dodd-Frank’s rules in particular. The Volcker Rule, named for former Federal Reserve Chairman Paul Volcker, who proposed it, would prohibit commercial banking institutions with insured deposits—such as JPMorgan—from proprietary trading, in which banks take on excessive risk by making speculative investments that do not benefit their customers. This kind of trading played a large role in bringing down the financial industry just four years ago.

In the run-up to the crisis, many banks embraced a casino mentality, taking on greater and greater risk in housing-related financial securities. When those securities went bust and large banks began to fail, they turned to taxpayers for a bailout. “Risky proprietary investments by investment banks, along with trading for clients whose decisions were influenced by these banks, was one of the main forces that sustained upward pressure on securities prices” as the housing bubble grew, according to the Political Economy Research Institute at the University of Massachusetts-Amherst.

Last week’s events bring back unfortunate memories of that crisis. A London-based JPMorgan trading unit in charge of managing risk in the bank’s overall investment portfolio lost billions of dollars when what it claimed was a “hedge” turned sour. The losses, JPMorgan CEO Jamie Dimon said, resulted from “sloppiness” and “bad judgment,” and the ensuing wounds were “self-inflicted.” The trade was incredibly complicated, so much so that not even JPMorgan’s own traders and risk managers “appear to have fully understood the trade itself,” Bloomberg Businessweek reported.

JPMorgan is widely regarded as one of Wall Street’s smartest banks, causing advocates for stronger rules, including President Barack Obama, to wonder how complex and dangerous such trades could be. “This is the best, or one of the best-managed banks,” President Obama said Tuesday. “You could have a bank that isn’t as strong, isn’t as profitable making those same bets and we might have had to step in. That’s exactly why Wall Street reform’s so important.”

Under the latest draft of the Volcker Rule, hedges aren’t banned, and it is unknown at this point whether the trade in question would be subject to the rule.

What is clear is that in the months and weeks leading up to its losses, JPMorgan engaged in an extensive lobbying effort to create carve-outs and loopholes in the Volcker Rule. According to OpenSecrets.org, JPMorgan has spent nearly $10 million lobbying since the beginning of 2011, much of it aimed at the Volcker Rule. In February JPMorgan bankers met with Federal Reserve officials to argue that trades that originated on the Chief Investment Office desk—the same desk that oversaw the current trade—“not be included as prohibited proprietary trading,” Bloomberg reported. And just two weeks ago, it was part of a coalition of Wall Street banks that again met with Fed officials regarding the rule.

Those efforts paid off. The Volcker Rule draft now has a loophole big enough “a Mack truck could drive right through it,” Sen. Carl Levin (D-MI) said. And it potentially allows the type of trade JPMorgan made to remain legal.

The rule, however, hasn’t been finalized and won’t go into effect until July, and the White House announced its support for a stronger Volcker Rule last week. The timing of JPMorgan’s losses gives taxpayers and policymakers a chance to make their voices heard as well.

Though opponents of reform spent the last two years working to weaken the Volcker Rule, the huge JPMorgan loss should serve as a wake-up call for policymakers and regulators in charge of finalizing the rule. They now have a golden opportunity to ensure the Volcker Rule is strong enough to help protect taxpayers and the American economy. They should take advantage of it.

Travis Waldron is an Economics Researcher at the Center for American Progress and a Reporter/Blogger at the Center for American Progress Action Fund.

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Authors

Travis Waldron

Sports Reporter, ThinkProgress