Inconvenient Truth

What Jamie Dimon’s Senate Testimony Got Right

The JPMorgan Chase CEO is more correct than we’d like to believe about the impossibility of regulating risk.

As part of the ongoing saga of JPMorgan Chase and it multi-billion-dollar trading losses, CEO Jamie Dimon testified this morning in front of the Senate Banking Committee. Ever articulate, Dimon rehashed much of what he has said over the past weeks: I’m sorry. We blew it. We will make changes. Government regulation has become unwieldy and wouldn’t have prevented this from happening. It’s a risky business, and we didn’t manage that well.

None of this would have risen to the center of the public agenda were it not for the backdrop of the 2008 crisis and the government bailout of the financial system that follower. JPMorgan Chase is a private company that lost money. Rarely should that be a government issue, or even the occasion for the type of outcry that has met the news of the bank’s failed trades. Research in Motion and Nokia have been hemorrhaging money as a result of their failure to make the needed changes to remain competitive in the smartphone market, and their executives have not been put in the crosshairs (Canadian and Finnish though they are).

The rejoinder, of course, is that the collapse of smartphone and handset makers doesn’t endanger the global economic system, whereas the “too big to fail” nature of global banks does. Fair enough, but Dimon’s point is that the current lattice of regulations would not have prevented the errant trades in JPMorgan’s unit that was tasked with managing the holding company’s portfolio and hedging against risks. And in that, he is entirely right.

Dimon’s solution, hinted at during his testimony, would be to revisit much of the Dodd-Frank legislation passed in the wake of the 2008 crisis. That infuriates many who see the mismatch between the current profitability of banks and the lack of easy credit, the ongoing foreclosure wave, high unemployment, and general sluggishness of the economy. More to the point, Dimon does not and has not addressed the systemic issues with anywhere near the force or acumen with which he has addressed the regulatory failings.

That creates its own conundrum: he is more right than many acknowledge about the foolishness of many of the reforms, at least insofar as they are redundant, chaotic and unclear. Much of what Dodd-Frank addresses already had been addressed in prior laws and simply adds more regulators. Dimon clearly believes that market forces, rather than regulation, have led to far less risk in the system than was the case five years ago, and in his testimony directly said that many of those risks are gone, whether in the ending of “off balance sheet” vehicles and the curtailed trading in many of the more ill-considered derivatives.

This argument is endless and ultimately becomes easily partisan. But neither side adequately deals with the systemic risks that remain, as the ongoing crisis in the euro zone remind us daily. In a globally interwoven financial system, there remain few circuit breakers that can contain panic, contagion, and sudden liquidity vacuums. JPMorgan’s sour trades were a failed attempt to mitigate those risks and generate profits to offset possible losses. But nothing in its current structure alleviates those systemic risks and nothing in the current legislation does either.

So it really doesn’t matter whether Jamie Dimon’s testimony is strong or hypocritical, whether people like him or revile him. Yes, it’s better for a major CEO of a very visible company to appear competent and to exude integrity, and even better for him to be competent and have integrity. Either way, we remain at risk.

The only, and truly the only, way to reduce the risk of global synchronous financial collapse would be to erect real fire walls that separated deposits from trading in a manner akin to what existed during the Glass-Steagall era. By the time that bill was formally repealed in 1999, most of its strictures had been eroded already, but until the early 1980s, they held. Depository banks couldn’t speculate and benefited from the guarantees of the government in the form of federal deposit insurance. Now, as we know all too well, those walls are as effective as the Great Wall of China is in keeping the world at bay.

That said, there is no political will to go this next step, and barring actual collapse, there likely won’t be. Even then, the risk would only be reduced, not eradicated. So we are left with the uncomfortable fact that the financial world is far riskier than it was in the middle of the 20th century. Of course, it is also far more stable than it was in the distant mists of the past that predated the Great Depression, a fact that is also lost in the current climate of fear and hyperbole. There is a risk of synchronous collapse, most likely stemming from the euro zone right now but which will migrate elsewhere in the future.

JPMorgan’s losses were yet another reminder. But the presence of that risk is not the same as the likelihood of collapse. In our collective anxiety now that we peer behind the curtain and see that there is no wizard minding Oz, we have collectively gone to the other extreme and assumed that the presence of risk means that collapse is probable. JPMorgan blew it, and their business and reputation have suffered. That may be a sign of the apocalypse, but more likely, it is simply a sign that we live in a world of flawed but still functional institutions and uncomfortable but manageable risks. The sooner we adjust to that reality, the better.