Daily Archives: October 4, 2011

Let’s agree that a lot of bad stuff happened along the way to the 2008 financial meltdown and that a good portion of the responsibility can justifiably be laid at the feet of the Wall Street community. Whether or not laws were broken, the lack of discipline and inadequate controls around many lending and risk taking practices certainly merit some version of the vigorous rethink of the regulatory apparatus that is now in process.

That said, it is still possible to feel Jamie Dimon’s pain as he vented his frustration over new regulatory proposals at Mark Carney, Bank of Canada governor, while perhaps not always loving his tonality. As the chief executive of JPMorgan Chase (full disclosure: also a friend of mine), Mr Dimon presides over a bank that emerged the least scathed from the meltdown and arguably conducted itself more responsibly than most of its peers.

For its trouble, JPMorgan is now at the short end of the stick: potentially penalised for being American (because of the tougher US response to the crisis, at least so far) and penalised again by elements of the proposed Basel III rules, such as the potential requirement for an extra capital charge as a financial institution considered too big to fail.

That may be unfair but it’s not totally surprising. As New York was at the epicentre of the debacle, it’s only logical that Washington would take a stronger hand in reworking the rules and the oversight. And within the US political process, overreaction can easily occur, as it did with the Sarbanes-Oxley Act, which was intended to reform corporate governance and improve corporate accountability following a raft of fraud cases a decade ago.

Meanwhile, with no reliable mechanism yet in place to address the problem of ‘too big to fail’, a safety net of additional capital under these immense institutions is at least a political necessity, and arguably an economic necessity. In the fullness of time, Mr Dimon may well be proved right that such prudence is excessive, and a serious constraint on lending, not to mention shareholder returns. But in the meantime, bankers must appreciate that the understandable rage of the citizenry dictates nothing less.

Implicit in Mr Dimon’s commentary is the indisputably valid grievance that notwithstanding the broad recognition that financial markets around the world are interconnected and interdependent, we still lack a global supervisory framework. Just as US regulators may pursue toughness, so may – as many American bankers allege – some European supervisors choose a lighter touch.

A further conundrum is that the financial system consists of far more than just traditional lenders. Within the shadow banking system, hedge funds and other quasi-unregulated pools of capital can provide much of the same kinds of financing. The tougher the capital requirements and other strictures become on banks, the more business will flow to these dark pools, creating another set of risks to the financial system.

For the moment, the practical impact of Mr Dimon’s grievances may well be limited to his firm’s share price. Loan demand remains weak, and JPMorgan boasts a formidable capital base. With Europe deep in crisis, competition from continental banks will be muted for some time. And Basel III is years from taking effect.

What is urgently needed – but sadly nowhere on the horizon – is a comprehensive, worldwide system of regulation and supervision for a financial system that constitutes a sort of global circulatory system. While Mr Dimon may not agree with all the rules that would emerge from such an arrangement, at least all lenders would be competing on a level playing field.

The writer is former counsellor to the US secretary of the Treasury. He contributes a monthly column to the FT and blogs regularly.

Response by Desmond Lachman

We should be asking whether the banking reforms go far enough

Steven Rattner’s spirited defence of Jamie Dimon’s position in his row with Mark Carney is curious. For it comes at the very time that European events are pointing to the real likelihood of a second Lehman Brothers-style global banking crisis within the next year or so. If ever there was a time that the global banking system needed an enhanced safety net for banks that are too big to fail, it has to be now. Similarly, it would seem that this is the time to be thinking about not only more effective banking regulatory reforms, but deeper reforms of the global banking system that might minimise the possibility of yet another banking crisis down the road.

The 2008-2009 US-led subprime banking crisis could not have been as acute as it was without the ample and reckless financing provided by the American financial system over many years. So too is the case with the present European sovereign debt crisis. In the absence of an extended period of overly-generous provision of bank credit at low interest rates, the Greek government would not have been able to finance its excessive spending. Nor would the Irish and Spanish property bubbles occurred to anywhere near the degree that they did without reckless bank lending.

The European Central Bank is right to fear that a sovereign Greek default now could result in a major European banking crisis. For it is difficult to see how a Greek default will not trigger real contagion to Portugal, Ireland, and Spain at a time when the European banking system appears to be undercapitalised. The International Monetary Fund has recently suggested that Europe’s banks could be short of at least €200bn in capital needed to deal with a wave of potential defaults in the European periphery.

Before dismissing the pressing need for an enhanced safety net for the large banks that are too big to fail, Mr Rattner might have wanted to consider how exposed the US financial system is to the European banking system. In a recent study, the Fitch rating agency estimated that the US money market industry was exposed to Europe to the tune of $1,200bn. The US banks’ exposure to Germany and France is in excess of $1,000bn, according to numbers from the Bank for International Settlements. This exposure should be of deep concern to US bank regulators particularly since the intensification of the European crisis seems to be occurring at the very same time that a double-dip recession in America could put added strain on its banks’ balance sheets.

A possible second Lehman Brothers-style banking crisis has to raise the sort of questions that Mr Rattner is asking about the adequacy of global banking supervision. However, we should also question whether the 2009 banking sector reforms went nearly far enough. Instead of placing undue reliance on all-too-fallible bank supervisors and regulators, should we not now be considering doing something serious about the perverse incentives to overly risky bank lending, as well as to the ‘too big to fail’ problem in the US and global banking systems?

The writer is a resident fellow at the American Enterprise Institute.

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