Daily Archives: May 14, 2012

Let’s stipulate that the $2bn trading loss at JPMorgan resulted from a strategy that was, in the words of chief executive Jamie Dimon “flawed, complex, poorly reviewed, poorly executed and poorly monitored”.

Mr. Dimon (full disclosure: a friend of mine) was wise to flog himself before he could be flogged by others, even though his self-flagellation is unlikely to halt the broad and well-founded criticism of the bank’s failed risk management.

But as the piling on continues, we should devote at least equal time to making this a “learnable” moment. In that spirit, here’s what I think I’ve learned:

First, as best can be discerned, the loss was incurred not in the pursuit of hedging but in pursuit of risk. Specifically, in the credit default index positions that were ultimately responsible for the loss, the bank was apparently not buying insurance against risky loans that it had made; it was providing insurance to others.

If ultimately confirmed, such a strategy would likely be deemed a violation of the pending Volcker rule prohibiting naked bets with a bank’s capital and a reminder that as difficult as implementing the rule has proven to be, limitations on how depositors’ money is used are necessary and prudent.

Second, while JPM doubtless has legitimate business reasons for refusing to make public the details of its misstep (its massive positions still need to be unwound), as a quasi-public institution, it needs to be as transparent as possible as quickly as possible. We need to make the most of this learnable moment.

Third, we shouldn’t forget that in the vast magnitude of the global financial system, this was small beer. For one thing, offsetting the $2bn loss (which Mr Dimon acknowledged could eventually be more) was at least $1bn of profits from other, similar activities.

More importantly, even at $2bn, the loss represents only about 20 per cent of JPM’s pre-tax profit in the first quarter of 2012 alone and a bit more than 1 per cent of its equity market value.

So this loss never endangered JPM or its depositors, let alone any other banks or financial institutions. We need to accept without panicking that a bank –particularly one as large and as well capitalised as JPM – may from time to time lose $2bn in a non-systemic misstep. Far more was lost by banks from old-fashioned corporate loans turning sour during each of the last two recessions. Banking has always involved risks and always will.

Fourth, to those who say Wall Street never pays for its mistakes, please take note of JPM’s shareholders (many of them employees), who saw $14bn lopped off the value of their holdings in Friday’s trading.

Meanwhile, the executive in charge of the botched operation and two of her colleagues are expected to resign Monday. Knowing Mr. Dimon, I wouldn’t be surprised if further departures follow.

Finally – and perhaps most consequentially – we need to be careful about how this event affects the remaining steps in the implementation of Dodd-Frank and other post-crisis regulatory measures.

With the takedown (at least temporarily) of Mr Dimon’s outsized reputation, Wall Street’s last credible voice against excessive regulation has now been effectively silenced.

But that should not mean that foes of banks be allowed to rampage untrammeled. For example, eliminating any ability of banks to hedge would substantially impede their ability to undertake prudent risk management and would therefore have the paradoxical effect of either increasing the possibility of unexpected losses or reducing the banks’ willingness to lend or both.

In taking down JPM’s equity value by vastly more than its projected losses from its bad bet and those of other banks by smaller amounts, the market is clearly concerned that Washington will mete out a severe punishment indeed to Wall Street.

By all means, pile on Mr Dimon, who will likely be harder on himself over such a big misstep than most of his critics. But at the same time, let’s keep calm and carry on, because to react too violently in a way that damages the most important capital market in the world could be as costly as the reverse.

Extreme political dysfunction is now undermining a Greek economy already hobbled by imploding consumption, explosive joblessness, accelerating capital outflows and debt insolvency. The consequences are multi-faceted and extend well beyond the country’s borders. For the longer-term stability of Europe and the global economy, European leaders need to urgently redefine their historical unity project rather than leave it in the hands of increasingly disorderly conditions on the ground.

A week ago, the Greek electorate delivered three devastating messages to the country’s political elites: an unambiguous rebuke of traditional parties; unusual migration to fringe parties that are eager to dismantle the past but lack coherent plans for the future; and disgruntlement with economic policies that hurt but don’t work (to adapt a phrase that British politician Ed Miliband used in a different context).

It should come as no surprise that post-elections Greece is having problems forming a government. The political landscape is now full of parties with different interpretations of the past, present and future. As a result, the three with the biggest share of the recent vote failed last week to garner sufficient support to form a ruling coalition. This was followed by President Karolos Papoulias’ inability on Sunday to coerce the major parties into an emergency government.

Political dysfunction is the last thing that Greece needs at this historical juncture. It undermines the fulfillment of policy commitments made under the bailout provided by the Troika (European Central Bank, European Union and the International Monetary Fund). It also precludes the design of a better policy mix that would warrant disbursement of much-needed external support but under a more promising approach.

All this puts Greece’s eurozone partners in a very difficult position. Absent an urgent and imaginative response, they face a lose-lose situation: they lose by disbursing more good money after bad and see that too evaporate with no sustained benefits for Greek citizens and their European counterparts; or they lose by not disbursing and accelerating Greece’s slide into chaos, with unpredictable consequences for Europe and the world economy.

It is time for the eurozone to pivot away from an approach that offers little prospects of growth, jobs and financial stability. This involves a very difficult but needed redefinition of the eurozone, and a tricky combination of exit and different support mechanisms for countries that are not up to the new reality.

Given conditions on the ground, the current 17-member eurozone needs to evolve into a smaller and less imperfect union if it is to avoid the growing risk of total fragmentation – namely a closer economic and political union among the big four (France, Germany, Italy and Spain) along with other members with similar initial conditions.

This is a very complicated and outright awkward evolution. It only occurs in the context of a better policy mix for individual countries; stronger internal funding and coordination mechanisms, including regional firewalls; a less vulnerable banking system; and quite a bit of luck too. Moreover, as they redefine the eurozone, European leaders need to establish an off ramp to allow countries exiting the zone to remain in the 27-member EU and access post-exit stabilisation funds, as well as technical assistance to establish over time a credible monetary policy.

None of this is remotely straightforward and success is far from assured. But what should be increasingly clear in European capitals is that the current approach is faltering badly and will be even more costly down the road – and not because of the willingness of politicians to keep the eurozone intact but because of developments on the ground.

The eurozone’s fate is shifting from politicians and directly into the hands of the population, a portion of which is both angry and disillusioned. And having already forced a change in eight governments but still sensing an equally bleak future, the probability is increasing that they opt for a bigger mix of economic, financial, political and social rejection.

Looking beyond Greece, European politicians and policymakers still have the ability – indeed, the obligation – to channel the more direct involvement of citizens into a redefinition of the important European project. It will be expensive and initially disorderly. But the alternative of fragmentation is much, much worse for all involved. They better hurry up if they wish to remain relevant in a proactive, rather than just reactive fashion.

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