It’s Not About Jamie Dimon
My quote is from the middle of the article, so please read the whole thing to know how it starts or ends. Just don’t expect mindless hatred aimed at Dodd-Frank, because you won’t find it here:
In the aftermath of the JPMorgan mess, politicians and reporters have been invoking the Dodd-Frank law’s ‘Volcker Rule.’ Named after Paul Volcker, the Federal Reserve chairman from the Carter and Reagan eras, the rule prohibits banks whose customers benefit from taxpayer-backed deposit insurance from engaging in ‘proprietary trading,’ or speculation. But the Volcker Rule isn’t a rule at all: it prohibits behavior that has no set definition. Twenty-two months after Dodd-Frank became law, regulators have delayed enforcing the rule because they still cannot figure out what proprietary trading really is. Consider how JPMorgan lost all that money: creating derivatives that let it sell billions of dollars’ worth of protection against the risk that some corporate securities would default. That sure doesn’t sound like a good idea. Banks, because they’re lenders, are already at risk if people and companies default in droves.
But does selling such synthetic ‘insurance’ constitute proprietary trading? Michigan Senator Carl Levin, who helped draft the Volcker Rule language, says it does. Bank officials have argued that such behavior is hedging, which would be okay under Dodd-Frank.
Real rules could govern Wall Street, but politicians must give regulators the backing to create and enforce them. Rather than worry about the Volcker Rule, politicians and reporters should be focusing on derivatives rules. One reason that Washington had to bail out the financial system four years ago was that financial firms such as AIG had taken on virtually infinite risk through the derivatives markets. Through derivatives, AIG could ‘sell’ protection against other companies’ defaults with almost no cash down. Lo and behold, that’s what JPMorgan Chase was doing, too. Regulators should demand that traders—whether big banks or tiny hedge funds—put a set amount of cash down behind such bets, curtailing the amount of potential unpaid debt in the financial system. Regulators should also require that traders execute such transactions on open clearinghouses and exchanges—so that markets can determine which bets are going well and which aren’t, and clearinghouses can demand more money from traders to cover their losses. Such rules empower market signals, not regulatory micromanagement, to control risk. If such rules were in place, it’s unlikely Dimon would have visited the White House 18 times in three years, as he would have had no way to manipulate a restriction that, after all, applied to everyone.
The best way to stop bailouts is to limit borrowing and demand transparency. When markets know that financial firms have put a cash cushion behind their bets—and where the risk behind such bets lies—they’re unlikely to pull their money out of the financial system en masse, necessitating a government rescue. The Volcker Rule, by contrast, adds no such protection against future taxpayer rescues; all it does is unleash regulators to debate, in private, the definitions of risk.
Dodd-Frank gave regulators the authority to impose real rules on derivatives, and the regulators have done so. But lobbyists demanded and secured exceptions, which could eventually prove the rule. With such loophole-ridden reform, America has hardly set a good example for Europe, which lags even further behind in enacting derivatives rules. In fact, JPMorgan Chase may have executed the derivatives deals from London because the bank perceived London as a looser environment. Moving this activity around the world so that financiers can play inconsistent rules against one another does nothing to help the struggling Western economies.
As always, I welcome critiques and comments.