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JPMorgan Chase Losses: No Reason for More Regulation

Posted By David C. John On May 11, 2012 @ 5:19 pm In Featured | Comments Disabled

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JPMorgan Chase’s announcement that it has lost $2 billion in a failed hedge strategy sent shock waves through the financial world yesterday. And in Washington, the reaction has had a political tone, with calls to accelerate adoption of the “Volcker Rule [2]” limiting investments by banks. But policymakers should take a breath before taking out the regulatory pen. While the case clearly reflects a management failure, it is not a systemic problem that requires or would be fixed by additional regulation. As JPMorgan Chase’s Chairman Jaime Dimon said [3], “Just because we’re stupid doesn’t mean everybody else was.”

A few points about this situation:

  • The Volcker Rule would not have prevented the losses, since it would not have affected this transaction. JPMorgan Chase’s losses were due to hedging, an activity designed to reduce the chance of losses from other bank activities. Such hedging would not be restricted by the Volcker Rule.

While in this case the hedging produced losses rather than protecting against them, the activity is an extremely valuable way to protect the bank against many types of market risk. Hedges are often very complex [4] and require an expert to understand. Chase did a bad job of structuring the hedge. As Dimon said, “There were huge moves in the marketplace, but we made these positions more complex and they were badly monitored.”

  • The losses can easily be absorbed by Chase. There is no danger that Chase will fail or of any kind of systemic collapse. This will not become another federal bailout. A $2 billion loss is huge, but Chase has more than enough capital to absorb it. As a $2.3 trillion bank with a net worth of $189 billion, this $2 billion loss reduced the bank’s capital ratio from 8.4 percent to 8.2 percent [5]. The bank is nowhere close to needing any form of federal intervention.

In addition, for all of 2012, the bank will still produce a healthy profit. One bank analyst says [6] that he expects JPMorgan Chase to earn about $4.70 a share, down about 40 cents from previous predictions, while another expects about a 5 percent drop.

  • The system worked: The JPMorgan Chase losses were not discovered by regulators; they were discovered by the bank itself conducting its own management reviews.

Mistakes that cause losses are part of capitalism, but they should be handled responsibly by the company that made the error. This is what happened here.

 


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URL to article: http://blog.heritage.org/2012/05/11/jpmorgan-chase-losses-no-reason-for-more-regulation/

URLs in this post:

[1] Image: http://blog.heritage.org/wp-content/uploads/JP-morgan.jpg

[2] Volcker Rule: http://www.heritage.org/research/reports/2010/02/the-volcker-rule-not-the-solution-to-reducing-financial-risk

[3] said: http://i.mktw.net/_newsimages/pdf/jpm-conference-call.pdf

[4] very complex: http://blogs.reuters.com/felix-salmon/2012/05/10/jp-morgan-when-basis-trades-blow-up

[5] to 8.2 percent: http://www.marketwatch.com/story/jp-morgan-reveals-surprise-2-billion-trade-loss-2012-05-10

[6] says: http://www.marketwatch.com/story/jp-morgan-shares-slump-after-2b-trading-loss-2012-05-11

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