JP Morgan: Why the Volcker Rule could not have saved them

As the size of JP Morgan Chase and Co’s trading loss reportedly grows, so does the discussion of what should have, or could have been done to prevent this risky bet gone awry.

In one of Wall Street’s biggest mea culpas,  JP Morgan Chief Executive Officer Jamie Dimon attributed what started out as a $2 billion loss to poor strategy and poor decision-making. In an interview with Meet The Press’ David Gregory, Dimon said, “We know we were sloppy.  We know we were stupid.  We know there was bad judgment and of course regulators should look at something like this.  That’s their job and they will come to their own conclusions.  But we intend to fix it, learn from it, and be a better company when it’s done”.

While this may not prove to be a crippling loss for JP Morgan, the fact that a seemingly solid, risk-savvy bank could make a mistake of this magnitude leaves many to wonder what type of risky bets other financial institutions are taking and who is monitoring them.

Within moments of Dimon’s announcement, questions began to swirl about whether or not the proposed Volcker rule, which in theory would stop banks from making risky trades for their own gain — a practice known as proprietary trading, could prevent these types of losses. But, with exceptions for hedging and market making, could the Volcker rule have stopped a loss at JP Morgan and possibly prevent future financial disasters? According to some the answer  is “no”.

“I think this shows the futility of the Volcker rule,” said John Berlau, senior fellow for finance and access to capital at the Competitive Enterprise Institute. Berlau continued, “The Volcker rule is a clumsy way to ensure banks safety and soundness. It’s difficult to tell what is a trade and what is a hedge. And proprietary trading as opposed to other types of trading really wasn’t a significant cause of the financial crises.”

According to Dimon, the trade that would spiral into disaster did in fact start off as a hedge “in a stress credit environment”.  During a conference call with analysts, Dimon added, “it morphed over time and the new strategy which was meant to reduce the hedge overall made it more complex, more risky and it was unbelievably ineffective, and poorly monitored and poorly constructed and poorly reviewed and all that”.

For many Americans, the idea of one of the nation’s biggest banks bleeding capital due to risky betting adds insult to injury. After the hefty sum of taxpayer funds used to bail out Wall Street firms during the financial crisis, most expected more prudent investing and more stringent regulation.

“It’s the whole problem with regulation,” said Scott Fearon, president of Crown Capital Management, a hedge fund based in Northern California. “You set up these guidelines and people spend a whole lot of time figuring out how to skirt around them. It’s certainly true the best way to structure a free market is that when people get it wrong, they’re allowed to go broke. The most powerful regulation of all is bankruptcy.”

Both Berlau and Fearon are in agreement that the focus of regulation should be on preventing the practices that actually led to the financial meltdown as well as creating bankruptcy proceedings for instances where large companies fail. According to Berlau, current regulation is largely focused on political agendas and optics rather than concrete and helpful reform, “We’re regulating other things that either had nothing to do with the financial crises or are an ineffective means of preventing the next one.”

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