ONE OF the characters in the classic 1939 film Stagecoach is a banker named Gatewood who lectures his captive audience on the evils of big government, especially bank regulation. “As if we bankers don’t know how to run our own banks!” he exclaims. As the film progresses we learn Gatewood is, in fact, skipping town with a satchel full of embezzled cash.
As far as we know, Jamie Dimon, the chairman and chief executive of JPMorgan Chase, isn’t planning anything similar. He has, however, been fond of giving Gatewood-like speeches about how he and his colleagues know what they’re doing, and don’t need the government looking over their shoulders. So there’s poetic justice – and a major policy lesson – in JPMorgan’s shock announcement that it somehow managed to lose $2 billion in a failed bit of financial wheeling-dealing.
Just to be clear, businessmen are human – although the lords of finance have a tendency to forget that – and make money-losing mistakes all the time. That, in itself, is no reason for the government to get involved. But banks are special because the risks they take are borne, in large part, by taxpayers and the economy as a whole. And what JPMorgan has just demonstrated is that even supposedly smart bankers must be sharply limited in the kinds of risk they’re allowed to take on.
History tells us that banking is and always has been subject to occasional destructive “panics” which can wreak havoc with the economy as a whole. Current right-wing mythology has it that bad banking is always the result of government intervention, whether from the Federal Reserve or meddling liberals in Congress. In fact, Gilded Age America – a land with minimal government and no Fed – was subject to panics roughly once every six years. And some of them inflicted major economic losses.
So what can be done? In the 1930s, after the mother of all banking panics, we arrived at a workable solution involving both guarantees and oversight. On one side the scope for panic was limited via government-backed deposit insurance; on the other banks were subject to regulations intended to keep them from abusing the privileged status they derived from that insurance, which is in effect a government guarantee of their debts. Most notably, such banks weren’t allowed to engage in the often risky speculation characteristic of investment banks like Lehman Brothers.
This system gave us half a century of relative financial stability. Eventually, however, the lessons of history were forgotten. New forms of banking without government guarantees proliferated, while both conventional and newfangled banks were allowed to take on ever-greater risks. Sure enough, we eventually suffered the 21st-century version of a Gilded Age banking panic, with terrible consequences.
It’s clear, then, that we need to restore the sorts of safeguards that gave us a couple of generations without major panics. It’s clear – that is, to everyone except bankers and the politicians they bankroll – that now that they have been bailed out the bankers would, of course, like to go back to business as usual.
Enter Dimon. JP Morgan, to its – and his – credit, managed to avoid many of the bad investments that brought other banks to their knees. This apparent prudence has made Dimon the point man in Wall Street’s fight to delay, water down and/or repeal financial reform. He has been particularly vocal in his opposition to the Volcker Rule, which would prevent banks with government-guaranteed deposits from engaging in “proprietary trading”, basically speculating with depositors’ money. Just trust us, the JPMorgan chief has in effect been saying – everything’s under control. Apparently not.
What did JPMorgan actually do?
As far as we can tell it used the market for derivatives – complex financial instruments – to make a huge bet on the safety of corporate debt or something. The key point is not that the bet went bad; it is that institutions playing a key role in the financial system have no business making such bets, least of all when backed by taxpayer guarantees.
For the moment Dimon seems chastened, even admitting that maybe proponents of stronger regulation have a point. It probably won’t last; I expect Wall Street to be back to its usual arrogance within weeks if not days.
But the truth is that we’ve just seen an object demonstration of why Wall Street needs to be regulated. Thank you, Mr Dimon.
