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JPMorgan loss makes case for Volcker

By Claes Bell ·
Friday, May 11, 2012
Posted: 4 pm ET

It's been a tough week for JPMorgan CEO Jamie Dimon. Just as he's argued large swaths of the Volcker rule restrict banks too much, his own bank may have become a case study in why the rules are needed.

As you may have heard, JPMorgan announced yesterday it had lost $2 billion trying to hedge, or reduce the risk of, risk to its lending portfolio. To many analysts, though, the trades look more like proprietary trading, the practice of banks making investments for their own profit rather than on their clients' behalf. That practice would be outlawed under the so-called Volcker rule still being finalized by the Federal Reserve.

From Charles Forelle at The Wall Street Journal:

At the crux of the J.P. Morgan debacle is just what Mr. Iksil and his group were doing with these synthetic credit indexes. The bank insists the group was making trades to hedge its exposure to the defaults in the broader economy. The precise mechanics of what Mr. Iksil did, and what the bank did to try to unwind his position isn't clear, but one thing is: If the trades were a hedge, they were an evidently bad one.

Whatever you want to call it, this particular trading operation involved a $100 billion (with a "b") bet on the credit quality of high-grade corporate bonds. Basically, the JPMorgan trader in question, Bruno Iskil, bet that the economy would improve and companies' debt would get less risky. Unfortunately for JPMorgan, their bet was so big that, even though the index they were betting on only went down a little bit, the net loss ended up being $2 billion this quarter, and may cost the bank up to $1 billion in the next quarter.

While Dimon is insisting the trades would have been legal even if the Volcker rule had been in effect, he has harshly criticized the proposed version of the rule for being too restrictive for banks. In an interview with Fox Business in February, Dimon had this to say about Paul Volcker, the former Fed chairman who originally advocated for including the rule in the Dodd-Frank financial reform law: "Paul Volcker by his own admission has said he doesn't understand capital markets. Honestly, he's proven that to me."

Dimon himself admitted on a conference call yesterday that the incident will give ammunition to those looking to make the rule more restrictive just as the Fed looks to complete the rule-making process: "It is very unfortunate and plays right into the hands of a whole bunch of pundits out there, but that's life, and we'll have to deal with that."

For banking customers of JPMorgan Chase, life probably won't change as a result of this incident. JPMorgan remains among the most well-capitalized of the nation's large banks. The long-term consequences, however, remain to be seen. JPMorgan, and Dimon himself, have been considered among the most skilled at managing risks, so this may have the effect of undermining faith in the soundness of the U.S. banking system.

Also, if Dimon is right that the trades JPMorgan made comply with Volcker, it also implies that the loopholes in the law are so big as to make it nearly useless, forcing regulators to once again go back to the drawing board on how to keep banks from making risky bets with their own assets.

What do you think? Does this loss prove banks need to stop proprietary trading? Or is this just an isolated incident?

Follow me on Twitter: @ClaesBell

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May 12, 2012 at 8:14 am

It so astounding how one persons actions can have such huge financial consequences.