J.P. Morgan’s $2 billion loss renews debate on size

Is there no such thing as ‘too big to fail’?

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J.P. Morgan’s announcement of a spectacular trading loss of $2 billion last week gives fuel to regulators who are inclined to slim down or at least stop the growth of such “too-big-to-fail” megabanks in the future, banking analysts say.

As the nation’s largest bank with a breathtaking $2.3 trillion in assets, J.P. Morgan rivals the U.S. government in size and is bigger and more influential in the global economy and financial markets than most nations.

The $2 billion loss that shocked Washington and Wall Street was just small change for the New York goliath, which the Federal Reserve deemed to be the only megabank that was strong enough to have survived the 2008 financial crisis without a bailout. J.P. Morgan even took advantage of the crippling of its rivals to acquire Bear Stearns at a bargain-basement price in a move that helped make it the giant it is today.

The complex and highly leveraged transactions on which J.P. Morgan lost money involved the kind of arcane derivative securities that the bank invented, sells and distributes around the world in the so-called “shadow” financial markets that blew up during the 2008 crisis.

The wrong turn taken by J.P. Morgan’s traders in London last quarter escaped detection not only by the bank’s regulators at the Fed, but also by its own vaunted chief executive officer, Jamie Dimon, whose brilliance and command of the mind-numbing details of finance had brought him widespread respect and deference as the main defender of the megabanks in recent years.

Because J.P. Morgan was viewed as the best, brightest and most infallible of the big banks, “we think the bigger impact of the news will be on the debate over ‘too big to fail,’ ” rather than whether the megabank was violating any particular rules or regulations, said Brian Gardner, analyst at Keefe, Bruyette & Woods.

Regulators have begun investigations into the incident and are empowered under the 2010 financial-reform law to prohibit risky trading as well as limit the banks’ leverage and acquisitions in the future, if they deem that to be justified, he said.

The J.P. Morgan incident may provide them with the “political will to act” to cut down the size of such banks, he said.

“The argument will be, some transactions are too complex for even the best bank management teams; therefore, we the regulators need to limit the size and complexity of the biggest banks,” he said.

The bank’s announcement prompted lawmakers who favor breaking up the big banks to reintroduce legislation this week mandating limits on their size and concentration.

While that legislation is not likely to pass in the heavily divided Congress, where most Republicans want to roll back the financial-reform law, today’s significantly empowered regulators may not need any new tools to accomplish the same kind of downsizing, Mr. Gardner said.

Liberal groups are calling for action by both Congress and the regulators.

“When banks are so big they assume government will bail them out, their excesses can be catastrophes,” said Robert Borosage, co-director of Campaign for America’s Future. “It’s time for the government to place sensible limits on the big banks.”

Some conservatives have also advocated downsizing the big banks. Thomas Hoenig, the influential former president of the Fed’s St. Louis reserve bank, is an “outspoken critic of ‘too big to fail,’ ” and he recently was appointed to the board of the Federal Deposit Insurance Corp., which is responsible for seizing and dismantling failing banks.

Mr. Borosage noted that the six largest Wall Street banks today control assets equal to 64 percent of annual U.S. economic output and remain so large that their collapse has as much potential to bring down the U.S. economy and financial markets as in 2008.

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