Wednesday, May 23, 2012

Investment-services firm J.P. Morgan blew $2 billion on bad trades, and the total damage could rise to $5 billion. Though the Obama administration wants you to think otherwise, this is proof the market works.

Federal agencies already are pouncing. The Commodities Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC) and FBI have opened investigations even though J.P. Morgan has not been accused - so far - of wrongdoing and there is no indication that the bank is at financial risk. The White House hopes this massive loss can serve as a pretext for further regulation. If anything, J.P. Morgan’s mistakes demonstrate the robustness of market discipline.

The SEC and FBI are poring over J.P. Morgan’s regulatory filings - the public disclosures that are required under law for trades deemed to be risky. The CFTC has jurisdiction because it is supposed to regulate the market for credit derivatives, the financial instruments that were used to hedge a trade that went wrong and triggered the multibillion-dollar loss.

Even if the final damage tally reaches $5 billion, J.P. Morgan still will be in the black, with profits of $25 billion. The company’s assets are valued at $2.3 trillion, so the firm’s missteps are far from fatal with such a massive diversified portfolio. The only losers from this bad deal are the people who, if it had gone the other way, would have reaped the rewards: the J.P. Morgan employees who set up the deal and the investors. Instead, heads rolled within a week at J.P. Morgan, and the firm lost some of its value and reputation.

That’s exactly how financial markets are supposed to work. It is a risky business. The same people who stand to earn the rewards must bear the risk. The notion of a risk-free, error-free market is fundamentally flawed. Some trades inevitably will go wrong. What is important is to make sure that third parties - such as taxpayers - aren’t stuck with the bill when that happens. The alternative is to do what Congress did in 2008: bail out banks, breaking the link between risk and reward.

Regulators should ensure adequate disclosure so investors are aware of the risk they are taking on, but they aren’t even good at this limited task. Despite the massive oversight failures at the SEC that enabled Bernie Madoff’s Ponzi scheme to rip off $50 billion and regulators who didn’t notice the funds that went missing at MF Global Holdings, no bureaucrat was fired for this massive on-the-job failure.

The Obama administration claims the loss at J.P. Morgan highlights the need for the Volcker rule, which restricts trading activity and is mandated by the Dodd-Frank Act. The surest way to keep banks strong is not by adding more layers of bureaucratic regulation but by keeping the link between reward and risk tight. Enforcing market discipline means no more taxpayer-funded bailouts because there is no bank that is “too big to fail.”

Nita Ghei is a contributing Opinion writer for The Washington Times.

Copyright © 2023 The Washington Times, LLC. Click here for reprint permission.

Please read our comment policy before commenting.

Click to Read More and View Comments

Click to Hide