I was debating someone earlier who took the following position:
“All this uproar around JP Morgan’s big loss is unwarranted. Sure, investors lost a bunch of money on a bad, sloppily-managed bet. But that’s the point: investors, not taxpayers, lost money. If anything, this shows that Dodd-Frank type reforms are not necessary.”
To which I say: nonsense.
First, a deal involving derivatives of this magnitude, where the inherent risk was so poorly understood, could easily have generated losses multiples higher than the ones we’re learning about now–losses that are growing, btw.
But the more important reason why it’s nuts to go to the “reform-is-irrelevant” place is that at the heart of Dodd-Frank is something I’ve written about a lot here: deeper capital reserves. To their credit, JPM had enough of a capital cushion on hand to absorb a large loss like this. But that’s no accident. It’s a direct outcome of Dodd-Frank’s capital reserve requirements and the subsequent actions by large banks to build up their reserves in anticipation of the new rules.
The fact of inadequate reserves–overleveraged banks whose bets couldn’t be covered by their capital on hand–was a major factor in the crash, and if anything, this episode reminds us just how important it is to get this right going forward.
To suggest the opposite–that this somehow shows reform is not necessary–is like saying sure, we crashed the car into a wall but the airbags deployed and only the passengers, not any bystanders, were hurt. Therefore, we don’t need airbags.