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Outside editorial: The bad old days of risky derivative trading never left

Posted: May 17, 2012 - 12:07am

The following editorial appeared in the St. Louis Post-Dispatch:

For the vast majority of Americans — 99 percent, to borrow a phrase — banking is commercial and relatively simple. A checking account, a savings account, a credit card or two. A mortgage, a small-business loan or a line of credit for daily business cash flow.

But at the 1 percent level, where investment banking is done, banking is extraordinarily complicated and extraordinarily rewarding. The risks, as the nation discovered in 2008, are hideous, but that’s what the public is for.

This is why JPMorgan Chase’s admission Thursday that it had suffered a $2.3 billion loss and an $800 million gouge in its earnings from unmonitored derivatives trading is so distressing. The bank was playing with house money, not client money, and at least some of it was commercial deposits insured by the federal government.

It was as if the 2008 financial meltdown had never occurred. It was as if JPMorgan never had accepted (and paid back) $25 billion in federal bailout money. It was as if the Dodd-Frank financial reform bill never had been written. It was as if JPMorgan, the nation’s biggest bank, had realized that as a “Systemically Important Financial Institution” it is officially too big to fail and will do whatever it damn well pleases.

To be sure, Thursday’s announcement included expressions of regret for “errors, sloppiness and bad judgment” from Jamie Dimon, the bank’s chairman and CEO. But Mr. Dimon also was defiant; he has been a leading critic of efforts by U.S. and international banking regulators to crack down on risky trading behavior.

At the heart of these efforts is the so-called “Volcker Rule” that will go into effect in two years. That is, unless Congressional Republicans and compliant regulators succeed in further gutting it before the rule is finalized.

Former Federal Reserve Chairman Paul Volcker insists that banks should be prohibited from proprietary trading — trading with bank money instead of making trades on behalf of specific clients. Banks succeeded in watering it down when the Dodd-Frank bill was before Congress; those efforts continue as regulatory agencies continue writing the final version.

Mr. Dimon insists that the $2.3 billion loss was caused by a traders making “hedging” trades — insuring against potential losses on other trades — rather than proprietary trades involving the larger bank portfolio. The claim is absurd.

It’s obvious that Bruno Iksil, the so-called “London Whale” at JPMorgan’s Chief Investment Office, wasn’t investing for specific clients when he took on $100 billion in credit default obligations, betting on the upward performance of “Markit CDX.NA.IG.9,” an index tied to what other investors thought of 121 corporate bonds.

No, he was doing what investment bankers do, trying to create profits and bonuses out of thin air by betting on derivatives that have only remote ties to actual money, don’t create any jobs and serve no actual social purpose.

The Whale’s huge position attracted hedge fund harpooners. They drove the price down by betting against him, and also betting against the very bonds within the index fund. JPMorgan’s $2.3 billion loss is their gain and as hedge fund managers, they’ll pay taxes of 15 percent on their gains, not 35 percent on earned income. The Republicans want to keep that deal in place, too.

Americans have very short memories, but this is the primrose path that led to recession, epic income inequality, deeper deficits and lingering high unemployment. Remember?

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