A JPMorgan office building is shown, Monday, May 14, 2012, in New York. JPMorgan Chase, the largest bank in the United States, said Thursday that it lost $2 billion in the past six weeks in a trading portfolio designed to hedge against risks the company takes with its own money. (AP Photo/Mark Lennihan)
WASHINGTON—The $2 billion
trading loss at JPMorgan Chase has renewed calls for stricter oversight
of Wall Street banks. Two years after Congress passed an overhaul of
financial rules, many of those changes have yet to be finalized.
JPMorgan's misstep gives advocates of stronger regulation an opening to argue that regulators should toughen their approach.
The
Obama administration has argued that it went as hard on banks as
possible without further upsetting global finance. Now Democratic
lawmakers and administration officials say JPMorgan case proves that
more change is needed.
Still,
many in the industry warn against reading too much into one trading
loss. They say losing money is an inevitable part of taking risk, as
banks must.
Some fear that
after JPMorgan's announcement, regulators will greet industry concerns
with more skepticism as they flesh out key parts of the overhaul law.
Here's a look at four key parts of the financial overhaul and how they might be affected by JPMorgan's losses:
This
provision restricts banks' ability to trade for their own profit, a
practice known as proprietary trading. It is named for former Federal
Reserve Chairman Paul Volcker.
--
Battle lines: Banks say it disrupts two of their core functions:
Creating markets for customers who want to buy financial products and
managing their own risk to prevent major losses.
They
say proprietary trading was not a cause of the 2008 financial crisis
and the rule is a means of political revenge on an unpopular industry.
Advocates of stronger regulation argue that the rule would have
prevented JPMorgan's loss. They say the trades were made to boost bank
profits, not to protect against market-wide risk.
--
State of play: A draft of the rule satisfied neither side. It includes
exceptions for hedging against risk and for market-making, but banks say
they the exceptions are too narrow and difficult to enforce. It's
nearly impossible to tell whether a bank bought or sold something for
itself or for customers.
--
JPMorgan effect: Attitudes about the Volcker rule are likely to shift as
a result of JPMorgan's disclosure, experts say. Even if JPMorgan's
trades truly were a failed attempt to protect against risk, the
resulting loss strengthens the argument that regulators should err on
the side of scrutinizing trades.
During
the 2008 financial crisis and the bailouts that followed, the
government was unwilling to let the biggest banks fail, for fear of
upending the financial system. As part of the overhaul, Congress created
a process to shut down financial companies whose failure could threaten
the system.
-- Battle lines: Most players agree that this is a good idea, despite some differences on the details.
--
State of play: The Federal Deposit Insurance Corp., the agency
responsible for closing smaller banks that falter, has taken the lead on
writing rules to shut down big firms. Most observers believe that the
FDIC, under acting chairman Martin Gruenberg, is on track toward
creating a system that markets would trust to close a big bank.
Banks have been working with
regulators to create "living wills" detailing how they would wind
themselves down without disrupting markets. This exercise has forced
them to look more deeply at their operations -- a defense against the
accusation that banks have grown "too big to manage."
However,
U.S. regulators can't do it alone. A big problem after the failure of
Lehman Brothers investment bank in 2008 was what to do with its overseas
operations. It wasn't clear which regulators were in charge, or whose
bankruptcy court would control the disposal of Lehman's assets.
Regulators
are negotiating with their European counterparts, but it could take
years before they agree on rules that would allow a global company to
dismantle itself without spreading confusion through the financial
markets.
-- JPMorgan effect:
Like other banks, JPMorgan supports giving the government the power to
dismantle a failing bank. CEO Jamie Dimon said so clearly in an
appearance on "Meet the Press" on Sunday.
JPMorgan's loss probably doesn't affect the likelihood that regulators will break up a bank in the future. The loss wasn't nearly big enough to threaten JPMorgan with failure.
JPMorgan's loss probably doesn't affect the likelihood that regulators will break up a bank in the future. The loss wasn't nearly big enough to threaten JPMorgan with failure.
JPMorgan's
bets involved complex investments known as derivatives whose value is
based on the value of another investment. Before 2008, many derivatives
were traded as individual contracts between banks and hedge funds,
without any transparency for regulators. The financial overhaul sought
to bring more derivatives onto regulated exchanges and force derivatives
traders to put up more cash in case their bets turned against them.
--
Battle lines: Overhauling the rules governing this market, estimated at
$650 trillion, has proved as complex as the investments themselves.
Banks support many parts of the overhaul but generally argue that
forcing too much transparency would make it harder and more expensive
for companies to use derivatives as a hedge against risk. They say it is
an unnecessary cost that would be spread across all types of companies.
The
agency most responsible for implementing these rules, the Commodity
Futures Trading Commission, faces the threat of a much smaller budget
than it says it needs to write the rules and increase its oversight of
the derivatives market.
Advocates
for stronger regulation argue that the new rules apply to the sorts of
derivatives believed to have magnified the financial crisis -- and
JPMorgan's losses -- but do not threaten investments like energy
futures, for example, which airlines use to control fuel costs. They say
banks are just trying to protect a lucrative business that other
companies can't compete in today.
--
State of play: About half the rules are done, but many crucial
questions have yet to be decided. The rules will be phased in this fall
through next spring. Banks are lobbying hard to protect their hold on
this profitable business. Banks support pending legislation that would
limit U.S. regulators' control over derivatives trades by their overseas
affiliates.
-- JPMorgan
effect: Fairly or not, JPMorgan's big loss on derivatives trades is
likely to revive scrutiny of that market. That could give advocates of
tighter rules some juice in ongoing negotiations with regulators. It
also could empower those who believe the budgets of the CFTC and
Securities and Exchange Commission should be increased to reflect the
need for broader oversight.
BANK OVERSIGHT
The
overhaul calls on the Federal Reserve to oversee the biggest and most
important financial companies and apply a stricter set of standards for
financial fitness. For example, the companies must hold more capital as a
buffer against future losses. Before, the biggest banks were overseen
by a patchwork of regulations.
--
Battle lines: Industry officials say they're working with regulators to
fine-tune how big companies will be overseen. They are concerned, for
example, about the extra costs imposed on the big companies to offset
the extra risk they create in the financial system.
--
State of play: Industry officials say many of these changes were
happening behind the scenes even before the financial overhaul was
passed in 2010. They say banks already are better capitalized and meet
other standards laid out by regulators.
It's
still not known exactly which financial companies will fall into this
category. The biggest banks are included automatically. Regulators have
more discretion when it comes what are known as non-bank financial
companies, such as huge insurance companies. Companies on the margin
reportedly are lobbying hard to avoid this designation.
--
JPMorgan effect: As the nation's biggest bank, JPMorgan automatically
will face stricter oversight. The trading loss there is unlikely to
affect detailed negotiations about how exactly such companies will be
overseen.
By
Daniel Wagner AP Business Writer
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