Normally, government should not concern itself with a business' operations, but when taxpayer money and the public welfare are at risk, it has a responsibility to investigate. That was the premise of Senate Banking Committee Ranking Member Richard Shelby's (R-Ala.) opening remarks during a recent hearing where JPMorgan Chase Chairman and CEO Jamie Dimon answered questions about trading losses totaling over $2 billion sustained by his firm late this spring.
As Shelby noted, Congress was concerned that the incident may illustrate a threat to the financial system and to the economy as a whole. Multiple federal agencies, including the FBI, are investigating. And many commentators have been pointing to the losses as evidence that more financial industry regulation is needed.
However, before they rush to impose more rules, lawmakers need to consider three key questions. Was this a case of systemic risk? Were taxpayers at risk? Does this episode indicate a market failure or illustrate a need for greater regulation? The answer to all of these questions turns out to be "No."
As Dimon explained in his opening statement, JPMorgan Chase had created a small division within its Chief Investment Office (CIO), to manage risk and guard against a possible "systemic event"—such as a bank failure—by overseeing a "synthetic credit portfolio" of derivatives.
However, as Shelby noted, at least some employees within this division had multiple conflicting mandates, to use trades to not only manage risk but also turn a profit, which they referred to as, "the icing on the cake." In short, changes in risk modeling and a lack of managerial oversight along with human error put the division in a bad position.
JPMorgan Chase appears to have reacted the best way it could. As trading losses mounted, Dimon chose to publicly disclose the episode on May 10. At the hearing, Dimon said that even with the losses fully accounted for, JPMorgan Chase expects to report billions of dollars in earning for the second quarter 2012. He also noted that the firm has replaced the leadership of the CIO, comprehensively reviewed risk management procedures, and implemented revisions universally. Its Board is currently conducting an independent investigation as well.
JPMorgan Chase's enormous size—it loaned well over $1.5 trillion to businesses and entrepreneurs in 2011—helped it weather this storm. The losses were easily absorbed by cash reserves and did not affect the many other areas of its business. There was never any possibility the Federal Deposit Insurance Corporation would need to step in, never mind require a taxpayer bailout. Likewise, no systemic risk was posed. The bank sustained the hit as well as any organization could be expected to.
The decline of the firm's stock price reflects concern about managerial judgment and procedures, not its diversified, rather conventional business model. That the bank lost money is a sign that market discipline still holds some relevance in the post-meltdown, bailout-era financial sector. We have a profit and loss system, as Milton Friedman always emphasized.
This was a big deal to JPMorgan Chase, obviously, but it should not be the concern of the government. The most troubling aspect of the hearing was the detailed, technical nature of the frankly unqualified Senators' questions about the firm's practices, Dimon's knowledge and decision-making processes, the intricacies of structured finance, and the operations of the CIO. Micromanaging any industry, never mind financial services, creates uncertainty that impairs its basic functioning. And in any case, lawmakers' should not be trying to read CEOs' minds.
Jamie Dimon and his team have already managed, analyzed, learned from, and moved beyond their business' private crisis. That process was well underway before anyone outside the company knew what was happening. The Senate, the regulatory agencies, the FBI, and government in general are behind the curve. All they can do at this point is unnecessarily interfere.