'Whale' failure shows how little has changed

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May 18, 2012

'Whale' failure shows how little has changed

Anonymous Daily Star The Daily Star Fri May 18, 2012, 03:25 AM EDT

One positive development resulting from JP Morgan's recent $2 billion trading blunder is increased scrutiny of the regulations put into place since 2008 to prevent a repeat of that year's financial collapse.

The loss was blamed on London-based trader Bruno Iksil, who made bad bets on synthetic credit indices tracking corporate debt. JP Morgan Chase maintains that Iksil, dubbed the "London Whale" for his unusually large bets, was hedging against other risks the bank had taken.

Such bets on derivatives are notoriously risky, as institutions such as AIG, Merrill Lynch, Bear Stearns and Lehman Brothers learned during the 2008 meltdown. Those institutions were burned badly by bets on collateralized debt obligations and credit default swaps that eventually went bust -- becoming so-called "toxic assets" or "green slime."

One might argue that such losses are inherently a part of banking, and that depositors can hold such institutions accountable by moving their money elsewhere. In theory this is true, but a run on a bank the size of JP Morgan could be disastrous for the entire economy. Such institutions are often described as "too big to fail," as the entire U.S. financial sector could be put at risk -- or another taxpayer bailout necessitated -- on the whims of a few bank employees.

In 2010, Congress passed the Dodd-Frank act, which would restrict the ability of banks to gamble depositors' money on overleveraged assets and allow the government to carve up banks that are "too big to fail."

JP Morgan CEO Jamie Dimon has been leading the charge against such regulation. His credibility rests largely on JP Morgan's record of making it through 2008 largely unscathed.

But in today's anything-goes environment, even an ostensibly well-run institution like JP Morgan can fall prey to the temptation of trying for the big, bonus-inducing score on high-risk, high-reward financial instruments, as shown by the "London Whale." Last month when Iksil's bets raised eyebrows at The Wall Street Journal, Dimon dismissed such skepticism as "a tempest in a teapot," saying other banks make similar bets all the time.

Dimon's cavalier attitude should raise alarm and give lawmakers fresh urgency to enact the Dodd-Frank Act's Volcker Rule, which would ban proprietary trading but has waited in limbo for two years as lawmakers and lobbyists have squabbled over the rule's language and enforcement measures. In April, the Federal Reserve pushed the rule back until July 2014, saying it hoped banks would handle their own "good-faith planning efforts" until then.

President Barack Obama seems careful not to appear too tough on Wall Street during an economic recovery. But he would look much worse if, for lack of regulation, the same bank mismanagement that hamstrung the economy in 2008 repeated itself.