Memo to banking regulators: You can't control greed and ambition.
The announcement J.P Morgan Chase will lose at least $2 billion to some failed hedge strategy has unleashed a fierce debate about the need to implement the Volcker rule contained in the Dodd-Franks bill as well as a debate on the ability of such regulation to prevent this type of occurrence.
A few facts:
• No-one knows what has happened at J.P. Morgan and so it would be best to wait until we find out all the relevant facts before reaching a decision.
• J.P. Morgan Chase is, financially speaking, a very strong bank which, its chairman indicates, will report a profit this quarter even after the huge loss.
• No government bailout money is involved.
I started my banking career in the stodgy days of the early 1970's when interstate banking was illegal; banks could not pay interest on checking accounts; character was one of the factors considered in the credit evaluation process; mergers and outsourcing were unheard of and job security a given. Those were the boring days of a highly regulated industry.
But I was also working in international banking, probably the riskiest of all banking segments, and learned to deal from a servicing and controls stand-points with such back then esoteric activities as the Euro and the foreign exchange markets. I didn't generate the trades; I was responsible for insuring that they were properly accounted for and reported.
Over the years, we dealt with the failures of Herstatt bank (Germany, 1974, foreign exchange losses) ; the failure of Franklyn National Bank in 1978 due to heavy bets on the foreign exchange market (and some other illegal activities); and the failure of Baring Bank, UK, thanks to the unauthorized trade of its star trader Nick Leeson.
Looking back, what is really unique about banking is how often history repeats itself … and how unprepared we are each time for such events.
In the 1970's we believed that countries could not go bankrupt. That is what David Rockefeller, then chairman of Chase was saying, and so who were we "country bankers" to question that? Banks everywhere, including our twin towers of CBT and HNB, committed billions to foreign countries and foreign banks. Mexico defaulted in 1982 and all banks took billions in losses.
In the 1980s, banks spearheaded the rush into real estate financing. Remember the days when speculators would buy pre-construction condos only to flip them a few weeks later for a sizeable profit? Rest assured, bankers concluded, this time is different: we are better at risk management. That was just before Bank of New England collapsed.
In the new millennium we were blessed with the 'goldilocks economy': conditions were just perfect, economists kept telling us. This time around, home ownership was the new mantra: a house was the right of every American irrespective of ability to pay. No income verification and 100 percent financing were the norm.
And with the help of Wall Street, we perfected securitization: generate the loans, package them and sell them to some investor somewhere around the world. No one could possibly get hurt because we had diversified the risk among a large pool of assets and the rating agencies had blessed the paper with their highest valuation.
That turned out to be the mother of all meltdowns.
Now the Dodd-Frank legislation is supposed to prevent future meltdowns by killing the bankers with paperwork. I'm not sure it will be any more successful than past regulatory attempts were in preventing past crisis.
Problem is that we are trying to regulate two very powerful drives: the drive to make profits and the personal ambition of people who work in that industry. Each time regulators squeeze banks' profit margins, management becomes that much more willing to consider transactions which it may otherwise not considered were it not under pressure to come up with alternative sources of profits to continue pleasing Wall Street.
And of course the newest breed of bankers feel that they are so much smarter than the last group and, aided by powerful trading platforms, they feel invincible.
So, what to do now? I am sure some additional regulatory steps will be taken and just as surely they will not prevent the next meltdown.
Here is my advice to management: next time someone tries to sell you on some unique proposal and tells you that this time is different, do yourself (and all of us) a favor and kick them out of your office.
Paul Pirrotta is president of Paul Pirrotta International in Glastonbury and writes on global trade issues. Reach him through the company's website at: http://italy-usatraderep.com/aboutus.html.