Tuesday, March 19, 2013

JP Morgan shows it is too big to police by regulators

In his Huffington Post column on JP Morgan's "Whale" trade, Leo Leopold discusses how the bank is too big for the regulators to police and therefore it needs to be broken up.

Your humble blogger agrees with Mr. Leopold that JP Morgan has shown it is too big for the regulators to police, but I disagree with his solution (which has also been championed by regulators like Dallas Fed president Richard Fisher and FDIC vice chairman Thomas Hoenig and Economists like Simon Johnson).

I disagree because the solution assumes that we know what size bank the regulators can effectively police.  The history of the financial crisis doesn't suggest a specific size.

In addition, this solution focuses on size, which is a red herring argument, when the important issue is the amount of risk the bank is taking.

Your humble blogger much prefers that banks be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This provides two immediate benefits.

First, ultra transparency greatly expands the resources available to the financial regulators to police each bank and the financial system.  Specifically, it allows the financial regulators to tap the market's analytical ability.

For example, it allows the financial regulators to go to each bank's competitors and ask what exposures worry them the most that each of their competitor banks has.

Second, ultra transparency subjects the banks to market discipline.  Specifically, this information allows market participants to link the risk that a bank is taking with the return they require for investing in the bank.  It is this linkage between risk and return that allows market participants to exert discipline and restrain risk taking by the banks.

Since banks are currently not subject to market discipline due to the lack of transparency, introducing market discipline is likely to put pressure on bank management to reduce the risk of the bank.

Risk reduction can take some combination of reducing the asset size of the bank and the complexity of the organization.

For example, the large banks have literally thousands of subsidiaries that are engaged in arbitraging regulations and tax laws. Market discipline will give management an incentive to close these subsidiaries.

What is nice about market discipline is that there is no argument that the banks and their lobbyists can attack over what is the right size or degree of complexity for a bank.

Market participants vote by assessing the risk of the bank using the information disclosed under ultra transparency and only investing in the bank if it offers an adequate return for this risk.

JP Morgan Chase is much too big to police. Even though there are dozens of regulators who work each day inside the big bank, the relationship depends entirely on the cooperation of the banks. 
The regulators can easily be run around in circles, if the bank is intent on misleading them and hiding crucial information. 
By now it should be obvious to all of us, if a big bank sees a way to make big bucks they will do so even if it breaks every law in the books. 
Dodd-Frank has no chance of working. 
Prosecution won't work either asAttorney General Holder made clear because the banks are viewed as too big to jail without threatening the entire global financial system.

The only rational and just option is to put JP Morgan Chase out of business. It should be broken into much smaller entities as soon as possible....

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