May 19, 2012 – 11:38 a.m.
Political Economy: Morgan’s Ghost
By John Cranford, CQ Columnist
There’s been a great deal of hand-wringing during the past week and a half about J.P. Morgan having lost $2 billion through a series of ill-considered hedge trades that involved credit default swaps and other complicated derivatives. But this talk is silly. J.P. Morgan died in 1913 (unless we’re referring to his namesake son, who died 30 years later). Both are long past losing money, although their specters are still quite capable of provoking the public.
If the references to financial loss in the news are to J.P. Morgan Chase & Co., the nation’s largest bank and the principal successor to the House of Morgan, the assertion is not exactly true, either. Corporations may be people in the minds of some, but they don’t exist outside some temporal legal framework. Whatever money comes in is never the corporation’s to keep.
So these losses — which may amount to $4 billion by the time the trades are all settled and the vultures have finished plucking at the carcass — will be borne by investors who bought shares in the bank. They’ll receive smaller dividend payments and, if they sell their stakes, they’ll reap smaller gains.
That’s called capitalism. And, lest we forget, that’s the way things are supposed to work in this economy. (We’ll get to the separate question of what this means for bailouts.)
Johnson may be right about that, or he may have succumbed to wishful thinking. But he went on to focus on an issue that gets to the heart of the hand-wringing. “The fact that this can happen at a bank with a solid reputation like J.P. Morgan is evidence that our banking regulators must remain vigilant,” Johnson said.
That really is the nut of the matter: that this episode once again shows that we are vulnerable to forces beyond comprehension. In the wake of the financial crisis, everyone is afraid that big banks can wreak havoc with the economy and that their basic business has become too arcane, too mercurial and too radioactive to be trusted.
Johnson’s prescription for vigilance notwithstanding, there are doubts that regulators could have understood the portfolio hedge that J.P. Morgan undertook until after it played out, not to mention determine whether it was appropriate. If J.P. Morgan’s investment managers didn’t realize that their models weren’t working properly until it was too late, how could an outsider see the problem sooner?
Big Is Bad
Behind all the noise is the conclusion on the part of populists on the left (and perhaps those on the right) that J.P. Morgan and its ilk are just too big. It’s the same view — not surprisingly — that led to enactment of the 2010 Dodd-Frank law and especially its “Volcker rule” provision barring proprietary trading by insured depositories.
The inescapable conclusion is that when big banks fail — especially when the failure puts the deposit insurance system at risk — they require big bailouts. It’s a concern that dates to the 1984 collapse of Continental Illinois National Bank and Trust Co. and that has come to dominate regulatory debates. Congress has periodically tried to rein in “too big to fail” banks, but to no avail. The proof is that the government now effectively owns Fannie Mae and Freddie Mac, and doesn’t know what to do with them.
There’s essentially nothing in Dodd-Frank that would require a $2 trillion bank such as J.P. Morgan to shrink in size, unless it clearly posed a “systemic” threat to the financial system. It may even turn out that Dodd-Frank, in its implementation, allows the sort of hedge trade that went south on J.P. Morgan. If so, what then?
Political Economy: Morgan’s Ghost
Lawmakers and sometimes presidents, responding to their anxious constituents, have routinely lashed out at financial powerhouses. As long ago as 1832, President Andrew Jackson campaigned for re-election against the Second Bank of the United States. As recently as last week, 20 Republican senators — many with tea party credentials — voted against what at other times would have been the routine confirmation of two Federal Reserve governors, in what was plainly a protest against the Fed’s role in the economy.
To that end, it isn’t inconsequential that Congress had the breakup of the Morgan empire in mind when it enacted the 1933 Glass-Steagall Act. Yet J.P. Morgan is today the No. 1 U.S. bank by assets, and its Depression-era offshoot, Morgan Stanley, is No. 7.
It remains to be seen what legislative or regulatory changes the latest episode might yield. But it’s plain the ghosts of the Morgans still haunt the corridors of the Capitol.