Last week's JP Morgan blowup has now put any lingering questions to rest:
Wall Street banks simply cannot be trusted to manage the massive risks they are taking.
After the financial crisis, when most of the world's banks were revealed to have been run by reckless gamblers, a couple of institutions stood above the fray.
JP Morgan was one of them.
The idiocy of a handful of gamblers should not be construed as a problem with the system as a whole, institutions like JP Morgan said.
Well-run banks should be trusted not to be so colossally reckless and stupid. Well-run banks should be allowed to manage their own risks. Well-run banks should not be hammered with strait-jacket regulations that would stymie their marvelous money-making innovation. Well-run banks should be free to look after themselves, like responsible adults.
The banking lobbying engine rushed this message to Washington and threw money around. And the bankers quickly persuaded Congress that Wall Street was fine, that the financial crisis was an aberration, that Wall Street should be left alone
JP Morgan was the prime engine of this message. And its brilliant CEO, Jamie Dimon, was Wall Street's defiant Adult In Chief.
(And I mean "brilliant" in all seriousness. I am a huge Jamie Dimon fan. The fact that this could happen to his bank makes clear that it could happen to anyone's.)
Dimon had credibility, because unlike all the other incompetent banks, his bank hadn't imploded and brought the system to the edge of catastrophe.
And unlike all the other CEOs, to his great credit, Dimon actually talked like a human, with language and confidence that persuaded even skeptics that he knew what he was talking about.
But now JP Morgan has blown up. just like all the other banks.
So we finally know the truth about Wall Street, a truth most Wall Street observers have known all along:
Wall Street can't be trusted to manage—or even correctly assess—its own risks.
This is in part because, time and again, Wall Street has demonstrated that it doesn't even KNOW what risks it is taking.
In short, Wall Street bankers are just a bunch of kids playing with dynamite.
There are two reasons for this, neither of which boil down to the "stupidity" that most people generally assume is involved. The bankers who place these bets are anything but stupid.
- The first reason is that the gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as "weapons of mass destruction." And those weapons have gotten a lot more complex in the past few years.
- The second reason is that Wall Street's incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else—the government or shareholders—covers the downside.
The second reason is particularly insidious. The worst thing that can happen to a trader who blows a huge bet and demolishes his firm—literally the worst thing—is that he will get fired. Then he will immediately go get a job at a hedge fund and make more than he was making before he blew up the firm.
Meanwhile, if the trader's bet works—and the bigger the better—he'll look like a hero and collect an absolutely massive bonus.
If you had those incentives, you would do exactly the same thing that Wall Street traders do: Bet the company, day after day. (It's not your company, after all, so who the heck cares?)
So, what's the solution?
Congress needs to:
- Increase bank capital requirements, so even massive bets can't threaten the system
- Once again, separate banking from gambling. Glass Steagall worked very well for 70 years—let's bring it back.
- Lay out a plan, in advance, to manage the failure of even the largest financial institutions—by stepping in, seizing the bank, firing management, zeroing out shareholders, haircutting bondholders, and then injecting new SENIOR capital (fully protected) into the firm before re-floating or selling off it. This will allow the entity to keep operating, and it will stick the losses where they belong—with the idiots who bought the bank's stock or loaned it money. Meanwhile, the systemic threat will be eliminated.
That's the answer.
And now that JP Morgan has proven that even the best banks don't know what they're doing, it's time for Congress to finally make it happen.
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