J.P. Morgan Trade Loss Opens Questions for Banks, Regulators, Consumers

NEW YORK (MainStreet) – Wall Street is buzzing about a $2 billion trade loss by banking giant J.P. Morgan (Stock Quote: JPM), leading to speculation that reformers will use the disclosure to press for tighter trading regulations on banks.

In the aftermath of the banking crisis of 2008, Congress enacted the Dodd-Frank Act. A key centerpiece of that legislation was the Volcker rule, named after former Federal Reserve chairman Paul Volcker.

The rule, designed to keep risky trades away from bank’s consumer lending arms, stipulated that banks should limit their trades to either carrying out trade orders from customers, or to safely hedge by offsetting one with trade with another. The latter is a murky, much maligned stipulation in the bank trading community, but Chase may have crossed the line just the same and likely invited a government regulatory review of its trading processes if reformers get their wish.

What happened at Chase? The trades, involving those much-maligned credit default swaps that helped set the stage for the economic collapse of 2008, were transacted on Morgan’s London synthetic trading desk over the past six weeks. The desk is a haven for in-house hedging strategies, which involve complex transactions, including hedges against speculative loans Chase made to at-risk companies.

Over the course of those six weeks, losses in the trading unit grew alarmingly, and even though gains in other trades offset the $2 billion trading loss, now the bank expects the London unit to post losses of $800 million in the quarter.

J.P. Morgan CEO Jamie Dimon was frank about the trading debacle, calling the loss “stupid” and an “egregious” failure in a trading unit that, ironically, was designed to modify risks for the bank. 

"There were many errors, sloppiness and bad judgment," Dimon said. "These were grievous mistakes, they were self-inflicted."

For consumers, it’s too early to say exactly what happens, if anything, from the Morgan trade fallout.The investment web site TheFlyOntheWall.com, a favorite for Wall Street insiders, announced earlier this morning that analysts at Stifel Nicolaus had already downgraded J.P. Morgan stock to “hold” from “buy.”

Past that, how the Chase trade pans out for Main Street consumers may largely depend on how traction, if any, reformers gain from the trading loss issue. J.P. Morgan certainly remains in good financial shape. The bank earns in excess of $4 billion per quarter, since 2010, and holds over $2.3 trillion in assets. But Dimon just met with the Federal Reserve of New York governor Daniel Tarullo last week to ask the Fed to curb its ongoing bank stress test program that measured how banks could stand up financially to heavy financial losses.

Even to a bank as large as Chase, $2 billion in six weeks represents a big loss. With U.S. taxpayers on the hook for a $1 trillion bailout on banks that are presumably “too big too fail”, the Chase $2 billion trading hit could renew calls from reformers to issue some tough love to banks -- even big, profitable ones.

"The enormous loss JPMorgan announced today is just the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making," said Senator Carl Levin in a May 10 statement. "Today's announcement is a stark reminder of the need for regulators to establish tough, effective standards."

The defining issue may be whether the Chase trades were simply poorly executed, or were a “tip of the iceberg” scenario where Wall Street is once again taking huge, unaccountable risks with bank assets.

Either way, count on Washington to take a closer look, with no appetite among taxpayers for any more big bank bailouts, and less faith among consumers that big banks learned any lessons at all from the banking collapse of 2008.