After big loss, D.C. shouldn’t cut to Chase

Lawmakers and regulators must resist the temptation to respond to JPMorgan Chase & Co.’s $2 billion trading loss with a knee-jerk reaction that leads to stricter regulation of big banks.

At this point, it isn’t even known whether the Volcker rule — which is being bandied about by proponents of more oversight as the antidote to JPMorgan’s gaffe — would have prohibited the catastrophic trades. Rather than immediately calling for tougher regulations, politicians, regulators and consumer advocates should encourage steps to discern whether the bank’s loss was, in fact, the result of reckless risk-taking or the unfortunate byproduct of wheeling and dealing in a free-market economy.

Headlines about JPMorgan’s loss again have put the issue of financial reform in the spotlight, rekindling debate about whether Wall Street is in need of stricter regulation. Whenever a giant bank, brokerage firm or insurance company discloses that it mismanaged its own risks, all financial services companies find themselves under suspicion of putting profits ahead of investor protection.

Predictably, some lawmakers and consumer advocates are pouncing on the opportunity to use JPMorgan’s loss to renew calls for the implementation of more provisions contained within the Dodd-Frank financial reform law, especially the Volcker rule. The Senate Banking Committee last week announced plans to hold hearings looking into Wall Street regulation, in which the JPMorgan debacle is sure to be a jumping-off point.

President Barack Obama said that the fact that a well-run bank such as JPMorgan experienced such a loss highlights the need for closer regulation of the industry.

Others — including Elizabeth Warren, who is running for the U.S. Senate in Massachusetts — are using JPMorgan’s blunder to call for the resurrection of the “33 Glass-Steagall Act, which kept commercial banks out of the investing business from the Great Depression until 1999.

“It’s unfortunate but true that when a giant investment bank with lots of smart people can’t figure out how to manage their own risks, it doesn’t reflect well on the financial services industry in general,” Michael Kitces, director of research at Pinnacle Advisory Group Inc., said after JPMorgan chief executive Jamie Dimon acknowledged that the bank had lost $2 billion by holding losing positions on synthetic credit securities and could face $1 billion more in losses.

Unfortunately, neither Mr. Obama nor other proponents of stricter regulation have taken the time to let all the facts emerge. Rather, they have made assumptions about what caused the loss, and what rules and regulations would have prevented it — had such rules been in place.

Rightly or wrongly, JPMorgan’s misstep bolsters the argument in favor of more regulation.

“POWERFUL CASE’

The loss makes a “very powerful case” for tougher rules on banks, Treasury Secretary Timothy Geithner said last Tuesday at the Peter G. Peterson Foundation’s third annual Fiscal Summit in Washington.

“This failure of risk management is just a very powerful case for reform, for financial reform — reforms we still have ahead and the reforms we’ve already put in place,” he said.

“The test to reform is not whether you can prevent banks from making errors of judgment or risk management; that’s going to happen — it’s inevitable,” he said. “The test of reform should be: Do those mistakes put at risk the broader economy, financial system or the taxpayer?”

Mr. Geithner is right.

Lawmakers and regulators should consider carefully whether JPMorgan’s misstep had the potential to destabilize the global financial system. If it did, then steps should be taken to enact rules and regulations to prevent that — but not before all the facts are unearthed.