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Saturday, 19 May 2012

Stop the banks from gambling!

The JPMorgan Chase debacle is ample reminder that banks are dangerously risking money on dubious bets with dire consequences if they are not stopped. 

US giant financial services group JPMorgan Chases trading debacle which has already lost US$2bil and which threatens to raise losses to double that, will likely put pressure for greater regulation of the banking industry, not just in the United States but around the world.

That is as it should be for despite the 2008 financial crisis which resulted from bankers structuring complex and questionable credit derivatives which few understood but many bought because they believed the rating assigned them by unknowledgeable credit rating agencies, the lessons dont appear to have been learnt.

With massive US government help, many banks which were on the brink of failure were rescued and the memories of those tempestuous times when the future of not just the banks but the worlds financial system was in jeopardy seems to have faded away from public consciousness.

Until now that is.

JPMorgans debacle is but a stark reminder that little has changed since the 2008 world financial crisis in terms of how banks operate and that the world is still held to ransom by rogue traders and others who risk shareholders funds and depositors money as easily and as nonchalantly as spinning the dice on a gambling table for a few dollars.

The sad truth is that little has been done despite all the rhetoric to ensure that the predatory chase for profits by banks does not involve gambling with shareholders equity and deposits. Players still get away with massive profits and bonuses when they succeed and little more than slap on the wrist when things go wrong.

It is an indication of a financial world that has gone awry as players such as hedge funds effectively search for new games to play in a massive, borderless casino where the uninitiated are quickly gobbled up and the others play high-stakes games in which some must become major losers.

This comment by Mark Williams, a professor of finance at Boston University, who has also served as a Federal Reserve Board examiner quoted in the New York Times aptly sums up JPMorgans mistake:

JPMorgan Chase has a big hedge fund inside a commercial bank. They should be taking in deposits and making loans, not taking large speculative bets.

The trades by JPMorgan are complex to say the least and no one really seems to understand them. The New York Times reported that the complex position built by the bank included a bullish bet on an index of investment-grade corporate debt and was later paired with a bearish bet on high-yield securities.

The report further said that the trading losses suffered by JPMorgan have accelerated in recent days and have surpassed the banks initial estimate of US$2bil by at least US$1bil. Part of the reason for this is that hedge funds already know JPMorgans position is under pressure and are piling in on the opposite trade. That means the US$4bil losses anticipated may materialise sooner rather than later.

While the US$4bil loss wont threaten JP Morgans capital base, the question that must arise is what if the losses were much bigger and they could well have been. JPMorgan would most likely be considered one of those banks that cant fail and would have been rescued by the US government.

To stop exactly such situations, the Obama administration had put up the Volcker Rule named after former Federal Reserve chairman Paul Volcker who helped formulate it but the legislation is still being hammered out. The rule basically seeks to prohibit banks from trading for their own account.

But there are exceptions and these allow banks to aggregate their positions and offset their exposures in a single hedge. Some feel that JPMorgans so-called hedge an oxymoron in this instance as it hedged nothing falls into that category but others dont.

For most of us, the solution is quite simple and straightforward if you are a bank and you take depositors money, you got no business speculating using that money, especially since you also have access to low-cost funds from the Fed and elsewhere by virtue of being a bank.

But it is an election year in the US and the silly season of course, much like it is here.

Remember, free enterprise and the capitalist system on which the US is built. You cant restrict free enterprise, the reasoning goes, even if it is your money the bank is using.

Big business has big money and they are using that to try and put Mitt Romney into the White House. If that happens, then it may well be bye-bye to banking sector reform which would be bad for the United States and the world.

New York Times columnist and renowned economist Paul Krugman was very blunt in his analysis of the JPMorgan debacle at the end of which he basically thanked JPMorgan Chases chief executive Jamie Dimon for confirming that the banking sector needs greater regulation.

Krugman, an unashamed and unabashed Democrat, has been one of those opinion makers who has been consistently calling for greater regulation of the US financial sector in the wake of world financial crisis.
JPMorgan, relatively unscathed by the world financial crisis sparked off by the subprime crisis but now in trouble through a trade engineered by a trader in London known as The Whale, is a timely reminder that little has been done to stop the recurrence of another world financial crisis.

Let us take heed before it is too late.

Independent consultant and writer P Gunasegaram sometimes thinks that the financial world is just one whole, big, casino of unimagined proportions. The trouble is no one knows who owns it.

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