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David Crisanti Headshot

Citizen Bane

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I agree with Jonathan Macey's opinion piece in Tuesday's Wall Street Journal ("Losing Money isn't a Crime") that we don't need to vilify JPMorgan for a trading loss. However, we also don't need respected newspapers promoting the views of academics, lawyers, and ideologues in shaping the Volcker rule any more than we need the court appointing a bond trader to defend George Zimmerman.

Mr. Macey, a law professor and Hoover Institute member, argues that everyone should just settle down about this trade because it was hedge people! And that as such there are offsetting gains elsewhere. There is speculation as to what JPM's exact trades were, but what is clear is that they were not a hedge. If it were an actual hedging strategy it wouldn't have caused a net loss (or gain -- it would have reduced gains or losses elsewhere) and JPM would not have announced it or fired those involved. Mr. Macey can wait for the news conference where JPM reports the net gain on the strategy along with those waiting for Columbia Pictures to announce that Ishtar was a homerun after DVD sales.

Macey, like most WSJ op-ed contributors or Hoover Institute members (possibly redundant since a Venn diagram of the two would look like a lunar eclipse) doesn't like the idea of any impingement imposed on banks. He writes that the only folks harmed in the JPM loss are traders who will lose their bonuses and jobs, so why regulate? In actuality the fact that those responsible will not help pay for these losses out of their own past compensation shows why the current banking regime doesn't work. Specifically it points to the only two sentences necessary in a Volcker rule that would fulfill its aim of removing excessive risk and moral hazard from the financial system: For systemically important financial institutions any employee's annual compensation in excess of $750,000 will be retained by the firm and used to pay down subsequent losses should they arise. The retained capital does not vest until the employee has left the firm and the positions for which he as been remunerated no longer exist.

As long as employees don't have to dip in to their own pockets to help make the bank whole after losses, excessive risk will continue no matter what the now bloated and convoluted Volcker rule reads. The elimination of asymmetrical payouts for traders and executives would unambiguously return the banking sector to a tolerable level of risk as it was pre-1990 when investment banks were private partnerships and publicly traded money center banks were prevented by Glass-Steagall from investment banking.
Dimon is quoted as saying JPM "will do the right thing and that may mean clawbacks. But these might be insufficient as no investment bank retains a meaningful reserve of an employee's past compensation -- the norm being 70 to 75 percent of pay vests immediately, and the rest in only three years. Moreover, unless Dimon is including himself among those potentially clawed back he isn't doing the right thing. The $5 billion that the CIO's trading desk made in the previous three years (10 percent of the firm's profits over that time) contributed (10 percent?) to Dimon's compensation in that period, and he (and others who were paid on it) should give some back if the loss turns out to be large enough that merely reducing this year's compensation to zero doesn't cover it. That's the right thing, and it should make Dimon and others more alert and hesitant to allow egregiously large exposures forming at their company.

My advocacy of returning symmetry to banker pay is admittedly and thankfully no longer unique as many (though seemingly not those crafting the Volcker rule) recognize its obvious merits. And the opinion is not based on the JPM incident it's based on common sense views of human nature and ease of implementation.

However, the papers are using the JPM loss as a referendum on banking regulation -- should we or shouldn't we. But that is disingenuous as we don't yet know enough about JPM's exposure. Though they have (rather unusually) told the market that they are in a losing position while it is still on, they have understandably not made public exactly what those positions are.

The coverage of this trade highlights one of the reasons our society seems to be bifurcated and Washington in gridlock. Instead of presenting the story for what it is -- a man swelled by hubris is dealt a blow but faces the music in a relatively quick manner -- the WSJ (and others) used the issue to publish polemics. On Friday, even as articles in the WSJ were documenting how the trades were probably not a hedge, the Journal printed an opinion piece by Lawrence Lindsey that denounced regulation and (again) stated that the JPM trade was a hedge.

The WSJ doesn't have a monopoly on publishing opinion pieces by writers of questionable expertise that happen to agree with the paper's worldview.

The New York Times, publishers of Gregg Smith, held true to form in this case too. Googling "nytimes jpmorgan trade regulation" the first link returned a piece written by a lawyer on why the trade highlights the need for more regulation. The next link was an article by a professor of economics with the same view.

In being so predictable each paper diminishes its credibility. I have been surprised and confused when I see journalists finish towards the bottom of surveys regarding which professions are the most trustworthy or admired.

Who doesn't admire the great investigative reporting that regularly appears in newspapers like the WSJ such as the articles detailing the evolving Bo Xilai situation? But I think survey respondents have publishers, editors and op ed pages in mind (not journalists) when they give these low rankings.

The JPM incident may yet be an important event with real evidence for or against regulation. But so far it's not even much of a story since lovers of schadenfreude are being denied a real prize because Dimon, unlike Madoff and Dreier (and Stewart and Paterno), was willing to admit early on that something went awry. But only if the exposures prove to have had legitimate potential for losses far in excess of $2 billion can the item then be honesty related to the issue of regulation.

Next up for the op-ed pages will be the Facebook trading glitch and how a thirty-minute delay in the opening of the stock means our markets are out of control and regulation is needed. Or that the glitch was harmless in the scheme of things and shows how resilient our trading platforms are without regulation. Though the glitch means neither, we know which side each paper will take. This is a loss for us all, since in addition to reducing the quality of dialogue, it keeps us from discussing real issues like the fact that earlier in the month Broadsoft (BSFT ) traded down 5 percent the day before announcing disastrous earnings (and a further 18 percent decline), and if this kind of suspicious trading activity relates to the ongoing exodus of retail investors from our markets.