The columns, blogs, tweets and sober cud-chewing over the J.P. Morgan Chase & Co. trading debacle continues. What have we learned? Well, not as much as you'd think, given the notion that the Internet is the greatest investigative reporter since Woodward and Bernstein. We know J.P. Morgan made some complex bets with excess deposits from its London chief investment office unit; we know that it was hedging/betting against a credit default swap index. We know that some bets were bearish and some were bullish (Andrew Ross Sorkin told us that on Monday, trying to simplify), but they weren't symmetrical, rendering the hedge imperfect. We know at some point that those bets turned bad -- hedge funds piled on to bet against the bank -- resulting in Jamie Dimon's Worst Career Moment Ever, probably more embarrassing than his falling out with Sandy Weill's daughter all those years ago. While heads are ritually rolling, we don't yet know what Dimon, who is mea culping like crazy, knew or didn't know, or what would stand up as credible evidence of either. Did CIO Ina Drew gild the lily for him? Was he preoccupied with other matters, like the Volcker Rule? How could he not have known about a position that large and one that was (let us not forget) in newspapers he probably, if angrily, peruses?
The fact that we still don't know all that much about the trade suggests there's a transparency problem. How can shareholders value a bank when such large positions are unknown? And what about those regulators? It's obvious, to say the least, that, as Joe Nocera points out in yesterday's New York Times, that Drew and her folks were too highly compensated to operate purely as a risk-reducing hedging operation. They clearly were tasked with making money, and given the sheer size of the bank's excess deposits -- another big political problem that Felix Salmon pointed out on Monday -- one does wonder if the bank isn't too large to operate efficiently, that is to manage. But you always come back to Dimon. Every time Dimon is mentioned, so too is the can-rattling meme that he knows risk management better than any other bank chief, and that his skill and foresight allowed him to guide the bank safely through the financial crisis. But do we want a whole banking system that depends upon the perfect judgment of a genius? Dimon, after all, can only run one bank at the time. Is that any way to run a banking system? For years now, Dimon, as a Weill protégé, was known for his operational knowledge and sharp nose for risk. Like Weill (who is little appreciated these days), he was risk-averse. But it wasn't as if Dimon exactly saw the financial crisis coming -- though that's often implied. It wasn't as if the bank wouldn't, under other circumstances, have loaded up with subprime. It was at least partially the case that Dimon spent the years before the crisis slimming Chase down, reorganizing, restructuring and digesting the Bank One acquisition (and J.P. Morgan & Co. before that). He did a fine job at that, but there's an element of timing as well.
Obviously (since everyone says so), the big trading loss (size still unknown too) revives a) a tougher Volcker Rule, b) talk of reducing the sheer size of the biggest banks, c) renewed interest in higher capital levels and lower leverage. J.P. Morgan has now done more to make the argument for all three than any rambling talking points by politicians, regulators and sainted former regulators. That's another meme. Alas, politically, that meme ain't going nowhere in a Congress full of Republicans who take the view that Dodd-Frank is nearly as evil as health care reform and that everything is Obama's fault. Hell, the GOP would even like to get rid of resolution authority, which may or may not work, but which remains the keystone of Dodd-Frank. Without it, Dodd-Frank is simply a bag of rules -- some good, some bad -- and new bureaucracy. Without resolution authority, too-big-to-fail will continue to be a cancer on the banking system. Of course, we won't know if it will work -- markets remain skeptical that our human overseers will ever use it -- until we try it out on some big bank, though simply tossing it away as an example of excess regulation doesn't help much.
That said, the renewed "debate" in the aftermath of Jamie's big loss does suggest how we got to this benighted state. Many pundits, politicians and academics have declared that J.P. Morgan violated the Volcker Rule, even though the rules have yet to be set. Carl Levin on Meet the Press Sunday offered the circular argument that a hedge isn't a hedge if it results in more, rather than less, risk. In other words, a poorly designed hedge is a speculation. He was willing to quote from the legislation, which he helped co-write. David Gregory moved on, undoubtedly relieved to avoid the ambiguity between hedging and betting.
The fact is, no bank is immune to these problems. No bank chief or uber risk manager is perfect or prescient. That alone should keep the door open to rethinking the size and leverage of the biggest banks. But add to it the reality that the underlying drivers of the financial crisis -- at least in banking -- remain. We have not removed any complexity from the system; we have not reduced interconnectivity, as worries over Europe suggest (J.P. Morgan's hedging/bet appears to be deeply intertwined with euro-zone issues). Competition remains intense, and markets are increasingly global. Commodization continues to wring profits out of even complicated products, fueling size and scale. Innovation driven by technology, particularly in derivatives and trading, remains a powerful force. We have not touched the linkage between shareholders, share prices, compensation and risk; in fact, for all the muttering, earnings per share remains the go-to metric in banking. We will not begin to rein in the unleashed potential destruction of risk and leverage until we tackle all those intertwined issues. Writing a few more rules, even the Volcker Rule, won't cut it.
Speculation, like compensation, remains a symptom, not the underlying problem. We can chop down the size of the big banks, separate "lending" from "casino gambling," in that far-too-simple a dichotomy. We will have a far safer banking system, though that's what they said about S&Ls too. But like the S&Ls, we may discover that we have a banking system that is safe but weak; prudent but incapable of driving a large, complex and mature advanced economy; consisting of small, if occasionally dumb, players desperate to make a buck. Compensation will fall, if higher capital outlays depress earnings per share growth to a nice safe, say 8 percent. Even "big" banks will be boring again. But -- and there's always a but -- disintermediation, innovation, technology and globalization, with its advantages of scale, will still exist.
Shareholders, who already complain of having too few objects of their affection, will look elsewhere for growth. Sharp finance mavens eager for the big payday will reject the banks and seek the high-octane excitement of non-bank players, or drift overseas; the highly regulated banks will resemble old Ma Bell or the Post Office. Again, perhaps that's the prudent thing to do now that we know that there are no geniuses.
Everywhere you look, however, there are tortuously difficult tradeoffs. We don't want to confront them, even when something as messy as this occurs. We want more rules; we want bright lines in a world of shifting sand. We want, in fact, someone in authority -- the president, Levin, Volcker, Dimon -- to make the sand stop moving. But we don't really want to look hard at how we got here or how difficult it is to untangle a mess that was a half-century in the making.