Big banks just can't seem to catch a break. While publicly griping about the costs involved with all the new regulations that have been introduced since the financial system teetered on the brink of collapse back in 2008, they seem to remain intent on reminding us just why those regulations – or something else of the same kind – were needed in the first place.
Making matters all the more worrying, the two banks that provided those reminders last week have until now been seen as relatively healthy institutions, and "winners" in the wake of the crisis.
Barclays (BCS), hit with a regulatory penalty of about $450 million after some of its employees sought to rig the key LIBOR inter-bank lending rate, rode out the crisis without needing to seek an infusion of cash from the government, and ended up expanding its footprint when it picked up assets of the bankrupt Lehman Brothers. True, Marcus Agius, the chairman of the bank who’s expected to resign Monday, did take some heat for turning to investors from Abu Dhabi and Qatar, rather than existing shareholders, to raise emergency capital during the financial crisis. Yet Barclays emerged from the crisis as more of a global powerhouse, propelled by its now-embattled American CEO Bob Diamond.
JPMorgan Chase (JPM) was also a clear winner; while it did take TARP funds, they were rapidly repaid, and the bank also ended up in a dominant position, having picked up Bear Stearns and Washington Mutual at firesale prices at the height of the crisis. Then came the "London Whale" and the complex trades that CEO Jamie Dimon confessed might cost the bank upward of $2 billion in losses. Now, if media reports are accurate, the real figure could be closer to $9 billion – considerably more than even the most bearish observer had predicted.
The recent problems at both banks support the idea that what is wrong with the financial system can't be fixed overnight simply by passing new rules that ban certain kinds of activities. After all, it's fair to say that rigging bank lending rates didn't need to be banned – it was already against market rules. That's why Barclays traders displayed the kind of awareness they did in e-mails and instant messages with their colleagues and clients about the scheme. Comments like "If you know how to keep a secret I'll bring you in on it" and "The way you pull off deals like this chicken, don't talk about it too much ... this is between you and me but really don't tell ANYBODY" are a pretty clear sign that they knew they were up to no good.
Nor, it seems, is it possible to legislate good risk management: If it were, it's safe to assume that Jamie Dimon – despite his professed aversion to regulation – would have done whatever he could to avoid ending up in the embarrassing position of having to testify in front of hostile members of Congress.
The problem is that financial institutions are hard-wired to chase profits. They're not selling shampoo and toilet paper; they're working with money. Many of the traders and investment bankers who work on Wall Street and in the City didn't grow up with a lot of the stuff; they chose their careers knowing that this was one way they could use their skills and interest to become relatively wealthy relatively rapidly. And they work in an environment in which any kind of action that does not lead to the most lucrative outcome for them or a client is simply irrational. If they are told they'll get a bonus for boosting trading profits on their desk by a certain percentage this year, that's what they'll strive to do – and the target they'll try to beat.
That doesn't mean they'll consciously seek out shady tactics, but it does raise the odds that at least a handful of those in the business will deliberately close their eyes if a colleague does so, as long as it's going to help them all make more money. Conversely, someone who suggests that a money-making strategy may be unwise from a risk-management perspective or even teetering on the verge of illegality is likely to be shunned by his or her peers. Just ask anyone who argued against cramming more subprime mortgages into CDOs in 2006 and 2007, or who felt leveraging up a bank's balance sheet to maximize its return on equity might not be a great long-term strategy.
Do we need more regulation? Possibly. Is Dodd-Frank, and the other post-crisis changes in the way banks are supervised, a panacea? Almost certainly not. Go back a century or more in the history of American finance, and you'll find bankers trying to outwit the system and the regulators. That's unlikely to change, especially now that the stakes are so high.
If policymakers ever do manage to devise a foolproof regulatory system that prevents malfeasance and stupidity of all kinds within banks like Barclays and JP Morgan, it's a fairly safe bet that those institutions will find themselves unable to do business – and then the public will be hollering about a lack of liquidity, the inability to raise capital and the way in which a slump in trading volumes means their mutual fund managers are stuck with money-losing positions.
There's no good solution to this conundrum. Jamie Dimon is on record saying his bank will report a solid second-quarter profit – begging the question of what other sets of risks might have been taken to generate the additional profit needed to offset that London Whale-sized loss of $4 billion, $6 billion, $8 billion or whatever the final figure ends up being. The only viable alternative to the current state of affairs – short of a DNA transplant for the entire workforce in the financial system, or a requirement to run these institutions as non-profits – is to cap the size of the likes of a Barclays or a JP Morgan. Then they wouldn't have the kind of balance sheet that enables them to accumulate multi-billion dollar losses – and any debacles would be less likely to endanger the entire financial system.
We don't want to strip the risk-taking out of Wall Street, and we may never be able to find a way to force each and every trader and banker to view some kinds of activities as irrational or dangerous. What we can do is ensure that a future London Whale can't swamp the entire system.