Yesterday's JP Morgan implosion has now put any lingering questions to rest.
Wall Street banks simply cannot be trusted to manage the massive risks they are taking.
After the financial crisis, when most of the world's banks were revealed to have been run by reckless gamblers, a couple of institutions stood above the fray.
JP Morgan was one of them.
Well-run banks should be trusted not to be so colossally reckless and stupid.
Well-run banks should be allowed to manage their own risks. Well-run banks should not be hammered with straight-jacket regulations that would stymie their marvelous and creative innovation. Well-run banks should be free to look after themselves, like responsible adults.
And the banking lobbying engine rushed this message to Washington and threw money around. And the lobby quickly persuaded Congress that Wall Street was fine, that the financial crisis was an aberration, that Wall Street should be left alone.
JP Morgan was the prime engine of this message. And its brilliant CEO, Jamie Dimon, was Wall Street's defiant Adult-In-Chief.
Dimon had credibility, because unlike all the other incompetent banks, his bank hadn't imploded and brought the system to the edge of catastrophe...
But now JP Morgan has blown up.
So we finally know the truth about Wall Street, a truth most Wall Street observers have known all along:
This is in part because, time and again, Wall Street has demonstrated that it doesn't even KNOW what risks it is taking.
In short, Wall Street bankers are just a bunch of kids playing with dynamite.
There are two reasons for this, neither of which boil down to "stupidity."
- The first reason is that the gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as "weapons of mass destruction." And those weapons have gotten a lot more complex in the past few years.
The second reason is particularly insidious. The worst thing that can happen to a trader who blows a huge bet and demolishes his firm—literally the worst thing—is that he will get fired. Then he will immediately go get a job at a hedge fund and make more than he was making before he blew up the firm.
- The second reason is that Wall Street's incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else—the government or shareholders—covers the downside.
Meanwhile, if the trader's bet works—and the bigger the better—he'll look like a hero and collect an absolutely massive bonus.
If you had those incentives, you would do exactly the same thing that Wall Street traders do: Bet the company, day after day. (It's not your company, after all, so who the heck cares?)
So, what's the solution?
It's very simple.
Congress needs to:
- Radically increase bank capital requirements, so even massive bets can't threaten the system
- Once again, separate "banking" from Wall Street gambling. Glass Steagall worked very well for 70 years—let's bring it back.
That's the answer.
- Lay out a plan, in advance, to manage the failure of even the largest financial institutions—by stepping in, seizing the bank, firing management, zeroing out shareholders, haircutting bondholders, and then injecting new SENIOR capital (fully protected) and re-floating or selling off the firm. This will allow the entity to keep operating, and it will stick the losses where they belong—with the idiots who bought the bank's stock or loaned it money. Meanwhile, the systemic threat will be eliminated.
And now that JP Morgan has proven that even "the best" banks haven't the faintest idea what they're doing (or don't care), it's time for Congress to finally make it happen...