Analysis/Comment
Dr Peter Morici: JP Morgan debacle points to regulatory incompetence, corruption
By Professor Peter Morici
May 30, 2012 - 6:01 AM

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Dr Peter Morici: President Obama is shameless to cite JP Morgan’s $3bn trading loss as evidence banks need more regulation. More accurately, the debacle raises serious questions about incompetence and corruption among federal regulators and inside the Obama White House.

JP Morgan’s Chief Investment Office got in trouble trying to undo positions—first the CIO bet bearish on corporate bonds, through derivatives on an index of those securities, and then tried to bet bullish as it read market sentiment shifting.  

Both can be legitimate hedges, but taken together are too complex to manage. Stupid perhaps, but I doubt reasonable implementation of the Volcker Rule prohibiting trading with banks’ funds would keep big financial houses from taking such positions.
 
The Federal Reserve and Comptroller of the Currency have 110 regulators imbedded in JP Morgan—not just visiting occasionally to check the books but domiciled inside. Yet, the CIO, which was responsible for the ill-fated trades and manages nearly $400bn, had not a single official inside its unit.
 
Senior bank executives convinced federal officials the CIO was merely hedging, managing cash and taking no significant risks, and naively, regulators believed the bank or were bullied by their political bosses to turn a blind eye.

It turns out the unit was also buying stakes in distressed firms, including the publisher of Ebony, which is headed by former Obama White House official and Democratic Party operative Desiree Rogers.

Investing in distressed firms is work for private equity and hedge funds, not FDIC insured banks. It is analog to Grandma cashing in CDs to play slots in Las Vegas, and has nothing to do with the Volcker Rule.  

More importantly, those bets raise questions about whether senior bank officials lied to regulators, political influence altering JP Morgan investment choices, and the self interest influencing regulation inside the Oval Office. 

Senior JP Morgan officials can and do go over the heads of resident regulators to their politically-appointed bosses in Washington and the Fed to deny on-site regulator’s requests for information and sometimes succeed. And, in addition to revelations about Desiree Rogers, Barack and Michelle Obama have between $500,000 and $1m invested in a JP Morgan “private client” account.

Merely writing ever more complex regulations and stationing bureaucrats inside businesses—sort of like boarding an IRS agent in your home for 30 days before April 15—will not fix these problem. Taxpayers would learn how to distract the Treasury gum-shoe while they itemized “grey area” deductions, and no doubt JP Morgan CEO Jamie Dimon is even more imaginative.

Mr. Obama is corporatist in the French and Latin American tradition. He wants a market economy where the public interest is safeguarded and government purposes are served through heavy supervision of the daily operations of private businesses. But the lessons of Europe and Latin America are that all this breeds is corruption and slow growth.

Mr. Dimon is a Democrat, and employees at JP Morgan and other behemoth Wall Street Institutions have ploughed huge sums into Democratic campaigns. Senior officials at JP Morgan assured regulators the CIO was making no risky bets when it was running a casino. 

Dodd-Frank was supposed to fix the problem by hiring more regulators but that didn’t keep JP Morgan’s CIO from betting on distressed firms, and it has encouraged consolidation of banks into larger and larger institutions.

The upshot—small business in Iowa can’t get loans, because Wall Street is distant and doesn’t appreciate their value, and bigger banks can easily snucker regulators. When they can’t, they can fall back on the political influence campaign contributions appear to buy.

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone

pmorici@rhsmith.umd.edu

http://www.smith.umd.edu/lbpp/faculty/morici.html

http://www.smith.umd.edu/faculty/pmorici/cv_pmorici.htm

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