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Time for Regulatory Change?

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The shocking news out of JP Morgan this week about a $2 billion trading loss is a stark reminder that even Jamie Dimon, the CEO of such a major firm, can be completely in the dark about what's happening inside the very firm he runs. Dimon has said publicly that this surprised him.

Nonetheless, the timing is perfect for the politicians and regulators to pile on with their solutions to fix the banking industry. There are several regulations that will be referred to in the media and blogosphere during the next few weeks in relation to the JP Morgan trading losses.

Thankfully, you don't have to go to Washington, DC, or Wall Street for the debate. The New York Society of Security Analysts (NYSSA) is hosting a program called "Regulatory Changes as an Opportunity" this September. The speakers for the event will be Jim Allen, CFA, Head of the Capital Markets Policy Group for CFA Institute; and Kim Olson, a principal with Deloitte & Touche LLP.

Do we need more overall regulation, or do we need more stringent rules within firms on how to report gains and losses...or do we need better trained CEOs?

It's likely we need a little of each. That's before you figure out that the $2 billion loss is just part of the potential overall loss attributable to this position at JP Morgan. We don't know what other CEO was in the dark as much as Dimon, nor do we know the size of other positions at JP Morgan or otherwise. What's been a theme surrounding the OTC market is that "when there's news, it's bad news." Having transparency, centralized clearing, and regulated margins that must be maintained is the bare minimum.

During the presentation at NYSSA, the speakers will cover:

  • Market participants, products, and trade ideas likely to gain from new regulations
  • Products that will be most affected by the legislation
  • Impacts on liquidity and possible responses from major market participants
  • Risks and mitigating actions for companies who want to profit from these changes 

What are the tradeoffs besides the potential benefits of Basel III? The OECD has stated that there will be a potential cost to GDP of .05 to .15%, but that seems like small potatoes when you look at the percentage of what the taxpayers are on the hook for as a moral obligation, should more of these banks go under. According to research at the Milken Institute, "the higher capital requirements within Basel III are being phased in, but there is still a lack of full coordination regarding the regulation and, if needed, resolution of big banks that operate in multiple countries."

To understand how we got here, you have to go back to the Banking Act of 1933 and the Glass-Steagall Act, which had been in place (and effective) for 61 years before it was repealed by the Gramm-Leach-Bliley Act of 1995, allowing US banks to effectively become "more competitive" and make room for laws that reflected the changes to the world's financial system, according to former US Secretary of the Treasury Robert Rubin.

The US Commodity Futures Trading Commission (CFTC) has delayed implementing Dodd­­–Frank until the end of 2012, according to a recent article in Platts. Commissioner Scott O'Malia said "that early 2013 is a stretch." But that's not surprising given that the combined law is approximately 2,000 pages—longer than the Old and New Testaments and the Quran, combined. "Despite a frenetic work pace and, by all accounts, grueling schedule for CFTC staff, the agency is still less than two-thirds of the way through finalizing the more than 50 new rules mandated by Dodd-Frank," the article stated.

Volker Rule deliberately prohibits proprietary trading at banks or bank holding companies that "is not at the behest of its clients, and from owning or investing in a hedge fund or private equity fund, as well as limiting the liabilities that the largest banks could hold." Naturally, the banks feel this is too stringent.

Putting all these rules in a pot and letting them simmer still might not be the solution to limiting fraud, trading errors, greed, or moral hazard. William K. Black noted in his recent presentation to the Modern Monetary Theory Summit that there is a solid fraudulent recipe to becoming a bank billionaire:

"(1) Grow massively, (2) By making very poor quality loans at high rates of interest, (3) Use extreme leverage (high corporate debt), and (4) Set aside virtually no loss reserves for the massive losses that will be coming. If you do these four things, you are mathematically guaranteed to report record short-term income," he said. In that light, it's hard to see that following such a plan would not amount to a proprietary trade using the bank's capital.

The bank holding companies began their new lives on March 11, 2000. History will note that NASDAQ hit its all time high on March 10, 2000—the day before.

–Michael Martin

Michael Martin is author of The Inner Voice of Trading: Eliminate the Noise, and Profit from the Strategies That Are Right for You and owner of The Martin Kronicle.

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