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Sunday, December 11, 2016

What Five Hours From Last Thursday Can Tell Us About Dodd-Frank And JP Morgan

In the course of an afternoon, we saw the problems Dodd-Frank is trying to solve, the solutions on the table, and the efforts to roll them back — not in that order.

Let’s take a quick look at a time frame lasting less than five hours from last Thursday, May 10th, 2012.

At 12:10 p.m., Martin J. Gruenberg, Acting Chairman of the Federal Deposit Insurance Corporation (FDIC), gave the keynote at the 48th Annual Conference on Bank Structure and Competition held by the Federal Reserve Bank of Chicago. In the long-awaited speech, he outlined the overall vision, as well as the problems and pitfalls, of the FDIC using “resolution authority” to oversee the failure and unwinding of a Too Big To Fail financial firm. These powers were granted to the FDIC in the Dodd-Frank financial reform bill in order to achieve both accountability and stability while avoiding the panic and contagion that occured in the fall of 2008.

At 2:15 p.m., House Republicans passed H.R. 5652, Paul Ryan’s Sequester Replacement Reconciliation Act of 2012, by a vote of 218 to 199. This reconciliation act does many things; one is that it takes lots of money from poverty relief programs and gives it to the military, and another is that it renegs on automatic cuts that were agreed to as a result of the Super Committee’s failure, which will almost certainly trigger a crisis on the next debt ceiling fight. But for our purposes, one specific thing it does is revoke Title II of Dodd-Frank, which is the resolution authority powers Gruenberg was presenting. It replaces them with nothing.

At 5 p.m., the large, systemically risky firm JP Morgan had a surprise conference call where it announced, following what was disclosed on its 10-Q, that it had a giant loss of $2 billion in the last quarter. This suprised the market and sent analysts running to their phones and computers.

There are two ways to look at the relationship between the Dodd-Frank financial reform framework and JP Morgan’s loss disclosure. One is that it shows the need for a strong implementation of Dodd-Frank broadly and the Volcker Rule specifically, which is designed to separate prop trading from large, risky financial firms. Marcus Stanley of Americans for Financial Reform has a great post up discussing what happened, how the principle of the Volcker Rule should work in this situation, and the threats it faces. Dodd-Frank is designed to make the financial markets more transparent and robust to shocks through such mechanisms as expanding clearing requirements for derivatives and reducing interconnectedness between large financial firms. It is also designed to make it less likely that any individual firm will collapse by having stronger capital requirements for larger financial firms and eliminating certain business lines they can participate in through the Volcker Rule. This is crucial for a Too Big To Fail firm like JP Morgan.

But the second is to acknowledge that businesses run profits and they run losses. There is something to a conservative like Kevin Williamson’s remark that “The odd thing about this is that it is now considered somehow scandalous when a business loses money. It’s a scandal when banks make profits, and it’s a scandal when they make losses.” On a long enough timeline, the survival rate for everyone drops to zero. Though it was clear quickly at 5 p.m. Thursday that JP Morgan wasn’t in danger of collapsing, if things had been different it could have failed.

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Copyright 2012 The National Memo