Why There Are Laws

The recent loss of $2 billion by JP Morgan Chase is the subject of today’s column by Paul Krugman. He argues that there are some things banks should not be allowed to do, because they are dangerous to the economy as a whole.

Just to be clear, businessmen are human — although the lords of finance have a tendency to forget that — and they make money-losing mistakes all the time. That in itself is no reason for the government to get involved. But banks are special, because the risks they take are borne, in large part, by taxpayers and the economy as a whole. And what JPMorgan has just demonstrated is that even supposedly smart bankers must be sharply limited in the kinds of risk they’re allowed to take on.

Why, exactly, are banks special? Because history tells us that banking is and always has been subject to occasional destructive “panics,” which can wreak havoc with the economy as a whole. Current right-wing mythology has it that bad banking is always the result of government intervention, whether from the Federal Reserve or meddling liberals in Congress. In fact, however, Gilded Age America — a land with minimal government and no Fed — was subject to panics roughly once every six years. And some of these panics inflicted major economic losses.

Krugman goes on to say that in the 1930s we came up with a workable solution involving oversight and guarantees. “Most notably, banks with government-guaranteed deposits weren’t allowed to engage in the often risky speculation characteristic of investment banks like Lehman Brothers.” This gave us “half a century of relative financial stability.” Then banks began to engage in risky speculations again, and the results were a financial disaster in 2008 in which taxpayers had to step in to prevent total meltdown.

But, predictably, the crew at Reason say that regulation is still wrong.

… the Wall Street calamities that shook the economy a few years back weren’t a result of isolated mistakes at the individual bank level. They were the result of networked failures, in which multiple market players make the same set of mistakes at the same time, taking up all the give in the system simultaneously.

Some of us would say that Chase’s $2 billion loss was something of a canary in the coal mine, showing us that there still is danger lurking in the financial sector. The correct response is to step in now to fix the bug and not wait for another system fail. And, without looking, I’m willing to guess that the crew at Reason was opposed to regulations that might have prevented the 2008 disaster also, before it happened. The “free minds” at Reason rarely surprise me.

And, of course, next they say that there’s no reason to think that more regulation would change anything, because regulations might not be implemented properly —

… “proper” implementation is always harder than it sounds. And I’m not sure we have any more reason to trust that regulators have the wisdom and judgment to prevent such losses any more or better than the bankers themselves.

This is the argument one hears every time there’s a death in a coal mine. Some mouthpiece for the coal mining industry argues that the accident shows that regulations aren’t necessary because (blah blah blah). The truth is that safety regulations passed into law in 1977 gave us nearly two decades of death-free coal mining. Then the Bush Administration turned the Mine Safety and Health Administration over to industry insiders, who weakened regulations, resulting in the loss of 70 miners in six separate disasters.

And this is supposed to prove that regulations don’t work.

Back to the financial sector — saying that a single incident (less than four years after Lehman Brothers died) doesn’t prove a need for more regulation is like saying that because there were only 4.8 homicides per 100,000 U.S. residents in 2010, we don’t need homicide laws. And those evil government prosecutors sometimes get the wrong guy convicted, anyway.

Michael Hiltzik writes in the Los Angeles Times,

The Whale affair shows that JPMorgan doesn’t understand how to manage risk. When you’re making multibillion-dollar bets using inherently volatile and unpredictable financial devices, nobody does — JPMorgan’s own risk models showed that its exposure had suddenly doubled in a period of weeks prior to its disclosure, which means either that the risk models were hopelessly outclassed, or that risk models can’t ever be reliably accurate under all conditions. Either way, it leads to the conclusion that Dimon desperately tried to evade on “Meet the Press”: that the only way to make this sort of risk-taking safe for the financial system is to make it illegal in the first place.

You really have to be pretty delusional to argue that the JPMorgan episode is not a warning that there are regulatory loopholes that need to be closed.