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Risk worry renewed

$2b loss at JPMorgan triggers calls for more rules to rein in speculative trades

Peter Giacchi worked at the post that handles JPMorgan on the New York Stock Exchange on Friday. Peter Giacchi worked at the post that handles JPMorgan on the New York Stock Exchange on Friday. (Richard Drew/Associated Press)
By Beth Healy
Globe Staff / May 12, 2012
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The $2 billion trading loss JPMorgan Chase & Co. disclosed Thursday has renewed calls for greater oversight of Wall Street banks from critics who said it shows they are returning to risky activities despite the financial crisis and government bailouts.

“They’re taking massive speculative positions and betting a significant share of the bank on them,’’ said William K. Black, a professor of economics and law at the University of Missouri Kansas City and a banking specialist. “There is no reason why we should have a federally insured entity doing that. There’s zero social gain, and enormous potential downside.’’

There is no public bailout at hand in this instance, and JPMorgan is still expected to report a large profit on its overall operations in the second quarter.

But the event has sparked new fears about the kind of trading big banks are pursuing and the level of risks those entail. Indeed, the losses JPMorgan revealed this week were based on the same type of complex instruments that were central to the last crisis - credit derivatives.

Congressman Barney Frank, a Newton Democrat and ranking member of the House Financial Services Committee, said the bank’s loss is further evidence that Wall Street needs the overhaul he helped author after the losses of 2008 and 2009. Specifically, he reiterated the importance of the Volcker Rule, which would restrict the kind of trading banks can do to trades that protect their assets or those of customers. Banks would have to break off operations that conduct so-called proprietary trading - higher-risk buying and selling designed to generate profits - into separate entities.

“It certainly does indicate that this notion that banks trading in derivatives isn’t a problem, and never will be, is a hard one to maintain,’’ Frank said in an interview Friday.

Securities regulators in the United States and in the United Kingdom have said they will investigate the JPMorgan losses. The bank’s shares fell more than 9 percent Friday, to $36.96.

JPMorgan’s chief executive Jamie Dimon and other bankers and their lobbyists have been fighting the new Volcker Rule hard, arguing it will be too costly and cumbersome. They have flooded the Federal Reserve and other regulators with comment letters as the final rules are being crafted, in advance of the law’s July 21 effective date.

Neither the bank, nor the trade groups that represent the industry, had additional comment Friday.

Frank noted that the estimated $400 million to $600 million it could cost JPMorgan to comply with the rules is much less than what it lost in the hedging strategy, which Dimon himself called “flawed, complex, poorly reviewed, poorly executed, and poorly monitored.’’ In addition to the $2 billion loss already reported, Dimon acknowledged JPMorgan could lose another $1 billion on the trade.

The question lawmakers, academics, and market participants were asking Friday was whether the Volcker Rule would even have stopped these particular trades.

“If it was a trade aimed at hedging against a specific transaction, it probably would have been all right,’’ Frank said. “On the other hand, if it was a general hedge against the whole position, I think it shouldn’t be allowed.’’

Dimon, in a telephone conference with stock analysts Thursday, said the trade was a hedge to the firm’s “overall credit exposure.’’ JPMorgan executives have insisted the trade was consistent with the proposed Volcker Rule.

But critics say it was just a big bet, not a true hedge, involving credit default swaps, a kind of insurance, on corporate debt. The idea was that JPMorgan believed worries in Europe were easing, and therefore that the swaps weren’t overly risky. But the position grew so large that the bank itself was artificially moving up prices on the debt, according to published reports. A number of hedge funds bet against JPMorgan’s position, and reaped big gains when the bank lost.

The Associated Press reported that ratings agency Fitch downgraded the bank’s credit rating by one notch, from AA- to A+, and Standard & Poor’s cut its outlook on JPMorgan to negative from stable, indicating a credit-rating downgrade could follow.

It’s not clear whether other banks may have their own risky positions. Earlier in the week, State Street Corp. chief executive Jay Hooley told the Globe he was confident the Boston financial services company had far better risk management than in 2008, when it accumulated billions of dollars in subprime mortgage securities that went bad.

Frank said he is convinced other banks are still conducting risky trades. And Michael Mayo, a banking analyst at Credit Agricole, suggested on Bloomberg Radio that if JPMorgan, widely seen as a well-run bank, can lose $2 billion when “Europe sneezes,’’ there could be more problems ahead. If “this is the best of breed, what does that say about the rest of the class?’’ he said.

Peter Cohan, who teaches at Babson College and writes several business blogs, said that while the final details of the Volcker Rule are still in flux, the banks will continue to push back even with the JPMorgan losses in the news. “They’ll delay until people have forgotten about this whole thing, and hope that that they’ll be able to make the rule toothless,’’ he said.

The new regulations ought to protect against these mistakes that banks make, Cohan said, because they can’t foresee every move in the market, and they often don’t give regulators enough information to understand the risks they’re taking.

“It’s like playing with nuclear waste,’’ he said, “and hoping you have enough protection.’’

Beth Healy can be reached at bhealy@globe.com. Andrew Caffrey of the Globe staff contributed to this report.

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