But it did fail, endangering virtually every other large financial institution. Bailouts became plentiful.
Since those terrifying days, new attitudes have come to the fore. Where once the public, and regulators, took for granted that big banks were adequately capitalized, now there are newly determined regulators. That is especially true for the big banks — now known as Sifis, for strategically important financial institutions. They face tougher regulations than their smaller competitors because of the greater damage their failure could cause.
That move to tougher regulation is particularly sharp in the largest financial markets — the United States, Britain and Switzerland. Having a big financial industry was viewed as a sign of success before 2008; now it is seen as a risk to the economy. Iceland and Ireland went broke because of financial systems that were too large and too badly managed.
Along with initiatives to assure that the large institutions could survive a new crisis there are efforts to assure that even if they did fail, they could be dismantled without severe damage to the rest of the system or to the economy. Whether those efforts would work remains to be seen.
Bailouts were necessary in 2008 to keep the financial system operating, but it is now more important than ever to distinguish why that was important. We need banks to provide payment systems, safe places for deposits and loans to individuals and businesses. In other words, we need them to provide the services that were traditionally provided by commercial banks and savings and loans. It is those functions that justify offering deposit insurance as well.
It was once taken for granted that letting the banks do all those other things somehow made them stronger. We now know that need not be true, and that it is possible the opposite will often be the case.
The big bank that seemed to most successfully navigate the shoals of 2008 was JPMorgan Chase. Whether by luck or good judgment, it avoided the worst excesses of the boom. Jamie Dimon, the bank’s chief executive, became the most respected man on Wall Street.
Now, he sometimes seemed to be the most beleaguered. Rarely does a month go by without some new legal problem for his bank. JPMorgan’s most recent quarterly report contains nine pages of small type listing its legal issues. It says that resolving them is likely to cost — in excess of reserves already taken — somewhere between nothing and $6.8 billion.
For a company the size of JPMorgan, that is not all that much money. The latest balance sheet shows shareholders’ equity of $209 billion and total assets of $2.4 trillion. The bank says it has plenty of capital, although it will have to take steps to reduce its assets — or increase its equity — to meet proposed leverage rules aimed at large bank holding companies.
JPMorgan does sound chastened by the widespread problems. “Our control agenda is priority No. 1,” said a spokesman, Mark Kornblau. “We still have work to do and will cooperate with our regulators as partners in order to get it right.”
Reading through the list of legal problems, one thing stands out: most of them stem from activities outside traditional commercial banking. In other words, they were caused by activities other than the ones that justify the bank’s receiving the benefit of deposit insurance or a possible bailout if it gets into trouble again.
Foremost among them is the so-called London Whale trading conducted by the bank’s chief investment office, which cost the bank $6.2 billion. It was gambling in credit default swaps tied to corporate debt, and when the bets went wrong it threw good money after bad, with disastrous results. The bank now says that some of the people involved in the trading hid the scale of losses from their bosses by lying about how much the securities were worth. Two former employees are under indictment in federal court in New York.
The Whale tale provides a series of lessons about banks, circa 2013. One is that there is no certainty that bank gambling will be seriously restricted by the Volcker Rule, which supposedly bans “proprietary trading” by banks. That rule, named for Paul A. Volcker, the former Federal Reserve chairman, was part of the Dodd-Frank financial overhaul law, but final regulations have yet to be issued.
Floyd Norris comments on finance and the economy at nytimes.com/economix.
Article source: http://www.nytimes.com/2013/09/06/business/the-perils-when-megabanks-lose-their-focus.html?partner=rss&emc=rss