May 11, 2012

FEW WALL STREET institutions enjoy greater prestige than JPMorgan, whose $2.3 trillion in assets make it the largest U.S. commercial bank. Jamie Dimon, the 56-year-old chief executive, is an industry hero for building a “fortress balance sheet” and steering JPMorgan through the mortgage meltdown relatively unscathed. Of late, Mr. Dimon has been deploying his influence to resist tighter federal bank regulation — specifically, the “Volcker rule,” a provision of the 2010 Dodd-Frank law that would ban federally insured banks from speculating in hedge funds and the like.

Former Federal Reserve chairman Paul Volcker argues that the separation would prevent banks from exploiting their federally insured status to take destabilizing risks. Mr. Dimon answered that the rule is an unnecessary constraint on well-managed banks like his. The public ultimately would pay for the rule, he says, in the form of higher banking costs and less job-creating capital formation. He has questioned Mr. Volcker’s understanding of modern capital markets.

Alas for Mr. Dimon, the markets delivered a verdict of sorts on this dispute Thursday — and it was not favorable to him. JPMorgan announced that it has suffered $2 billion in losses on its proprietary trading, a staggering figure which, Mr. Dimon acknowledged, “could get worse, and it’s going to go on for a little bit unfortunately.” Mr. Dimon’s candor, welcome as it is, cannot obscure the fact that this failed transaction makes Mr. Volcker look like a prophet. Accordingly, it strengthens the case for the Volcker rule, a final version of which has been held up by wrangling between the financial industry and the regulators.

That case was already strong. Mr. Dimon and other critics have focused, correctly, on the many loopholes and complexities that have crept into the draft rule prepared by the Federal Reserve and other agencies. It is not always easy to draw a clear and enforceable line between ordinary hedging, or fulfilling customer orders, which would be allowed, and trading for profit, which would not. Nor are JPMorgan’s losses, big as they are, likely to shake the entire financial system.

But the difficulty of writing a crystal-clear rule is partly due to the fact that banks themselves don’t always fully understand their own complicated trading positions. As Mr. Dimon put it: “In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective as an economic hedge than we thought.” And even if the systemic risks from JPMorgan’s losses are modest — now — it’s not clear that its strategy offered offsetting public benefits.

JPMorgan’s mishap proves that even a well-capitalized federally insured bank, managed by a chief executive at the top of his game, can gamble in the markets and lose — big. In a way, that has been Mr. Volcker’s point all along.