There are at least three ways to break a bank. Give him a little more time and Jamie Dimon may demonstrate all three of them.
One way is to invest in assets that lose value. Jamie's chief investment office is reported to hold over $100 billion in European mortgage-related securities and other risky assets that are difficult to imagine as hedges.
The Volcker rule won't help to prevent bad securities investments, because it restricts trading and not investments.
Supposedly, examiners routinely review bank assets both for suitability and valuation. If the bank can't demonstrate that an investment is suitable and fairly valued, then remedial action is required. The relevant standards are prudential, but they have teeth. Maybe Jamie's bad investments were too blindingly obvious to be noticed.
A second way for a bank to fail is through trading losses. It doesn't matter how high quality or how suitable the assets are. They can be T-bills. You can still go broke buying and selling them.
It may be hard to distinguish good traders from bad. John Paulson made billions, then lost billions. But volatility of return is an absolute. As in Paulson's case, a strategy or risk appetite that can make a lot also can lose a lot.
When Jamie's CIO allegedly made $9 billion in one year, there might have been someone, somewhere, even in Washington if not New York, capable of seeing that the same people and processes could just as easily lose $9 billion another year — or even a multiple of that.
Worse. In this instance, having made $9 billion in one year, they increased their bets and risk exposure and loosened their controls, stretching futilely to repeat this success.
The sensible rule would be to allow banks to do only agency transactions (true brokerage) for customer accounts, with no principal trading at all except for the bank's own investments. This would be far easier to administer than the Volcker rule: one paragraph rather than 100 pages.
If banks no longer deal with them as principals, then affluent consumers could trust banks as they now trust fee-only advisors — rather than distrust banks as they do securities brokers.
If banks continue to trade, then to protect deposit insurance and taxpayers, bank supervisors need to do what they have neglected to do since Glass-Steagall was repealed: Formulate enforceable standards that limit trading risk. No version of Volcker will suffice to do this, since it's obviously possible to go broke trading to meet alleged customer needs.
Fortunately, none other than Mitt Romney has shown how to block this second route to failure. As he incisively noted, if Chase (for example) loses $2 billion, then someone else must have made $2 billion. So, nothing is ever lost by in-and-out trading, at the systemic level!
Hence, if we permitted banks to trade only with other domestic banks, the banking system as a whole could never lose money through trading. If a bank went broke via trading, the FDIC could make a special assessment on trading profits of other banks, so that taxpayers did not suffer.
Romney's insight just goes to show what to expect from politicians who have previously demonstrated outstanding business acumen in the private sector. Maybe as president, Mitt would further extend this principle to say that if a bank cheats a consumer out of $100, then the bank is making the $100, so the result comes out even for the economy and we don’t need the CFPB.
But, in our present imperfect environment of laws and regulations, the money Jamie lost through trading is gone, and Chase's and the system's resilience could be sorely tried both by money-losing trading as well as by bad assets held for years.
The third way to break a bank is by incurring contractual obligations that impose unbearable costs, for instance by selling mortgages that generate legal liabilities. Derivatives are another popular class of contract with this potential. Human ingenuity is boundless and other contractual sinkholes will surely be found or created. Jamie was heavily involved with derivatives also. Strike three.
The challenge is how to constrain the contracts into which banks enter. (Position limits afford a simple but incomplete safeguard.) We also need to make sure that all vulnerable contracts, not just derivatives, are exposed to and receive accounting, audit and regulatory evaluation.
Right now there is no will, and hence no way, to diminish mega bank and hence taxpayer exposure to bad assets, trading losses and derivative, loan sale and other risky contracts. So, we are pushed to do the impossible: trust Jamie.
Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.