In J.P. Morgan Loss, Bank Regulation Advocates See Opportunity

A $2 billion loss on risky trading has invigorated the rule's proponents.

By + More

J.P. Morgan Chase CEO Jamie Dimon acknowledged in a conference call Thursday that his firm's $2 billion trading loss "plays right into the hands of a bunch of pundits out there" who are pushing for stronger regulation. It's not just pundits, though: The bank's massive losses have already put the gears of Capitol Hill into motion.

[See why Chinese banks are moving into the U.S. market.]

Ironically, the company reported that the losses came from bets made by its London-based Chief Investment Office, which focuses on hedging (and therefore reducing risk). In this latest news, proponents of stiffer banking regulation are finding powerful new ammunition.

"J.P. Morgan's losses are a stark warning about the dangers of having major banks take these risky bets, so-called proprietary best," said Michigan Democratic Sen. Carl Levin in a Friday conference call with reporters. A section of the Dodd-Frank financial reform bill known as the Volcker Rule—aims to limit how much banks engage in risky proprietary trades, which use the bank's own funds, rather than being at the behest of customers. Dimon had been among that rule's most vocal opponents.

"We really do need this boundary between traditional banking—that is, taking deposits and making loans—and hedge-fund style investing," said Oregon Democratic Sen. Jeff Merkley during the same call.

Though the Dodd-Frank financial reform law was passed in 2010, the Federal Reserve has yet to finalize and implement the Volcker Rule. The rule's draft regulations allow the kind of hedging that J.P. Morgan engaged in. Merkley and Levin, who both worked to author the Volcker Rule, advocate closing this provision.

[See why upward mobility is harder in the South.]

"That's a big enough loophole that a Mack truck could drive right through it," said Levin.

The Volcker Rule has been controversial from the get-go, and the initial 10-page version grew to nearly 300 pages by the time it was opened up to public comment—a fact that some attribute to banks pushing for exceptions and further loosening of regulations. Proponents believe that this latest news will be a catalyst for faster and more stringent action.

"Hopefully it will give the Federal Reserve the spine that it lacks to implement a strong Volcker rule," says Ed Mierzwinski, consumer program director at consumer group US PIRG.

Of course, the devil is in the details for this complex rule, and some believe it is too byzantine to be practical.

"It's very complicated and unclear at this point as to how it will be workable," says a spokesman for Republican Sen. Richard Shelby, chairman of the Senate Committee on Banking, Housing, and Urban Affairs. "[Sen. Shelby] may be open to some form of it, because he does support the fundamental principal of protecting taxpayers."

Though many congressional Republicans are opposed to that rule, the GOP is also concerned with the large bank's stunning losses. Shelby's spokesman says that the senator's committee staff is contacting banking regulators to gather information on the details of what exactly happened to cause the massive losses.

[Read about why the Fed reform debate is going nowhere.]

The surprising losses have rattled the financial world, and with good reason. Not only is J.P. Morgan huge, but after the financial crisis, when many large American banks were seen as deeply troubled, J.P. Morgan was widely seen as a paragon of responsibility.

With its large assets, the bank will weather this storm, though its reputation has taken a hit, says Yiorgos Allayannis, a professor of business administration at the University of Virginia's Darden School of Business.

However, he adds that losses—even sizable ones—are a fact of life in the globalized financial world.

"The broader message here may be that it is very difficult to manage risks in this global environment," says Allayannis. "There's a tradeoff—the only way you cannot have losses is if you put the money in the bank and earn zero percent, but you have no return. By the mere fact that banks are in the business of loaning, there's going to be risk."