One Lesson From J.P. Morgan: Wall Street Has Changed

Banks need to fix their own problems, because taxpayers these days will demand rough justice.

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A JPMorgan office building.

Nothing is new on Wall Street, the conventional wisdom goes. The recent flap involving a huge trading loss at J.P. Morgan Chase shows that all the bad habits remain intact. The casino never closed, so step right up and place your bets.

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It's a convenient storyline, with the greedy bankers playing their predictable, nefarious role. But the full story of that trading loss, which is still emerging, actually shows a very different pattern from the disasters that dominated Wall Street in 2008 and 2009. There's even encouraging news in the way public and investor pressure has made banks more accountable for their own mistakes.

Wall Street critics seem shocked that a commercial bank could lose as much as $5 billion on one set of trades. But it's not illegal to lose money or make foolish investments. It is bad business, however, and J.P. Morgan has been duly punished for its sins. Its stock has fallen by nearly 25 percent since the news of the trading loss broke, slicing more than $40 billion off its market value.

Several of the top bank officials responsible for the loss have been promptly fired, with shareholder hawks watching closely to make sure they don't leave with the kind of huge payouts that were routine just a few years ago—even for bankers who oversaw massive losses. Isn't this the kind of accountability we've been trying to instill in Wall Street banks?

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The intensity of the interest in the J.P. Morgan screw-up itself signals far better scrutiny of Wall Street behavior. The size of J.P. Morgan's loss is startling, but the bank will still earn somewhere between $15 billion and $20 billion in profits this year.

Compare that to some of the losses of the past few years. In 2007, for example, Merrill Lynch had a net loss of $25 billion, while Citigroup lost $24 billion. The CEOs of both firms resigned, but Stan O'Neal of Merrill left with a $162 million severance package, and Chuck Prince of Citi got a $36 million payout.

Those were basically wink-and-nod deals among board members who put each others' interests above the company's. Sure, it could happen again, but it would probably ignite so much public fury that most board members wouldn't dare be so brash.

In fact, we've seen the opposite trend recently at companies such as Yahoo, Best Buy, and Chesapeake Energy, where boards, prompted by angry shareholders, have punished CEOs for far less egregious mistakes than those that nearly caused a depression a few years ago.

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There's an interesting parallel between the London-based J.P. Morgan unit responsible for that firm's recent woes—its Chief Investment Office—and AIG's Financial Products unit, which was also based in London and generated most of the devastating losses that ultimately sank the world's biggest insurance company. Both units generated handsome profits for a while, which allowed them to attain a degree of autonomy that led to reckless trades.

But when the government was forced to take over AIG, and it shut down the Financial Products unit, the man who had been running it, Joe Cassano, was paid $1 million a month as a consultant to help untangle the mess he had helped create.

Can anybody imagine that kind of arrangement today, with the hostility taxpayers feel toward bailouts and greedy bankers? Maybe that's why Ina Drew, who ran J.P. Morgan's Chief Investment Office, no longer works for the bank.

The 2008 and 2009 Wall Street bailouts revealed vast flaws in the nation's financial system and the regulatory regime meant to keep it healthy. But once government intervention became inevitable, there were two types of mistakes that turned distasteful bailouts into a mockery of the taxpayers who funded them, generating profound cynicism toward Wall Street and Washington both.

One was the failure to cancel bonuses and claw back pay at failed firms that required taxpayer-funded rescues. The other mistake was the "back-door bailouts" that went secretly to the trading partners of bailed-out firms to make them whole, when those counterparties should have suffered the consequences that are appropriate when any bet goes bad.

J.P. Morgan doesn't need a bailout, but its predicament gives us a chance to gauge whether anything would be different if a bank of that size did get into deep trouble again. We may still need tougher rules on the risks that banks can take, as President Obama and other reformers insist.

But the pressure is clearly on the banks to fix their own problems, and if they can't, the demand for rough justice will be universal and ferocious. There may still need to be bank bailouts in the future. But if there are, the bankers themselves will have an awfully hard time getting off the hook.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.