JPMorgan Chase and Why Wall Street Must Be Regulated

Congress is busy hammering out a financial reform bill, and JPMorgan Chase (NYSE: JPM  ) just reminded everyone how important it is.

Part of this bill is the Volcker Rule, named after former Fed boss Paul Volcker, which bans taxpayer-backed commercial banks from proprietary trading, or trading for their own account (as opposed to facilitating client trades).

If you're wondering why there's a movement to ban such activity, check out rumblings that JPMorgan just lost as much as $250 million on a single proprietary trade. Even in JPMorgan's world, this is real money. And what kind of trade was this? Adding liquidity to the mortgage market? Digging for price discovery in the small business loan market? No sir. As the New York Post writes:

Specifically, the firm's traders were believed to have been wagering on the differentials between the costs associated with shipping coal in northwest Europe and the price of delivering coal in South Africa's Richards Bay.

This is pure gambling, plain and simple. Try arguing that it isn't. Go ahead. Try.

Now, no one's saying we want a prohibition on risk-taking. But all the big trading banks -- JPMorgan, Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , Goldman Sachs (NYSE: GS  ) , and Morgan Stanley (NYSE: MS  ) -- are able to pull off these trades with taxpayer-backed capital in one way or another. 

You can still gamble your own money. But once you've lassoed and hogtied the support of the common citizen, your freedom to do stupid things is revoked. That's all the Volcker Rule says.

In most states, playing blackjack with your own money is illegal. On Wall Street, using subsidized money to throw the dice on shipping spreads is free game. Let's pass the Volcker Rule.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.


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  • Report this Comment On June 08, 2010, at 4:39 PM, dolmatov wrote:

    read on Goarticles .com "Just capitalism" and

    "Peace.Progress.Social development" part 2 of 3

    by Michael Zilbering

  • Report this Comment On June 08, 2010, at 5:11 PM, WilliamaA wrote:

    I am a big fan of JP Morgan but even more of a fan of Paul Volcker and the Volcker Rule. I have even blogged about him and his rule occasionally. But I must take my hat off to you. While I have rattled on in my longish articles making wonkish references to good bank supervision practices, etc., you have captured the essence of the argument much more effectively in only a few more words that I've taken in this comment! What a Fool!

  • Report this Comment On June 08, 2010, at 9:12 PM, dadoosdabom wrote:

    Hasn't JPM paid back the tarp money? Does your argument hold when a company makes such bets using resources acquired through traditional capital raising mechanisms and not from the taxpayer?

  • Report this Comment On June 08, 2010, at 9:23 PM, TMFHousel wrote:

    "Hasn't JPM paid back the tarp money? Does your argument hold when a company makes such bets using resources acquired through traditional capital raising mechanisms and not from the taxpayer?"

    Yes. JPM's cost of capital is close to zero because of Fed policy, FDIC-backed debt, FDIC-backed deposits, and an implicit too-big-to-fail guarantee. Taxpayers stand behind or are impacted by these backings.

  • Report this Comment On June 09, 2010, at 7:03 AM, dadoosdabom wrote:

    Taxpayers are backing incredible amounts of Federal spending that they simply have no control over ... whether its a bank bailout, a union bailout, or some other entitlement, the taxpayer is the one getting the bill. Why take up such a pious position when it comes to financial reform?

  • Report this Comment On June 09, 2010, at 10:25 AM, JasonApolloVoss wrote:

    Another problem that is rarely addressed is how investment banks incentivize their traders. The traders make gigantic money if their bets pay off for the investment bank. However, they are limited to a personal loss of "no bonus" if their trades fail. In effect, the traders get to play with house money until their trades are so consistently bad that they get fired. A more fair rule would put the traders' bonuses at stake should their trades go south.

    Additionally, the time horizon for evaluation is only one year - at the most! So you may have a trader that makes $200 million for her firm over the course of five years. Each year that trader receives bonuses based on that years performance. However, if that trader loses $250 million for the firm in year six, the trader may lose her job, but they get to keep the money they made in the previous five years, even though they lost $50 million for the firm, net. This is crazy.

    My suggestion would be that the bonuses awarded are put in escrow until the trader retires and then the trades are closed.

    Jason Apollo Voss, CFA

    Portfolio Manager, retired

    Author of the forthcoming book "The Intuitive Investor"

    Publisher of jasonapollovoss.blogspot.com blog

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