JPMorgan's massive basis trade blow-up that's cost it $2 billion (and possibly counting) has reopened the debate about the Volcker Rule and Too Big To Fail at the big banks. Of course, massive trading losses are nothing new. A rogue trader at Soc Gen lost that bank a few billion. Another rogue trader at UBS lost the big Swiss bank $2 billion. A big directional bet on subprime lost Morgan Stanley around $9 billion during the financial crisis. And that's just in the last few years. The notable thing about this loss isn't necessarily its size ($2 billion for a bank the size of JPMorgan is a lot, but it's not life-threatening) or its nature (this wasn't a rogue trader; it was the investment office) or even its legality (details have been scarce, but it appears the trade was compliant with the regulations in place to this point). What's really interesting here is it happened at JPMorgan, the banks that, under the leadership of CEO Jamie Dimon, has been leading the charge against financial regulation in the aftermath of the financial crisis.
The crux of Dimon's argument has been, essentially, that further regulation is unnecessary. He proudly points to his own bank as a model of fantastic management, and began claiming that more regulation was unnecessary the instant the markets stabilized in the aftermath of the panic. This loss blows a big hole in his argument. Now, I've never really gotten the obsession with Jamie Dimon in the press and among pundits and politicians. Sure, JPMorgan came through the crisis better than most of the other big banks (mostly because it shrank its subprime portfolio in 2006 rather than waiting for the markets to sound the alarm), but that's always smelled more like dumb luck to me than great leadership. In all honesty, I haven't seen or read any great insight from Dimon, or seen any evidence that he's anything special as a leader-- most of the hype seems to center on him looking like a leader and being outspoken (where Lloyd Blankfein is short and looks like one of those bald aliens on Star Trek with the giant ears and wrinkled foreheads).
The details on the trade are fuzzy. From what I can gather, the trade was in JPMorgan's derivative book, and their claim is that it was a "flattener" meant to hedge their overall credit portfolio (the bet was that short and long yields would "flatten", meaning shorter-duration bond yields would converge with longer-duration bond yields; generally, a flat yield curve is a bad sign). But it looks like someone lost control of the trade and ended up with massive next exposure in one direction that went bad (at least that's the benign version; it could well have been an outright bet).
Of course, Dimon is trying to minimize the impact of the trade-- he claims the press and politicians are "making a mountain out of a molehill" and it's not that big a deal. And while he's right that the loss won't sink his firm, the fact is that $2 billion in a relatively calm market is a BIG loss. The same kind of trade in a market like the one we had in the second half of 2008 would have put his company on the brink. And that just makes the case for better oversight clear. While I don't necessarily think that splitting up market-making and commercial banking is the solution, I do think that size is a problem. And JPMorgan is enormous. If this loss had been bigger, or even if it had happened in a more turbulent market, the bank would have been in line for a bailout. And it would have gotten it because a bank with around $2.3 trillion in assets like JPMorgan can't fail without sending the economy off a cliff after it. Lehman Brothers, which was about 1/4 the size of JPMorgan, less interconnected, and had no depositors, sparked a panic when it failed in September 2008. JPMorgan is a few orders of magnitude bigger.
The point this makes isn't very complicated-- it's that, when someone like Jamie Dimon comes out and says that banks don't need more regulation because people like him are too good at risk management to make bad judgments that could require public help, the response should be, "Baloney".
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