JPMorgan’s $2 Billion Loss: A Case for Regulation?
By Randall Holcombe • Monday May 21, 2012 12:08 PM PDT • 8 Comments
When JPMorgan announced it had sustained a $2 billion trading loss a few weeks ago, some commentators, including Paul Krugman, argued that their irresponsible investing was more evidence that we need stronger financial regulation. The evidence in the JPM case actually shows the opposite.
Krugman’s column presents the arguments on both sides. The correct argument, which Krugman acknowledges, is that the loss was entirely borne by JPM and their shareholders. They took the risk; they took the loss. That’s how markets are supposed to work.
I’ll go on to add that unless people take risks, economic progress will come to a halt. So the fact that people are willing to take risks is good for the economy, and the fact that in this case the bad outcome for the risk takers involved only their loss sends a signal to others to weigh carefully the risk against the return. The bottom line is that risk-taking is beneficial to the economy, and the incentives are correct in cases like this when losses are borne entirely by those who took on the risk.
Krugman’s argument that this case shows the desirability of more regulation relies entirely on hypothetical events that didn’t happen. He conjectures that if the losses had been bigger in this “too big to fail” bank, taxpayers would have been on the hook for those losses. I have some sympathy for this argument, in that if the bank’s deposits are covered by federal deposit insurance, and that if the bank is “too big to fail” so would be bailed out by taxpayers, there is a case to be made for regulation to limit the risks shifted to taxpayers. Or, there is a case to be made to eliminate the “too big to fail” status and let future financial firms follow in the steps of Lehman Brothers — which Krugman does not consider.
But, Krugman’s argument is based on hypothetical events that did not occur. The JPMorgan case provides no evidence that more regulation is desirable, because none of the bad things Krugman hypothesized could happen did happen. The market worked as it should have, and the people who bore the losses were the people who should have borne them. The JPMorgan case provides evidence against Krugman’s pro-regulation argument, not for it.
Tags: Bailouts, Business, Economics, Entrepreneurship, Free Market, Government subsidies, Money and Banking, Politics, Regulation 
I would say they are never to big to fail.If they something stupid they should deal with the consequences.I do it.They need less regulation to allow the smaller companies and mom & pop shops to grow.We don’t need more laws we need less.
Travis | May 21, 2012 | Reply
An unusual result, if it is. We have come to expect the public to rescue large banks and corporations mistakes rather than allow the bankruptsy proceedures to go forward, as they should.
richard | May 21, 2012 | Reply
The trouble with Dr Krugman’s analysis, is it supposes that regulators get it right. In fact, when independent analyst Martin Weiss published in a newsletter, his prediction that Lehman Bros would soon be bankrupt, regulators responded by investigating Dr Weiss on a theory of an insider-trading conspiracy. Months later, when the matter was before a House committee, it came out that Dr Weiss published the only subscriber-funded bank ratings newsletter. S&P, Fitch, and Moody’s all were paidby Lehman Bros, to rate Lehman Bros, and were rating it a good risk, as of 10AM the morning Lehman Bros went bankrupt. As long as there exists a revolving door between regulated industries, information providers, and reguatory agencies, this conflict of interest will continue.
Compounding the problem are numerous federal statutes, am^ng them the Legal Tender Act and the Currency Stabilization Act, that force most Americans to deposit money in licensed and regulated banks. If we could bury our life savings in diamonds, and use them to pay any bill or tax, there’d be an alternative to the banks. But if I walk into an IRS office with a briefcase full of foreign coins and try to pay my taxes with it, I’ll first be locked up as a suspected terrorist.
Deregulation of banking must begin at the beginning. Take away the power of the bank lobbyists, to buy laws and regulations that force every American to put our savings at risk in the banks. Then allow banks to compete fairly for deposits, from customers who have real alternatives to using the banks.
Bob Schubringg | May 21, 2012 | Reply
Paul Krugman is evidently incapable of ever getting anything right. Whatever he writes, assume the opposite. You can’t go wrong.
Steve H. | May 21, 2012 | Reply
I agree that JPM’s affair was how things should happen but feel that criticism of Krugman in that he invokes “hypothetical events” is a step too far. Unless regulation can be written in a manner that taxpayers are never on the hook [good luck on that] hypotheticals are in order. Would it not have been wise for the captain of the Titanic to ponder possibilities he felt unlikely [and bigger than the number of lifeboats implied]?
Malcolm Stewart-Morris | May 21, 2012 | Reply
“Deregulation of banking must begin at the beginning. Take away the power of the bank lobbyists, to buy laws and regulations that force every American to put our savings at risk in the banks. THEN allow banks to compete fairly for deposits”
Now this makes sense!
liz | May 22, 2012 | Reply
It’s like saying the Titanic sunk because it was too big and the ocean too small. It ignores decision making. Too big to fail and government intervention are the real culprits.
jorod | May 26, 2012 | Reply