JPMorgan’s $2 Billion Loss: A Case for Regulation?Randall Holcombe • Monday May 21, 2012 12:08 PM PST •
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.