An out-of-proportion outcry

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Article Highlights

  • The $2 billion loss by JPMorgan Chase has reawakened debate of whether #banks are taking excessive risks.

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  • A $2 billion loss is less than 1/1000th the size of the bank & only 0.5% of the portfolio the #bank tried to protect.

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  • ”The facts are important; let’s look before we leap.” – Peter J. Wallison

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Editor's note: The following article is an opposing view to USA Today's related editorial, "Whale of a loss feeds needs for rules."

The $2 billion loss by JPMorgan Chase has reawakened debate about whether banks are taking excessive risks, but many facts have gotten lost in the breathless media coverage.

Although the 2010 Dodd-Frank Act bars banks from engaging in trading for their own accounts, they are specifically authorized to engage in hedging transactions. Hedging is intended to protect banks' investments in the same way that a farmer might sell his corn crop before the stalks are out of the ground. In the farmer's case, if the crop is worth more when it is harvested than the price he received, he has suffered a loss, but has protected himself in case the weather makes the crop worthless. Was the farmer taking an excessive risk?

From the limited news media coverage of what actually happened, it appears that JPMorgan was attempting to protect a $400 billion investment portfolio threatened by the turbulence in Europe. This is not as simple as the farmer selling his crop, and there could well have been mistakes in structuring the hedge, but a $2 billion loss was less than 1/1000th the size of the bank and only 0.5% the size of the portfolio the bank was trying to protect. As usual, the size of the media outcry is far out of proportion to the problem.
"The facts are important; let's look before we leap." - Peter J. Wallison
The USA TODAY editorial, sadly, is of this genre. Citing this loss as an indication that nothing has changed on Wall Street really means that nothing has changed in the sensationalist media coverage of Wall Street. If JPMorgan had not attempted to hedge its $400 billion portfolio, and events in Europe had severely diminished its value, that would have been another news story about an irresponsible bank. Any USA TODAY reader who watched his or her IRA melt away in 2008 should understand this problem.

Higher capital ratios might be a good idea, but let's consider the effects on lending — especially in an economy spooked today by all the controls Dodd-Frank has already imposed. Re-imposing Glass-Steagall is another old, but irrelevant, standby. The facts are important; let's look before we leap.

Peter J. Wallison is a financial policy expert at the American Enterprise Institute. A former White House counsel and general counsel to the Treasury Department, he was a member of the 2009 Financial Crisis Inquiry Commission.

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