Coming on top of renewed turmoil in Europe that has increased the selling of European bank shares, JP Morgan’s announcement of a $2 b. trading loss, with more to come, sharply raises the perceived risks of U.S. bank shares. This news will severely undercut JPM’s reputation as the best-run U.S. bank and pushes global markets to another encounter with systemic risk.
The Fed faces a difficult choice. The need to counter the impact of financial uncertainty on the economy has risen, while the opposition to doing so has also increased in view of JP Morgan’s apparent willingness to embrace risks that it does not understand and/ or cannot manage. In the short run, expect Bernanke’s assurance that the system is sound and that the Fed stands ready to meet any liquidity needs. Over the longer term, the Fed will want to put bankers on a shorter tether, that limits proprietary trading.
At the very least, the JP Morgan fiasco demonstrates the ineffectiveness of Dodd-Frank as a viable guardian of financial stability. The problem is structural. Depository institutions that enjoy protection afforded by deposit insurance and their absolute large size—too big to fail—should not be allowed to engage in proprietary trading. Time to implement the Volcker rule.