Over-Regulation Can't Safeguard Against Rapidly Changing Circumstances

COMMENTARY Government Regulation

Over-Regulation Can't Safeguard Against Rapidly Changing Circumstances

May 19th, 2012 1 min read

Former Senior Research Fellow in Retirement Security and Financial Institutions

David is a former Senior Research Fellow in Retirement Security and Financial Institutions.

Even if it eventually doubles or triples, J.P. Morgan Chase's $2 billion loss doesn't mean that either the bank or the financial system is in crisis. And it certainly doesn't mean additional regulations are needed.

J.P. Morgan Chase is a $2.3 trillion bank with a net worth of $189 billion. While the bank's loss represents a clear failure of management, it's accountable to its shareholders. The loss will be covered by the bank's capital, just as it should be.

The focus of this discussion should be on the amount of capital a major bank has, and not just on its activities. In a very volatile environment, even supposedly safe activities could result in unexpected losses. With a capital ratio even after the known losses of 8.2 percent, J.P. Morgan Chase has more than enough to cover its own transactions without any chance that taxpayers will need to be involved. Meanwhile, other major banks are carefully examining their hedging strategies to ensure that they don't duplicate J.P. Morgan Chase's mistakes.

Trying to regulate every activity of financial institutions is bound to fail. For one thing, circumstances change suddenly. Take investing in mortgage-backed securities. Before late 2008, that was supposed to be incredibly safe, and J.P. Morgan Chase's recent losses came from a strategy designed to protect the bank's assets from losses in a volatile market. Their activities were almost certainly allowed under the Volcker Rule and the many other restrictions contained in Dodd-Frank. More and more regulations won't change the fact that unexpected losses are inevitable at some time or other.

Instead, we should be discussing how much capital a financial institution must have, as well as how liquid its assets should be. That's a better way to safeguard the financial system than micro-managing financial transactions. Both Bear Stearns and Lehman Brothers failed in 2008 because they had little capital to cover losses and nowhere near enough liquidity. (Neither were banks, by the way.)

J.P. Morgan Chase has much more than enough capital to cover its losses. The next discussion should be whether its competitors both here and abroad do also. No government can ensure that unexpected losses never occur. They're an inevitable part of finance. However, with proper capital levels, it's possible to ensure that those losses don't endanger the financial system or require that taxpayers get involved.

First Appeared on USNews.com