JPMorgan: The bank that kicked the hornets' nest

Its trading fiasco's timing is terrible for bank investors.

By InvestorPlace May 24, 2012 1:23PM
By Dan Burrows

The following is part of InvestorPlace's Future of Financials series.

Financial reform, with the enactment of Dodd-Frank and the creation of the Consumer Protection Financial Bureau, hasn't been the death by a thousand cuts that banks said it would be -- but it has added uncertainty and taken bites out of their revenues.

Now, just when the nation's financial institutions had largely adjusted to this brave new regulatory world, JPMorgan Chase's (JPM) $2 billion-and-counting trading loss has put the Volcker Rule back at the top of regulators' agenda.

And that's the last thing investors in bank stocks needed.

The financial sector has led the S&P lower during the past month, as the JPMorgan fiasco added fuel to a fire touched off by the crisis in the eurozone. And it's not just that the best risk manager on Wall Street -- the bank that came out of the financial crisis smelling like a rose -- had a complex bet on derivatives blow up in its face. True, that's bad enough, shaking confidence in the wider industry.

No, it's that the loss handed a cudgel to proponents of the Volcker Rule -- a proposal that cuts to the heart of what was once an outsized profit engine for banks.

The Volcker Rule, named for former Federal Reserve chief Paul Volcker, would bar banks from making speculative bets that aren't on the behalf of clients. Proprietary trading, owning or investing in hedge funds or private equity funds would be barred. The idea is that if these bets go bad and lead to catastrophic losses, well, the money the banks burned would have come from its depositors -- funds that are insured by the Federal Deposit Insurance Corp. and backstopped by U.S. taxpayers.

In short, banks shouldn't take risks with their depositors' cash.

Make no mistake: That's a good thing. But bank stocks sure don't like it. Even as the Volcker Rule still is being written -- and banks will have another two years to get in full compliance as long as they make what the Fed calls a "good faith" effort -- Dodd-Frank and the impending rule already are taking a toll on revenues, as banks shut down trading on their own accounts and exit hedge funds.

“The passage of Dodd-Frank has changed the business models and profitability for many U.S. financial firms, especially large ones, as it has changed the services, fee structure, and limited the services financial firms can offer,” notes Frederick Cannon, analyst at Keefe, Bruyette & Woods, in a report to clients.

JPMorgan says its bad trade was in compliance; that it was a poorly executed hedge -- a claim that has been met with skepticism and snickers. But whether that's true is almost beside the point as far as investors are concerned. The potential damage to the broader industry lies in all the heat it has brought down.

The Federal Reserve, the Securities and Exchange Commission and the Commodities Futures Trading Commission are all investigating. Meanwhile, the Senate Banking Committee is grilling executives in hearings, the Federal Reserve Bank of New York reportedly is examining how banks are managing cash and we're even hearing calls for the return of Glass-Steagall, the Depression-era law that split commercial banks from securities firms.

Lawmakers and regulators are saber-rattling over stricter interpretation of Dodd-Frank and a tougher version of the Volcker Rule. How much of that is political posturing in an election year and how much it ultimately costs banks very much remains to be seen.

But JPMorgan's loss couldn't have come at a worse time for bank investors. Regulatory uncertainty is an overhang on stocks, and investors won't get a sense of how it's going to play out until they get a look at the Volcker Rule. With no firm date set for the ink to dry, that's something that could take all summer long.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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Tags: banking
May 25, 2012 11:01AM
May 28, 2012 10:36AM
You can only fool people for a season or two...then your true colors show through...same with JP Morgan. Loads of issues with JPMorgan, Diamond, Blithe Master....if you listen closely you can hear the lies and manipulation. Lots of communication done in advance for damage control...JPM is a faltering company.
May 25, 2012 8:44AM
Not to worry, the party in control, of Congress, have been paid very well through policitical contributions to take care of the banks interests. The large banks, will remain free to make risky investments, with the depositors money. No chance for any expansion of the Volker rule.
Jun 1, 2012 9:46AM
 Dimon Blankfein are financial TERRORIST BANKSTERS They are exploiting our once great nation with crooked lawyers and an UNHOLY alliance between government and the banks They are life and nature DESTROYERS This wealth confiscation and destruction will keep playing out for years till possibly mass populous movements and demonstrations bring about mass changes in government and financial systems of the world as we know it.We will see.......
May 30, 2012 4:31PM
Unfortunately you can not legislate morality.  The fact that JP Morgan lost money in an investment is no big deal.  Any investor who has a perfect record is a liar.  The fact that JP Morgan bet against their clients and used inside information to hedge against downside losses is a big deal.  Seems that JP Morgan is now selling stock with undisclosed profits to keep a positive balance sheet next quarter and again this is a big deal, for not making accurate disclosures and for fixing the books.  Then they were one of the three that couldn't properly evaluate the Facebook IPO.  So if legislation isn't going to change their attitude (and I presume that there are enough beholding Senators and Congress men) then it's is up to the common investor to vote with their feet.
May 29, 2012 6:25PM

A totally unrestriicted, unregulated and free market economy will do what's best for the average Amercan citizen, Wall Street and Corporate America are committted to that, they are worried about the health of the Middle Class,  there will be jobs aplenty, and how do I know, well...............the GOP/TP has told me so.  Just consider how cutting the tax rate for the wealthiest in this country from 35% to 25% will help the average working (or wants to be wortking) person.  It's obvious, isn't it, at least Mitt, Boehner, McConnell, Limbaugh, Beck and Paul Ryan say so! 

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