Regulation. Over or Under?

American economies are widely regarded as reactive, meaning every time that there is a negative event, regulations are put in place to prevent that exact event from happening again in the future. However, as most everyone has observed, every crisis is different from the next and a more proactive posture has to be taken in order to help prevent future meltdowns from happening.

What has been happening lately is that whenever there is a relatively small market event, the government is now quick to pull the “new regulation” trigger. Take for instance the recent JP Morgan debacle where they lost the two billion and counting on the sales of the European corporate CDS contracts. In the grand scheme of things, this is a small loss.

The Chief Investment Office, which is the JPM group that is responsible for the 2B loss has total invested capital of over 300B USD and through March had unrealized gains of 8B in addition to performing well in 2011. So even though this particular 2B loss is less than a percent of the total portfolio and about a quarter of the offsetting gains, there is pressure coming from all over the political spectrum regarding more regulation.

Now, what I think could be a problem is that the potential losses associated with having to pay off claims on the CDS will no doubt be above 2B, some speculation is that it can be above 5B or possibly even higher. One reason for this belief, is because recently JPM sold off assets to realize profits believed to offset future realization of further losses. This is a reason that threats of regulation are counterproductive. Given a normal environment, JPM would have probably not bothered selling off any assets if they didn’t feel the need to ‘prove’ to the government how relatively insignificant the losses are. The government is therefore, inadvertently causing JPM to sell assets that it normally would have kept around as they were profitable investments.

It can be argued that regulation is good (when it comes to cases like Galleon Capital or basically any insider trading or front running cases), but it can also be argued that it has negative consequences when overdone. I for one am with Kudlow in the belief that Captalism and Free Markets lead to overall growth and Prosperity.

 

Agree, I think that (1) JPM doesn't need gov't oversight on this, they can take their loss like a big kid and (2) the Obama administration is wasting political capital on this incident.

On a side note, is it just me or are credit derivatives like plutonium? Everyone that dicks around with them dies a horrible death.

Get busy living
 
Best Response
UFOinsider:
Agree, I think that (1) JPM doesn't need gov't oversight on this, they can take their loss like a big kid and (2) the Obama administration is wasting political capital on this incident.

On a side note, is it just me or are credit derivatives like plutonium? Everyone that dicks around with them dies a horrible death.

heh, no idea what the valuations were on the underlying and what JPMs thinking was on this, but even to an average person who follows the markets should have realized that writing insurance policies on European companies was not a good idea. Especially to the extent that JPM did.

 

I hate to dodge the question, but I don't think its a matter of too much or too little regulation. Rather, it's that we currently have the wrong regulation.

Worst case scenario, JPM loses 5 billion. It's a lot, but the bank isn't put at risk. The possibility of such losses is core to the business of modern banking. But the bank is emerging from a truly terrible decision relatively unharmed, except for its reputation.

We are talking about regulating these relatively non-threatening (and typically profitable) activities while issues like TBTF and murky investor disclosure endure. You can't assess whether the amount of regulation is proper until they are regulating the right things.

 

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