Too big to fail, or too strong to bail?

FT.com

Last week Jamie Dimon was not arrested. JP Morgan Chase was not seized by federal regulators. Emergency laws were not passed by Congress. A grim-faced Barack Obama did not address the nation.

Queues of worried depositors did not form outside Chase branches. Black limousines of Wall Street chief executives did not descend on the Federal Reserve for crisis talks.

Bankers did not walk out of the bank's headquarters at 270 Park Avenue with cardboard boxes. No humiliating caricatures of Dimon were commissioned.

Yet the reaction to JP Morgan's $2 billion trading losses was nonetheless incendiary. Politicians jumped in front of the television cameras to pass judgment. Dimon should go, shouted Simon Johnson, the former chief economist of the International Monetary Fund. There were calls for hearings. Regulators were told to stiffen their resolve and toughen rules.

Part of the response is undoubtedly "tall poppy syndrome”, the unpleasant desire to drag down the successful that I always thought was not common in the US but seems to be spreading.

That doesn't mean that Dimon shouldn't be scrutinised for failures of risk management. At today's annual meeting shareholders should vote for an independent chairman, not because of last week's debacle but because it is the right thing to do at every large corporation, particularly one as complex as JP Morgan.

Having had billions wiped off the market capitalisation of their company, investors might also consider whether Dimon and others were too richly rewarded last year – and vote on that reflection. It has been heartening in this season of annual meetings to see some action from a traditionally supine US shareholder base.

But on the regulatory front, let's also consider what worked. JP Morgan has much more capital than it used to (and still much more than most other large banks around the world). The trading loss dented the capital cushion, which fell from 8.4 per cent of risk-weighted assets to 8.2 per cent under new Basel III rules. That is a flesh wound, not a mortal blow.

Could JP Morgan have withstood a much bigger loss – $20 billion for example? Probably. Where's the limit? These are the war games that the Fed is playing regularly.

Somehow, though, most of the discussion has been on a broad subject, only tangentially related to the losses on credit derivatives: we're back discussing the persistence of "too big to fail”.

That is a bit odd. JP Morgan was not too big to fail in the usual sense that the government would save a collapsing financial group rather than suffer the consequences. It was too strong to fail because it has not thrown away too much of its capital on bad assets, big bonuses and huge dividends.

Strange then that these losses have again reignited the calls to break up the banks. But it seems to reflect a yearning across the country from the tents of Occupy Wall Street to the offices of some Fed presidents. Ever since the crisis the calls for a more fundamental restructuring of the industry have died down, only to flare up again at the slightest prompt.

There are three things to remember there. First, it will take something far scarier than "the London whale” to persuade Congress (especially Republicans) to pass a new Glass-Steagall, the law that forced a separation between investment banking and commercial banking. The monumental Dodd-Frank bill used up all the energy on financial reform.

Second, the phenomenon of "too big to fail” has not been ended, despite the best efforts of officials. I saw Moody's analysts last week who believe that a failing financial institution might still be bailed out.

Dodd-Frank did include a resolution authority, allowing officials to wind down a failing financial group. But not all rating agencies believe it would be used. That means they give a higher rating to the big banks' debt than they would receive on an "unsupported” basis. That means the banks can borrow more cheaply.

Third, despite the previous points, there is lurking in Dodd-Frank the potential to impose more draconian restructuring of banking than is widely appreciated.

JP Morgan and its peers are finalising their 'living wills' that are supposed to describe how their assets could be safely sold if they fail. But the market has not fully understood that regulators have the power to order disposals if they believe financial groups are too complicated to be wound down safely. Even if it has little to do with 'too big to fail', JP Morgan's trading debacle has fuelled the calls for bank simplification. Regulators might now be willing to listen.

Tom Braithwaite is the Financial Times's US Banking Editor

Copyright The Financial Times Limited 2012.