JPMorgan, the Volcker Rule, and the Extreme Brevity of Financial Memory

Financial crises are a lot like childbirth -- they both involve a lot of pain and end up costing you a lot of money. But, after a while, you forget about all the negatives and are ready to do it again.
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Financial crises are a lot like childbirth -- they both involve a lot of pain and end up costing you a lot of money. But, after a while, you forget about all the negatives and are ready to do it again. Of course, with childbirth you at least get something positive out of it. In my own case, I'd forgotten enough about the downside of having a baby to do it again two years later -- without an epidural. (My older daughter just graduated from college this week -- time flies!) This propensity to forget, so useful when it comes to having babies, is incredibly destructive when it comes to our economy. So why do we do it?

In 1990, John Kenneth Galbraith tried to answer this vexing question in his book, A Short History of Financial Euphoria. Using the 1987 market crash as his launch pad, Galbraith looks at the history of financial bubbles -- and the subsequent and inevitable crashes -- and at why the lessons that would prevent boom and bust cycles from happening with devastating regularity are never learned. To Galbraith it's a combination of "the extreme brevity of the financial memory" and a general ignorance of history.

"There can be few fields of human endeavor in which history counts for so little as in the world of finance," he writes. "Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."

And not only is the boom and bust cycle repeated endlessly, so is the response. See if this sounds familiar: When the initial wave of public anger at a financial bubble bursting is at its highest, there are pledges from politicians to get tough and "never let this happen again." Some reforms are proposed but, as the public's anger -- and memory -- weakens, so does the "reform." By the time reform measures are passed (if they even are), lobbying has weakened them enough to make another crisis inevitable. In fact, that's how these measures are designed -- not with the intent of creating a fresh crisis per se, but by providing loopholes that explicitly allow the activities that will make the next crisis inevitable.

Exhibit A: The renewed battle over the so-called Volcker Rule in response to JPMorgan Chase's recent trading loss -- which might reach $5 billion. How did such a massive misstep happen? We want to think there must be some extraordinary reason for such an extraordinary loss. Was it because of a change in JPMorgan's risk model, which hid the true extent of risk the bank was taking on? Was it because of the personnel conflicts brought on by the vacuum created when Ina Drew, head of JPMorgan's chief investment office, came down with Lyme disease in 2010? Or was it, in fact, inevitable because "of a loophole in the reform legislation that Obama signed"?

In any case, it was no doubt helped along by the "extreme brevity of the financial memory." Right now the question is whether the small-bore outrage over the JPMorgan debacle will help the small-bore reform -- in the form of the Volcker Rule -- inch across the finish line in some more-than-meaningless form. But it's also useful to go back a bit, into Galbraith's "primitive refuge" of "past experience." Let's go back to 2008. It's not that long ago, but it has the feel of a distant memory when you recall the level of outrage directed at big banks at the time, and the kind of real reform that, for a minute or two, seemed possible. There were serious proposals to transform the way big banks do business, and to ensure that taxpayers would never again have to step in to pay the tab after another Wall Street bender. There was a lot of tough talk from the new Obama administration, which, if it was willing to do more than talk, had the public's will -- and outrage -- behind it.

But as the banks and their lobbyists surely knew, the devil is in the details. So, as the public began to forget its outrage, the lobbyists began to get to work. First, the most meaningful proposals, like bringing back Glass-Steagall, or getting rid of too-big-to-fail banks by breaking them up, were tossed aside. What was left became the Dodd-Frank bill, passed in the summer of 2010. In the year following the bill's passage, over two-dozen pieces of legislation were put into the mix to weaken it.

According to Public Citizen, members of Congress who support a weakened version of the rule raked in 35 times more in contributions from the financial industry than those who support a strong version -- $66.7 million to $1.9 million. And as lobbying intensified this spring, lawmakers were, as Bloomberg News put it, "signaling they're receptive" to revising the rule. Sounds like something out of a nature documentary -- modern democracy's equivalent of wild animals signaling they're receptive by lifting their behinds.

And now comes the JPMorgan trading loss -- exactly the kind of thing the Volcker Rule is supposed to prevent. "JPMorgan Chase has a big hedge fund inside a commercial bank," said Boston University economics professor Mark Williams. "They should be taking in deposits and making loans, not taking large speculative bets." Or, as Felix Salmon put it, the bank was "using its Chief Investment Office to gamble with taxpayer-backstopped funds." Once again, the taxpayer is the ATM at the Wall Street casino -- exactly what all the politicians, responding to our outrage in 2008 and 2009, were never going to let happen again.

And, once again, we're hearing the tough talk. "We are very confident that we will be able to make sure [the new rules] come out as tough and effective as they need to be and I think this episode helps to make that case," said Treasury Secretary Tim Geithner.

"Without Wall Street reform, we could have found ourselves with the taxpayers once again on the hook for Wall Street's mistakes," said President Obama. "We've got to finish the job of implementing this reform and putting these rules in place."

Could have? And finish the job? It's not like the loophole-ridden Volcker Rule will end too-big-to-fail -- and as long as that's the case, the banks know they have us right where they want us. And the president didn't mention anything about finishing the job a few days earlier when he appeared on The View and declared that "JPMorgan is one of the best-managed banks there is." Peter Boyer and Peter Schweizer say this is evidence of Obama's "passive-aggressive relationship with Big Finance," but when someone is passive-aggressive, they're expressing aggression in the guise of passivity. This is passivity in the guise of aggression.

As for finishing the job, even when the Volcker Rule is implemented in July, the banks have two years to comply -- and to further water it down. Or, if Mitt Romney wins, repeal the Dodd-Frank bill altogether, as he's pledged to do.

Hearings were held Tuesday in the Senate Banking Committee on finalizing the derivatives rules. Before the JPMorgan debacle the leading Democrats, Chairman Tim Johnson and Chuck Schumer, wanted to lighten protections. Now, Johnson says the JPMorgan case illustrates "why opponents of Wall Street reform must not be allowed to gut important protections for the financial system and taxpayers." But where was that tough talk before? After all, what happened with JPMorgan was inevitable under the looser rules Johnson and Schumer seemed to support as of a few weeks ago.

The Times editorializes that "JPMorgan's fiasco should be a teachable -- even a transformational moment." Well, don't hold your breath.

It's clear the solution to the destructive effects of the financial euphoria-driven boom and bust cycle will not be found in Washington. The banks will always win on that front -- they own the lobbyists, and the lobbyists have a stranglehold on the legislative process. When piecemeal rules are written, the banks will hide behind complexity and loopholes.

So we all need to stop forgetting. We need to tap back into the outrage we felt when the financial crisis erupted in 2008. And maybe there could be some sort of Clockwork Orange-like aversion therapy for those inside the banks. Just imagine what would happen if any time a dazzling new financial transaction is mentioned, an electric shock follows -- strong enough to make us question the wonders of financial "innovation." It's sometimes said that humans have natural aversions to snakes and cannibalism. Maybe with the right kind of training we can eventually add to that list financial trades in which complexity has somehow magically removed all the risk.

Would this aversion therapy work? I'm not sure, but I know it's got a better chance of stopping the next nobody-saw-that-one-coming crisis than a watered-down Volcker Rule. Otherwise, a few years down the road, we're going to once again find ourselves in a lot of pain, wondering, "How could I ever have forgotten just how horrible this is?"

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