The Best Policy

Last week JP Morgan stunned the world by announcing that it suffered over $2 billion in losses from derivative trades gone awry.  Ironically, JPMorgan was considered to be one of Wall Street’s more responsible banks – one that avoided the derivative disasters of the financial crisis. Even more ironic, JP Morgan’s CEO, Jamie Dimon, has been one of the most outspoken bankers fighting against increased regulation of financial services.  Unfortunately for Jamie, this news will probably lead to another round of regulatory wrath, and a bonus round of bank bashing by the general public.  While I’ve been critical of big banks myself, I’ll play the devil’s advocate in this post.  Big banks certainly have much to repent for.  That being said, they’re also not solely responsible for all the problems we face.

In some ways, banks are victims themselves.  Consider, for example, pre-financial crisis borrowers who took out big loans to buy some big houses (which they really couldn’t afford in the first place).  Regardless of who we fault for the outcome, the fact is that the borrowers received the benefit of living in those homes.   As home prices increased, the borrowers probably benefited some more by tapping home equity to redo their kitchens or to even buy shiny new cars.  Meanwhile, big banks were paying for the shopping spree.  Now as borrowers walk away from their homes and mortgages, the big banks are again getting stuck with the bill.  Think about it, a bank may have paid $500,000 to help a borrower buy a home based on a promise of repayment.  Today, when the borrower defaults, the bank is denied the interest and principal payments it is due.  As reparation, the bank gets to go through the trouble of foreclosing on a house it never wanted in the first place (which is only worth $200,000 now by the way).

Some will say that predatory lending forced those bad home purchases onto everyone and that increased regulation is the only answer – I’m not convinced that’s the case.  Clearly, banks acted recklessly, but so did countless borrowers. A person who thinks that $20,000 in annual income can carry a $500,000 mortgage will end up in financial trouble whether or not the loan is granted, and there’s no amount of regulation that will prevent that. While I think banks should be held responsible for their behavior, we are all responsible for our own actions.  In that sense, I think that encouraging responsible behavior may be the best policy that the government could pursue.

Victor K. Lai, CFA

This blog is for informational purposes only. Nothing on this blog constitutes investment, tax, or legal advice. You should conduct proper due diligence and / or consult with professional advisers before taking any investment action.

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