Big Banks Have Learned Nothing

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Despite Jamie Dimon's admission that a whale of a mistake occurred at JPMorgan Chase (NYS: JPM) in regard to its recent $2 billion-plus trading loss, it comes as too little, too late. Wasn't just a short time ago that he characterized worries about the incident as "a tempest in a teapot"? This sounds to me less like a true mea culpa than the bleatings of a thief who isn't so much sorry that he stole but sure is darned sorry he got caught.

Dimon claimed he wasn't aware of the magnitude of the mess when he made the flippant remark. Now it comes to light that the top brass at the bank had rebuffed warnings from its own shareholders about just this very issue more than a year ago. Two years before that, risk managers within the bank itself complained about the lack of controls in the investment division. The fact that Dimon would rather be regarded as one of the dimmest bulbs in bank-management history than admit to ignoring those warning bells just spotlights the fact that banks have learned absolutely nothing from the financial crisis.

A simple mistake, or business as usual?
The pains that Dimon took to hide from public view the extent of the problem points less to a one-time error in judgment and more to a sense that this model is considered to be at the core of what modern banking is all about. This is spooky in so many ways, but primarily because it seems to go on unabated, regardless of public outcry or legislative restraints. How many other losses like this have occurred, one wonders, but on a scale so much smaller than this that damage control actually worked?


JPMorgan isn't alone in its pursuit of creative banking practices that can pull in high profits for the banks. As you might expect, the largest banks govern 95% of the derivatives market: JPMorgan, Bank of America (NYS: BAC) , Citibank (NYS: C) , and Goldman Sachs (NYS: GS) . Morgan Stanley (NYS: MS) is also a player, and potentially faces the biggest downgrade of the bunch from Moody's Investor Service, in part because of subpar risk management and pricey credit-default swaps clogging its balance sheet.

Creative vs. conventional banking
Why do these banks persist in such activities, when history has shown how dangerous they can be? Quite simply, they've been spoiled by relaxed Depression-era rules that kept these kinds of shenanigans in check. When Glass-Steagall was finally repealed in 1999, banks got a taste of how much more money they could make trading and betting rather than tending to more mundane banking services such as taking deposits, lending to consumers, and maintaining savings and checking accounts. Low interest rates have taken much of the profit out of writing loans, and banks are fond of making lots of money. Simply put, banks would rather gamble on derivatives than participate in conventional banking activities.

Many hope that the Volcker Rule will help curb some of the excesses that have become endemic at the nation's largest banks. The law forbids banks from using depositors' money for trading, which would cut into profits in a big way. Big banks have lobbied long and hard against this rule, and Citigroup analysts say it could "cost" banks upwards of $500 million to comply. Considering that the new regulations would cover 80% of the worldwide derivatives market, they're probably not far off.

Does the Volcker Rule go far enough?
The one thing the new rule doesn't do is rebuild the firewall between investment and commercial banking -- a key ingredient in Glass-Steagall that worked so very well for many decades. The law also exempts hedges from the rule, which makes sense but could prove troublesome if banks make large bets and simply then hedge, as JPMorgan apparently did. Former Federal Reserve chief Paul Volcker himself has said he isn't in favor of "ring-fencing" the trading portion of bank activity from the commercial section, since banks will only find loopholes and carry on anyway. But the only way banks were able to get around that prohibition in the past was to lobby for legislative changes, such as the Gramm-Leach-Bliley Act, which effectively took the last brick out of the wall separating the two sectors.

The rule is forward progress, and baby steps are better than no steps at all. If the squealing emanating from the big banks is any indication, the law seems to be hitting its mark, which seems like a good thing. It appears that investors may initially have to take a hit right along with the banks -- although institutions will have a grace period of up to two years to comply -- but the changes can only help restore stability and health to the chaos that the U.S. banking sector has become. In the long run, this should be a benefit to investors, but only time will tell whether it's enough.

The Volcker Rule could make a big dent in big banks' profits, but it won't have a major effect on traditional regional banks. For a look at one name that our banking analysts identify as having some of the best performance metrics they've ever seen, check out The Stocks Only the Smartest Investors Are Buying.

At the time this article was published Fool contributorAmanda Alixowns no shares in the companies mentioned above. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase.Motley Fool newsletter serviceshave recommended buying shares of Goldman Sachs Group. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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