[ by Melanie Gretchen  and Howard Haykin ] Prior to JPMorgan Chase's $2+ billion loss, the firm seemed to prosper, in part by having the rare ability to steer clear of the kinds of investments that, for example, brought major financial institutions to their knees - like AIG and MF Global.  Its leader, CEO Jamie Dimon was practically deified on Wall Street for seemingly making all the right moves and for being in the "right place at the right time."  When financial giants Bear Stearns and Washington Mutual collapsed during the credit crisis, it was Mr. Dimon and JPMorgan Chase bank that were called in to "rescue" the companies and salvage existing business units. Then "financial reform" became the mantra in Washington, D.C. - in the form of the Dodd-Frank Reform Act, which showcased the so-called Volcker Rule, which promised to significantly restrict proprietary trading and investments by big banks with government-guaranteed deposits. Perhaps the most vocal opponent of the Volcker Rule was Jamie Dimon, and who had the backing of Wall Street's big banks, as well as key Republican Congressional leaders, who used their political muscle to throw delaying roadblocks in from of the Volcker Rule and complained bitterly that the overly prohibitive restrictions of the Rule could have a draconian impact on both the financial institutions and the U.S. markets.  In many ways, the Volcker Rule or several of its sharp-toothed provisions looked particularly vulnerable. Game Changer. Then, lo and behold, news came out of London that shook the very foundations of the global financial community.  JPMorgan's prop derivatives trader, known as the 'London Whale' because of his reputation for taking over-sized positions, took a devastating loss on derivatives that he had accumulated from numerous hedge fund managers.  Throughout the process, JPMorgan officials offered little oversight or resistance to the strategy, and risk management was an afterthought. For JPMorgan Chase and CEO Jamie Dimon, the loss was nothing short of a "wake-up call" or, as NYTimes Columnist Paul Krugman put it, "a major policy lesson."

"Just to be clear, businessmen are human — although the lords of finance have a tendency to forget that — and they make money-losing mistakes all the time. That in itself is no reason for the government to get involved. But banks are special, because the risks they take are borne, in large part, by taxpayers and the economy as a whole. And what JPMorgan has just demonstrated is that even supposedly smart bankers must be sharply limited in the kinds of risk they’re allowed to take on."

To prevent such mishaps, the federal government established a wall of protection by enacting rules, regulations and enforcement agencies in the 1930s that involved "both guarantees and oversight," according to Mr. Krugman.

"On one side, the scope for panic was limited via government-backed deposit insurance; on the other, banks were subject to regulations intended to keep them from abusing the privileged status they derived from deposit insurance, which is in effect a government guarantee of their debts.  Most notably, banks with government-guaranteed deposits weren’t allowed to engage in the often risky speculation characteristic of investment banks like Lehman Brothers."

How Soon We Forget. But that was then, and this is now.  And the modern age of banking - built on and encouraged by risk-taking - has emerged exposing not only the financial institutions, but the public, to the great risks of default and loss. To wit, Mr. Krugman concludes that it is time to "restore the sorts of safeguards that gave us a couple of generations without major banking panics."

JPMorgan made a huge bet in derivatives, complex financial instruments, on the safety of corporate debt, and that bet went bad.  Institutions that play a key role in the financial system have no business making such bets, least of all when those institutions are backed by taxpayer guarantees."

And, according to Mr. Krugman, it is to be expected that Wall Street will be back to its usual arrogance within weeks if not days, and possibly make the same mistakes again.

"The truth is that we’ve just seen an object demonstration of why Wall Street does, in fact, need to be regulated."  [NYTimes, 5/13/12]