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JPMorgan's Loss Provides Lessons for Reformers

NEW YORK ( TheStreet) -- Jamie Dimon is properly embarrassed and apologetic about JPMorgan's (JPM - Get Report) $2 billion trading loss in European credit derivative securities. Although Congress, the regulators and the public are all properly concerned and seeking to discover how America's best-run bank could have made such an error, each of them must bear in mind that there is no cause for panic because of this loss.

For example, $2 billion or $3 billion is a lot of money even on Wall Street. But when judged relative to JPMorgan's size, the loss is not as onerous. A loss of $3 billion would equal about 2.2% of JPMorgan's stock market capitalization of $131.25 billion and less than 0.15% of its assets, which total over $2 trillion. Similarly, although this loss will reduce the profits earned this quarter by JPMorgan, the bank will still be in the black this quarter, even after the impact of the trading loss.

This is not another Lehman Brothers moment.

Some in Congress and elsewhere are saying that had the "Volcker rule" (part of the Dodd-Frank legislation aimed at restricting the proprietary trading of banks) been in place, this loss never would have happened. How can those critics be so certain? There will always be percentages of trades (and loans for that matter) that go awry, even if they are put on as legal hedges.

The current hysteria in Congress is en route to making prescience the new standard of any bank lending and trading activity. Dodd-Frank is already more than 2,000 pages in length, and the Volcker rule has yet to be implemented after two years of trying to define acceptable vs. excessively-risky trading.

Rather than insisting on prescience or even more complex regulations, it would be more productive for the regulators to focus on two aspects of bank activity that can more efficiently protect taxpayers from the necessity of bailing out banks, such as JPMorgan, which are systemically too important to fail: leverage and alignment of executive compensation.

Excessive leverage is generally agreed to have been one of the critical factors that created the 2007-2009 banking crisis. Leverage for the largest banks in the U.S. banking system has been greatly reduced since then. This reduction in leverage, however, has come about not through Dodd-Frank or any other U.S. law but rather from the international regulator of the largest banks, the Bank of International Settlements in its Basel III directive. This directive now requires banks such as JPMorgan to have equity capital equal to 10.5% of their assets.
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