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JPMorgan's Loss Provides Lessons for Reformers

Other countries where banking represents a vital part of their economy have gone significantly further than the Basel directive. If Congress were to set a similar super standard for the largest U.S. banks, each of the banks would have as much as twice as big a cushion to absorb losses and thus be half as likely to ever require public assistance.

Another major contributing factor to the crisis of last decade was the normal human behavior of people being more tolerant of taking risk when the money involved is someone else's and not their own. Banking executives are human, and their appetite for risk increases when the funds at risk are undertaken with other people's money. When Congress, as a condition of TARP, required the compensation of banking executives to be less weighted toward bonuses than was the practice, it moved the incentives in the wrong direction. Now, with a greater percentage of an executive's total compensation being guaranteed as a salary as opposed to an incentive bonus, if a trade goes bad resulting in lower earnings, the executive suffers less than would have been the case of more heavily weighted incentive bonuses.

Dodd-Frank does take a step in the right direction by enabling "clawbacks" of previously paid compensation when trades put on in an earlier pay period later go bad. In the current case of JPMorgan, Jamie Dimon has indicated that he intends to pursue just such clawbacks.

An even better alignment of incentives would be to make the equity compensation (options, etc.) that the most senior executives receive in the form of "elevator equity," meaning that in the event of extremely negative results with a delayed fuse, not only would the value of the equity go to zero, but the clawback would permit attachment of the personal assets (beyond their equity in the bank) of the executives. Just as Sarbanes-Oxley's requirement of CEOs and CFOs personally attesting to the accuracy of financial disclosures under the threat of criminal penalties made senior executives of public companies much more vigilant in their financial disclosures, the threat of losing assets outside of the bank will make senior bankers less reckless with the capital they trade.

A return to the world of Glass-Steagall is nice in theory, but we are living in a world much more complex than it was in 1933. Micro-managing banks through increasingly detailed regulation is a fool's errand. Simpler regulation aimed at less leverage and curbing executives imprudent trading is a better solution for today's financial markets
William R. Gruver is a member of the board of directors at The Street, a professor at Bucknell University and a former general partner at Goldman, Sachs & Co. Previous to his work on Wall Street, Gruver served as a nuclear submarine officer.
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