WASHINGTON — The public won’t be protected from the type of risky bets that led to the huge trading loss at JPMorgan Chase & Co. until new rules are approved to allow better monitoring of complicated derivatives transactions, two key federal regulators told a Senate committee.
As it was, the heads of the Securities and Exchange Commission and the Commodity Futures Trading Commission said Tuesday that they learned of the unusual trading activity that led to JPMorgan’s $2.3-billion trading loss through media reports.
That loss, reported two weeks ago, has already grown to more than $3 billion, and some analysts expect it to go as high as $7 billion.
The Senate Banking Committee, which is holding hearings on the 2010 financial reform law, plans to question banking regulators about JPMorgan’s trading loss at a June 6 hearing and to call in JPMorgan Chief Executive Jamie Dimon soon after that.
“The company’s massive trading loss is a stark reminder of the financial crisis of 2008 and the necessity of Wall Street reform,” said Banking Committee Chairman Tim Johnson (D-S.D.).
SEC Chairwoman Mary Schapiro told the committee Tuesday that her agency is focused on the “appropriateness and completeness” of JPMorgan’s financial disclosures, including whether its recent earnings statements and first-quarter financial reports were “accurate and truthful.”
Commodity Futures Trading Commission Chairman Gary Gensler said his agency’s enforcement division is investigating the credit derivative products, traded by JPMorgan’s chief investment office, that led to the loss.
Gensler and Schapiro said they could not comment further on their investigations. The FBI has also launched a preliminary inquiry into the trading loss.
And the Financial Stability Oversight Council, a panel of top regulators, was briefed Tuesday on the loss at its regularly scheduled closed-door meeting. A Treasury Department spokesman said regulatory reviews of the loss are important to implementing financial reform rules “so that mistakes in judgment at individual banks are less likely to threaten the broader financial system and economy.”
The trading loss has been a major blow to JPMorgan. Its stock had tumbled 20% after the news was revealed May 10 before rebounding Wednesday to close at $34.01, a gain of $1.60, or 4.6%.
Sen. Richard Shelby (R-Ala.) said he was surprised that regulators did not know about JPMorgan’s loss until it was reported in the media.
“So you really did not know what was going on or the problems with the trade until you read the press reports like all of us?” he asked.
Gensler said that until rules are in place limiting so-called proprietary trading by banks and imposing new oversight on complex financial derivatives, “the American public is not protected.”
Democrats, including President Obama, have said JPMorgan’s loss highlights the need to implement tough rules called for in the 2010 Dodd-Frank financial reform law.
“If JPMorgan lost $2 billion — or some reports suggest likely more — through these trades, what’s to stop them from losing $10 billion the next time or, even worse, to stop another less-capitalized bank from taking losses so large that could bring it down?” said Sen. Robert Menendez (D-N.J.).
Schapiro and Gensler said the JPMorgan incident would be instructive as their agencies finish writing new rules to monitor and limit the type of trading in financial derivatives that led to the bank’s loss.
Among the regulations still being drafted under the reform law is the so-called Volcker rule, which is intended to limit trading that banks do with their own funds.
Gensler said the JPMorgan loss “gives us real, live experience, like [American International Group Inc.] and Lehman Bros. and Citigroup did in a more disastrous way” during the financial crisis.
But Republicans, who almost unanimously opposed the law, warned of an overreaction. Sen. Bob Corker (R-Tenn.) said he worried that regulators would try to broaden the new rules in reaction to the JPMorgan loss.
“What I fear is, in a rush to make it look like the Dodd-Frank legislation addressed these kind of issues ... what you’re going to do is end up causing the Volcker rule to be something it never was intended to be,” he said.
Corker and other Republicans said banks needed to use derivatives to hedge against losses. Placing too many restrictions on derivatives would reduce hedging and increase the risk of losses at banks.
The easier solution is simply to require banks to hold more capital to absorb losses, said Sen. Patrick J. Toomey (R-Pa.).
“Frankly, firms ought to be able to make decisions and then live with the consequences, and taxpayers shouldn’t be at risk,” he said.
Sen. Mark Warner (D-Va.) said regulators might be fortunate that the JPMorgan trading loss took place as regulators were writing the rules and provided a real-world example that did not damage the financial system. JPMorgan had more than enough capital to cover the loss.
“We were going to have an incident like this,” Warner said. “It could be a blessing that it was happening with the strongest financial institution we have in the country.”