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Big Banks: It Doesn't Get Better

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Regulators and ratings agencies appear doubtful that the banks can handle risk on their own. Now it looks like investors are also unsure.

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MINYANVILLE ORIGINAL Forget about getting rid of the Volcker Rule -- banks are probably going to face more regulation, not less.

There's plenty of talk about stronger regulation of the banks now. First, JPMorgan Chase (JPM), which is one of the tightest ships in banking that is run by one of the smartest executives around, announced that it lost $2 billion (or was it $7 billion? Whoops!) on a "hedge" (not proprietary trading). Then last week, there was a whole fiasco over Morgan Stanley's (MS) handling of the Facebook (FB) IPO after the company overpriced the stock and only told institutional clients their real opinion about Facebook's revenue outlook after the fact.

The Wall Street Journal also reported today that the same unit at JPMorgan that made those awful bets on derivatives also invested in some shaky companies, including LightSquared, which just recently filed for bankruptcy.

Ratings agencies aren't keeping quiet. Moody's is gearing up for an industry-wide downgrade of most of the major banks, some by more than one notch.

While regulators and ratings agencies are distrustful of the big banks, investors are increasingly betting against them. Credit default swaps on Goldman Sachs (GS), JPMorgan Chase, Morgan Stanley, and Bank of America (BAC) were among the most traded last week. Bets against the debt of these big banks amounted to $7.45 billion, according to the Depository Trust & Clearing Corp. (via Bloomberg). These shorts are betting that either ratings downgrades will drive up borrowing costs and make it hard for banks to do business, or that regulators will get overzealous, or both.

For months, even while Bank of America shares were up 65% from the beginning of the year, JPMorgan was lionized as the cleanest shirt in the financial laundry. JPMorgan dethroned Bank of America as the biggest bank by assets last fall, passed the latest of the Fed's stress tests with flying colors, and increased its quarterly dividend to $0.30 starting in April.

So who would have thought that JPMorgan left what appears to be unqualified people in charge of overseeing risk at the bank? Bloomberg reported today that the directors overseeing risk at JPMorgan were not exactly qualified to do so; none of the three directors had any experience in financial risk management. Apart from running the Museum of Natural History, one director, Ellen Futter, had experience on the compliance and governance committees on the board of American International Group (AIG) up until 2008. Hardly a feather in the cap for someone whose job is to manage risk.

Clearly, the argument that banks are responsible enough to manage risk without government is losing its appeal. Even Mitt Romney, who vows to repeal the Dodd-Frank law on his first day in office, backpedaled a bit on that.

Still, there are lawmakers that are calling for financial regulators to take the gloves off. Elizabeth Warren, who might win a Senate seat this fall, is calling for a return to Glass-Steagall, the Depression-era law that severed investment banking from commercial banking. Basically, we decided as a nation that we would separate people's life savings from the madhouse-cum-casino of Wall Street. That went out the door in the late 1990s with the merger that gave us Citigroup (C).

A return to Glass-Steagall, or a breakup of too-big-to-fail banks might not be so much of a cure-all, however. As Matt Yglesias reminds us in Slate, the bank failure that brought down the US economy and forced the government to get into bailout mode was not a universal bank. It wasn't too big to fail. The bank that was considered small enough to fail was Lehman Brothers (LEHMQ.PK), and Lehman didn't put any consumer deposits (or the FDIC) on the line at all.

Twitter: @vincent_trivett
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No positions in stocks mentioned.
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