Research Topics

The recent report by the Senate Permanent Subcommittee on Investigations on the operations of JPMorgan Chase’s Synthetic Credit Portfolio unit—aka the London Whale—has brought renewed attention to the risks of proprietary trading for insured banks, and provides depth to the larger risks inherent in the financial system after Dodd-Frank.  

This policy brief by Senior Scholar and Program Director Jan Kregel builds on an earlier analysis (Policy Note 2012/6) of JPMorgan Chase and the actions of the “London Whale,” and what this episode reveals about the larger risks inherent in the financial system. It is clear that the Dodd-Frank Act failed to prevent massive losses by one of the world’s largest banks. This is undeniable evidence that work remains to be done to reform the financial system. Toward this end, Kregel reviews the findings of a recent report by the Senate Permanent Subcommittee on Investigations and expands on the lessons that we can draw from the evolution of the London Whale episode. 

What a Hedge Gone Awry at JPMorgan Chase Tells Us about What's Wrong with Dodd-Frank

What can we learn from JPMorgan Chase’s recent self-proclaimed “stupidity” in attempting to hedge the bank’s global risk position? Clearly, the description of the bank’s trading as “sloppy” and reflecting ”bad judgment” was designed to prevent the press reports of large losses from being used to justify the introduction of more stringent regulation of large, multifunction financial institutions. But the lessons to be drawn are not to be found in the specifics of the hedges that were put on to protect the bank from an anticipated decline in the value of its corporate bond holdings, or in any of its other global portfolio hedging activities. The first lesson is this: despite their acumen in avoiding the worst excesses of the subprime crisis, the bank’s top managers did not have a good idea of its exposure, which serves as evidence that the bank was “too big to manage.” And if it was too big to manage, it was clearly too big to regulate effectively.

This eBook traces the roots of the 2008 financial meltdown to the structural and regulatory changes leading from the 1933 Glass-Steagall Act to the 1999 Financial Services Modernization Act, and on through to the subprime-triggered crash. It evaluates the regulatory reactions to the global financial crisis—most notably, the 2010 Dodd-Frank Act—and, with the help of Minsky’s work, sketches a way forward in terms of stabilizing the financial system and providing for the capital development of the economy.
The book explains how money manager capitalism set the stage for the outbreak of the systemic crisis and debt deflation through which we are still living. And it explains that, despite calls for a return to Glass-Steagall, we cannot turn back the clock. Minsky’s blueprint for a more stable structure is smaller banks and the restoration of relationship banking. Modifying and extending his idea for creating a bank holding company would preserve some of the features of Glass-Steagall. 

This monograph is part of the Institute’s research program on Financial Instability and the Reregulation of Financial Institutions and Markets, funded by the Ford Foundation. Its purpose is to investigate the causes and development of the recent financial crisis from the point of view of the late financial economist and Levy Distinguished Scholar Hyman Minsky, and to propose “a thorough, integrated approach to our economic problems.”

The monograph draws on Minsky’s work on financial regulation to assess the efficacy of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted in response to the 2008 subprime crisis and subsequent deep recession. Some two years after its adoption, the implementation of Dodd-Frank is still far from complete. And despite the fact that a principal objective of this legislation was to remove the threat of taxpayer bailouts for banks deemed “too big to fail,” the financial system is now more concentrated than ever and the largest banks even larger. As economic recovery seems somewhat more assured and most financial institutions have regrouped sufficiently to repay the governmental support they received, the specific rules and regulations required to make Dodd-Frank operational are facing increasing resistance from both the financial services industry and from within the US judicial system.

This suggests that the Dodd-Frank legislation may be too extensive, too complicated, and too concerned with eliminating past abuses to ever be fully implemented, much less met with compliance. Indeed, it has been called a veritable paradise for regulatory arbitrage. The result has been a call for a more fundamental review of the extant financial legislation, with some suggesting a return to a regulatory framework closer to Glass-Steagall’s separation of institutions by function—a cornerstone of Minsky’s extensive work on regulation in the 1990s. For Minsky, the goal of any systemic reform was to ensure that the basic objectives of the financial system—to support the capital development of the economy and to provide a safe and secure payments system—were met. Whether the Dodd-Frank Act can fulfill this aspect of its brief remains an open question.

This monograph is part of the Levy Institute’s Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis, a two-year project funded by the Ford Foundation.

In the current financial crisis, the United States has relied on two primary methods of extending the government safety net: a stimulus package approved and budgeted by Congress, and a massive and unprecedented response by the Federal Reserve in the fulfillment of its lender-of-last-resort function. This monograph examines the benefits and drawbacks of each method, focusing on questions of accountability, democratic governance and transparency, and mission consistency. The aim is to explore the possibility of reform that would place more responsibility for provision of a safety net on Congress, with a smaller role to be played by the Fed, not only enhancing accountability but also allowing the Fed to focus more closely on its proper mission.

The Minskyan Lessons We Failed to Learn

Senior Scholar L. Randall Wray lays out the numerous and critical ways in which we have failed to learn from the latest global financial crisis, and identifies the underlying trends and structural vulnerabilities that make it likely a new crisis is right around the corner. Wray also suggests some policy changes that would shore up the financial system while reinvigorating the real economy, including the clear separation of commercial and investment banking, and a universal job guarantee.