Question: When does risk aversion become risky behavior? Answer: when you are a large financial institution in today’s world, especially a behemoth bank like JPMorgan Chase, attempting to navigate both labyrinthine regulations and shareholder demand for endless profit. How not to solve that conundrum was evidenced last week when the until-now lauded CEO of JPMorgan Chase, Jamie Dimon, announced losses of $2 billion in an internal fund designed to, of all things, prevent losses. But this isn’t just a story of Dimon losing his luster. Faced with new dictates on trading and capital, combined with the continued drag of bad loans and the slow U.S. housing market, banks have been hoarding cash and coming up with innovative attempts to not lose any more money. Yet in this effort to avoid loss and steer clear of risk, they have placed themselves in precisely the same risk-taking, loss-courting position. There is no such thing as a free lunch and no such thing as banking without bets.
Financial institutions have been tripped up by software-enabled derivatives with arcane names (Goldman’s Abacus product that bundled credit default obligations, or CDOs—huh?), ill-fated gambles (like the bet on European debt that sank MF Global and its CEO, former New Jersey governor Jon Corzine) and risk-taking traders. When things go awry, they are invariably described as “rogues”—the Nick Leesons (Barings), Jérôme Kerviels (Société Générale), and Kweku Adobolis (UBS) of this world. In the case of JPMorgan Chase, the current meltdown seems linked, in some way, to a London trader known alternately as “the whale” or “Voldemort” for the ever-larger, ever-riskier trades he placed in an misguided pursuit of this central strategy to mitigate loss and decrease risk. Dimon blamed the $2 billion trading loss on “errors, sloppiness, and bad judgment” and sounded an ominous note, saying it “could get worse.” But what is really worse: risky business or playing it safe? Because if the years before 2008 were characterized by the belief that gains were easy and ultimate gains the ultimate goal, giving rise to extreme risk-taking behavior, our reality now, conversely, is characterized by the conviction that losses lie in wait everywhere—that greed is bad and risk aversion is the holy path to follow.
As a result, banks everywhere—but especially in Europe and the United States—hoard more and lend less. They blame regulators, and, indeed, the thicket of complicated, ill-conceived regulation bears some responsibility. But badly designed rules are only partly to blame. Banks only make money, and the overall economy only thrives and hums, when money is in motion. Small businesses need loans, consumers need credit, homeowners need mortgages, and infrastructure needs financing. If banks are so loath to expose their precious capital to losses, all of those activities are imperiled, and then so, too, is the vibrancy of our economy. What JPMorgan Chase teaches us is that the financial world has swung from the promiscuous pursuit of obscene profit to the relentless obsession with guarding against risk, a strategy that resembles driving 40 miles per hour in the fast lane. You may not crash, but you’re gonna get hit.