Reinventing Banking After the Jamie Dimon Flameout

Is the current financial landscape too complex for any self-styled J.P. Morgan to master?

May 21, 2012

Is the current financial landscape too complex for any self-styled J.P. Morgan to master?

Let’s face it: The current financial system simply does not work. It concentrates risk in the largest institutions, which have to be bailed out when they get in trouble. It prevents management from being held to account for its misdeeds.

It also promotes sharp-elbowed “investment bankers” to run behemoths, most of whose business is entirely routine. And it makes shareholders a despised peon class, with any thought of dividends completely subordinated to the stock-option appetites of management.

The recent shenanigans at JPMorgan Chase only echo the resignation letter by Greg Smith to his ex-employer Goldman Sachs, which he chose to publish in the New York Times (a powerful new format for a book proposal, as it turned out). His main charge was that Goldman no longer puts clients’ interests first.

That is no surprise for a firm like Goldman Sachs which, from 1994 to 1999, was run by Jon Corzine (who went on to greater infamy as head of the bankrupt investment firm MF Global). Goldman had certainly become a trading-oriented, client-exploiting behemoth by then.

The key piece of evidence is Lisa Endlich’s book, Goldman Sachs: The Culture of Success, published in 1999, just in time for Goldman converting itself from a partnership into a publicly traded company. The book is full of snide and very telling comments about how feeble and hidebound the old corporate finance guys were.

Goldman, then as now, is by no means unique. Its trajectory was only more visible to the public at large because of Goldman’s outstanding success. Other houses followed the same unhappy route of turning themselves away from being client-oriented businesses into casino-style trading hells-on-wheels as best they could.

The central problem of the current financial system is that the heavy blocks of capital necessary for nationwide commercial banking and insurance are given to speculators to play with.

Preventing that from happening was, in retrospect, the central virtue of the Glass-Steagall legislation that separated commercial and investment banking activities in 1933. It ensured that the depositors’ funds and the capital generated by a commercial banking operation of the size of Citicorp or Chase Manhattan were used almost entirely for relatively low-risk commercial banking — although, as Citicorp Chairman Walter Wriston demonstrated, foolish megalomania still got them in trouble from time to time.

Not too big to fail

Trading operations, along with brokerage and corporate finance, were then segregated in much smaller organizations. At that time, they were owned directly by their partners, with unlimited liability. These trading, brokerage and corporate finance operations differed significantly from each other (Salomon Brothers had little corporate finance activity, relative to its size, while Morgan Stanley and Kuhn Loeb did very little trading until the 1970s.) Either way, they were in no sense “too big to fail.”

When a sharp downturn in stock exchange trading activity, combined with a horrendous back-office crisis, sent several of the largest investment banks hurtling into bankruptcy in 1970, there was no question of a government bailout. Such acts of kindness back then were strictly reserved for the bankruptcies of such real-economy icons as the railroad Penn Central.

Now, in light of recent events surrounding the pseudo-titanic Jamie Dimon — not just the chairman of JPMorgan, but also its president and its CEO — it is well worth recalling the romantic dream by which opponents of Glass-Steagall drove the political campaign to repeal it, which eventually succeeded in 1999.

It was inspired — wouldn’t you know it? — by a vision of the old J.P. Morgan bank, which had bestrode the financial world like a colossus, bailing out both the U.S. government in 1895 and the British government in 1915.

However, that dream of a full-service universal bank, among the largest financial institutions, offering both commercial banking and investment banking services and driven by a titan of finance, was already outdated by 1914.

Moreover, it relied on the supreme genius of Morgan himself. After his death in 1913, the bank gradually lost its primacy to more aggressive (and alas, less ethical and competent) competitors — before being split by Glass-Steagall.

Why should it be different now? Not only is Jamie Dimon, no matter how large his ego may be, no J.P. Morgan. And even if he were J.P. Morgan himself, the financial landscape has become far too complex for any presumed titan to handle.

Fortunately, the seeds of a new financial system are already here. Look no further than a new generation of pure commercial banks, such as Wells Fargo and PNC Corporation. They are far more capable than their much-larger competitors and happy to stick to their large low-risk niche. They are also content to avoid the perils of investment banking — along with having to deal with the in-house unpleasantness of hyper-greedy investment banker colleagues.

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Takeaways

The central problem of the current financial system is that the capital necessary for nationwide commercial banking is given to speculators to play with.

Jamie Dimon is no J.P. Morgan. And even if he were, the financial landscape has become far too complex for any presumed titan to handle.

Goldman is by no means unique. Its trajectory was only more visible to the public at large because of Goldman's outstanding success.