The JPMorgan $2 billion-trading-loss story is nearly a week old, and the news has predictably gone through the various spin cycles of the political right and left. Initially, progressives pounced on the loss as reason to strengthen the yet-to-be-fully-implemented Dodd-Frank financial-reform law. Conservatives then pushed back on that conclusion, arguing that the loss was not a disaster for shareholders given the size and profitability of the bank overall and that policymakers shouldn’t overreact with more stringent regulation.
However, there is another, smaller chorus of voices that is blaming neither government inaction nor banker recklessness but the policies of the Federal Reserve. These critics are arguing that excessive intervention by the central bank has distorted financial markets and forced big banks to resort to risky moves in order to maintain profits.
David Schawel, a money manager and financial blogger, argues that quantitative easing policies, under which the Fed has bought up “risk-free” assets like U.S. Treasury bonds, have caused there to be fewer safe assets to go around. In addition, the Fed’s decision to keep interest rates near zero since the height of the financial crisis in 2008 has reduced the profitability of banks’ usual business lines. Writes Schawel:
“Bernanke is not responsible for risk failures at JP Morgan or any other TBTF bank. BUT, he certainly has fostered an environment that has encouraged investors (which includes banks) to take on risk due to their meager alternatives. Risk has crept into an area that is typically conservative on many levels.
It is said that the job of a central bank is to pull away the punch bowl before it gets out of hand. While the Fed pays close attention to inflation, it has left the punch bowl out in the chase for risk assets and is contemplating spiking it even further (QE3).
How will this end? Should we expect that revelations such as the JP Morgan trading losses will not occur given such policies? A chase for risk is what the Fed wanted, only the intention was not for it to occur at banks.”
R. Christopher Whalen, an investment banker and frequent critic of the Fed and the big banks, concurred with Schawel on the blog Zero Hedge yesterday. He turns the screws on the Fed even tighter, though, arguing that the Fed’s easy money policies stretch back decades and that the surfeit of dollars in the marketplace has nowhere productive to go. Whalen writes:
“The fact is that the vast expansion of the US money supply over the past three decades makes such financial alchemy necessary for the TBTF banks to generate even nominal profits.”
And in Fortune, Cyrus Sanati writes favorably of Dodd-Frank proscriptions against big banks making speculative bets with federally insured deposits but says current monetary policy actually works against the intent of those regulations:
“The banks clearly are to blame here as well, but the motivation to take such a bold move came from the low interest rates, nurtured by the Fed. The whole idea that low interest rates spur economic activity and increase lending is one of the most important axioms in economics. But it seems one can go too low for too long.”
These critics have a good point about the side effects of central-bank policy, and only Whalen seems to be putting the blame solely on the central bank. He has been a frequent and consistent critic of the Federal Reserve and American monetary policy — pretty much the ideological opposite of thinkers like Paul Krugman who argue for even more intervention from the Fed.
But the possibility that Federal Reserve policy has inadvertently pushed banks to take riskier moves isn’t necessarily an argument against more quantitative easing. After all, the very purpose of Fed policy since 2008 has been to induce investors to take on more risk. The hope was that those risks would come in the form of loans to aspiring home buyers or cash-strapped small-business owners. It would appear that JPMorgan simply had other ideas about how to profitably invest easy money from the central bank.
This doesn’t mean the Fed shouldn’t be aggressively trying to stimulate the economy. There are sound economic arguments for this approach. But just because you support aggressive action on the part of the nation’s central bank doesn’t mean you shouldn’t be aware of its dangerous side effects.