Fed Up

Yes, Jamie Dimon should lose his seat on the New York Fed board. But why stop there when America's financial regulation is such a mess?

The $2 billion and counting that JPMorgan Chase's chief investment office recently lost in London has turned the spotlight on CEO Jamie Dimon's seat on the board of the Federal Reserve Bank of New York, better known as the New York Fed. Dimon is due to testify on Capitol Hill starting on June 13, and things could get ugly.

It's about time Dimon felt the heat over his board seat. As one of 12 regional reserve banks that make up the Federal Reserve, the New York Fed's responsibilities include regulating big Wall Street banks like JPMorgan and Goldman Sachs. If Dimon sitting on the organization's board sounds like a conflict of interest to you, you're right: Nearly four years after the implosion of Lehman Brothers triggered a global economic meltdown, the fox is still guarding the henhouse.

JPMorgan's trading loss has already prompted many calls for Dimon's ouster from the Fed board. Treasury Secretary Timothy Geithner, who previously headed the New York Fed, conceded in mid-May that Dimon had a "perception problem," and Senate Democrats have explicitly called on the JPMorgan chief to step down from the board. In late May, Esther George, the president of the Kansas City Fed, made the same point more obliquely, noting that "when an individual no longer meets these [high] standards, the director resigns voluntarily to allow someone who does meet the criteria to serve."

I couldn't agree with George more. At the same time, her suggestion brings up a larger point: Why stop at Dimon? The entire system by which Wall Street banks are regulated needs to change, and urgently.

On June 13 and 19, Dimon will testify in front of the Senate Banking Committee and the House Financial Services Committee and be asked to explain his losses. It won't be easy. Many details of the loss-generating credit trades that JPMorgan -- the largest bank in the United States by assets -- engaged in remain unknown. And for good reason: The more information becomes public, the harder it will be for JPMorgan to unwind the deal. (Why? Because if you know which contracts the bank must dump, it's easy to wait for the price of the contracts to drop, thus adding to JPMorgan's losses.)

From the few snippets of information that have become available since the trading loss was first reported in May, it is clear that the bank's chief investment office bought so many contracts in certain credit indices that it was distorting the market. (Credit index here is shorthand for credit-default-swap index, the opaque and under-regulated "insurance policies" blamed by many for the 2008 financial crisis.) Credit-default swaps (CDSs) do not require that the owner of the derivative contract actually stand to lose from a credit default. When CDSs lack such an insurable interest they are considered "naked" -- the financial market's equivalent to buying insurance on your neighbor's house.

Although JPMorgan's risk positions remain obscure, one particular credit index seems to have been at the heart of the $2 billion loss: the Markit CDX.NA.IG.9. In less than a few months, the bank's position in the index almost doubled from under $80 billion to a whopping $145 billion, which makes one wonder where regulators were in all of this. The Depository Trust Company, a data warehouse, keeps information on 99 percent of all CDS trades all of which is accessible by the bank's regulators. Each and every regulator could easily have looked up who was moving the market and made further inquiries.

Dimon's problem, in other words, stems from a lack of oversight by both his bank and his regulators. But it's also problematic that Dimon sits on the board of the organization that's supposed to supervise his bank. It is entirely possible that officials at the New York Fed, which collects and reports data on individual banks' credit exposure, raised alarm bells about JPMorgan but somehow got rebuffed by Dimon, in much the same way that he brushed off initial press reports about a JPMorgan trader taking outsized positions as a "tempest in a teapot."

Turns out it was a pretty big teapot.

Even if JPMorgan's loss completely blindsided regulators, as supposedly happened to Dimon himself, there is still a conflict of interest. The Fed is tasked with implementing financial regulation to guarantee financial stability and prevent a new financial crisis from happening. But JPMorgan's chief has done everything in his power to preserve the old system, where the too-big-to-fail banks were able to make outsized profits by taking gargantuan risks thanks to taxpayers' backing.

Dimon has ranted against the Volcker rule, which prohibits banks from making bets for their own gain, and the Basel III bank capital rules, which prescribe the minimum ratio of equity to debt on a bank's balance sheet (last September, Dimon told the Financial Times that the latter were "anti-American"). And while Dimon has asserted that JPMorgan's money-losing trade did not violate the Volcker rule, it is close to impossible to lose more than $2 billion in a little over a month with a simple credit index, as the Financial Times's Lisa Pollack has pointed out. The bet that turned sour was most likely aimed at beating the market and earning big bucks for the bank, which is considered proprietary trading and banned under the Volcker rule. (Luckily for Dimon, the Federal Reserve announced in April that enforcement of the Volcker rule will be delayed until at least 2014, rendering the question of whether JPMorgan's trades violated the regulation moot.)

As the economist Willem Buiter noted in his keynote address at the Federal Reserve's Jackson Hole conference in 2008, the Fed listens to Wall Street and believes what it hears. Call it "cognitive regulatory capture" -- instead of special interests buying, blackmailing, or bribing the government, the big banks have somehow persuaded their ostensible regulators not to do their jobs properly. The Fed, under both Alan Greenspan and his successor, Ben Bernanke, has treated the stability, well-being, and profitability of the financial sector as an objective in its own right, regardless of whether this goal contributes to the Fed's dual mandate of maximum employment and stable prices.

So let's not stop with ousting Dimon from the New York Fed board. Groupthink, cognitive capture, and even direct capture (in the form of corruption) are ever-present threats for central banks, not only in terms of financial oversight but also with respect to monetary policy. And today they're out of control.

If we want to further reduce the hold that the big Wall Street banks have on central bankers and supervisors, we should make an eight-year, non-renewable term the maximum anyone can serve in any capacity as a regulator, supervisor, or member of the interest rate-setting committee. Greenspan served as chairman of the Federal Reserve from 1987 to 2006, more than twice what would be allowed under the term limits I propose. Bernanke is now serving a second four-year term as Fed chairman, and would be barred from reappointment if term limits were in place.

Since proximity tends to blur vision, it might be wise to place the financial supervision of the big Wall Street banks at a geographic distance as well -- say, with a regional reserve bank such as the Kansas City Fed. The New York Fed is literally too close to Wall Street for comfort. When he was the New York Fed president, Treasury Secretary Timothy Geithner was extremely close to Wall Street CEOs, enjoying private dinners at Jamie Dimon's home. Not coincidentally, Geithner shrugged at President Barack Obama's suggestion that banks that are too big to fail need to be broken up.

On the regulatory front, it is time to outlaw naked credit default swaps, for which there is no better economic rationale than horse betting. China took this step right after the 2008 financial crisis and the European Union has restricted naked CDSs on sovereign debt (though this appears to be more of a futile attempt to contain the debt crisis in the eurozone). Had naked CDSs been outlawed, JPMorgan would not have incurred its massive trading loss.

Smaller steps like demanding more coordination among regulators would also help. The Commodity Futures Trade Commission is now examining how JPMorgan's trading affected the market for credit derivatives and the Security and Exchange Commission is looking into the bank's public disclosures regarding the troubled trades. Neither agency, however, supervises banks like JPMorgan. That is left to the New York Fed and the Office of the Controller of the Currency, a little-known branch of the U.S. Treasury. When I asked both agencies which entity was primarily responsible for spotting exposures like the one incurred by JPMorgan, each organization discreetly pointed at the other.

Many a commentator has said that the 2008 financial crisis exposed the flaws of free-market capitalism. But the crisis could just as easily be attributed to a political system where people and corporations with deep pockets have an outsized influence on public policy and tilt the playing field in their favor. Under the right rules, capitalism works just fine. Maybe it's American democracy that's the real problem.

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Playing Dirty

Can Big Oil deliver the election to Mitt Romney?

Read about key swing states here. 

Is Barack Obama sufficiently dirty to win re-election? Not according to presumptive Republican nominee Mitt Romney, who says the president is too spic and span.

Calculating that clean energy is passé among Americans more concerned about jobs and their own pocketbooks, Romney is gambling that he can tip swing voters his way by embracing dirtier air and water if the tradeoff is more employment and economic growth.

Romney's gamble is essentially a bet on the demonstrated disruptive potency of shale gas and shale oil, which over the last year or so have shaken up geopolitics from Russia to the Middle East and China. Now, Romney and the GOP leadership hope they will have the same impact on U.S. domestic politics, and sweep the former Massachusetts governor into the White House with a strong Republican majority in Congress.

A flood of new oil and natural gas production in states such as North Dakota, Ohio, Pennsylvania, and Texas is changing the national and global economies. U.S. oil production is projected to reach 6.3 million barrels a day this year, the highest volume since 1997, the Energy Information Agency reported Tuesday. In a decade or so, U.S. oil supplies could help to shrink OPEC's influence as a global economic force. Meanwhile, a glut of cheap U.S. shale gas has challenged Russia's economic power in Europe and is contributing to a revolution in how the world powers itself.

But Romney and the GOP assert that Obama is slowing the larger potential of the deluge, and is not up to the task of turning it into what they say ought to be a gigantic jobs machine. The president's critics say an unfettered fossil fuels industry could produce 1.4 million new jobs by 2030. They believe that American voters won't be too impressed with Obama's argument that he is leading a balanced energy-and-jobs approach that includes renewable fuels and electric cars.

The GOP's oil-and-jobs campaign -- in April alone, 81 percent of U.S. political ads attacking Obama were on the subject of energy, according to Kantar Media, a firm that tracks political advertising -- is a risk that could backfire. Americans could decide that they prefer clean energy after all. Or, as half a dozen election analysts and political science professors told me, energy -- even if it seems crucial at this moment in time -- may not be a central election issue by November.

Yet if the election is as close as the polls suggest, the energy ads could prove a pivotal factor. "Advertising is generally not decisive. Advertising matters at the margins. ... But ask Al Gore if the margin matters," said Ken Goldstein, president of the Campaign Media Analysis Group at Kantar Media. "This is looking like an election where the margin may matter."

Romney is hardly the first major U.S. presidential candidate to embrace Big Oil. The politics of clean go back to Lady Bird Johnson's war on litter and Richard Nixon's embrace of environmentalism. But both presidents Bush came from the oil industry, and former Alaska Gov. Sarah Palin, the last GOP vice presidential nominee, gleefully led chants of "Drill, baby, drill" in 2008. Yet President George W. Bush also famously declared that "America is addicted to oil" in his 2006 State of the Union address, and initiated most of the energy programs for which Obama is currently under fire. And Palin's drumbeat in the end seemed to fall flat.

The Republican efforts appear to go beyond any modern campaign in their brash embrace of what is dirty, and their scorn of what is not. And the times seem to favor them. In 2009, the GOP, backed by heavy industry lobbying, knocked back environmentalists on their heels by crushing global warming legislation. Other previously central issues -- Afghanistan, Iraq, health care -- are still debated in the campaign, but not as centrally nor as viscerally as energy, said Frank Maisano, an energy and political analyst at Bracewell & Giuliani, a Houston-based law firm.

Obama advisors have said rightly that energy is only one component of a much broader American and global economy, but the GOP appears to have at least partially successfully injected the oil and gas boom as a defining feature of the economic discourse. In a Sunday op-ed in the New York Times entitled "America's New Energy Reality," industry consultant Daniel Yergin remarked that while Obama's 2010 State of the Union address focused on clean-energy jobs, the president pivoted this year to talk as much about oil and natural gas. "His announcement that ‘American oil production is the highest it has been in eight years' turned out to be an applause line," Yergin noted.

Romney grants that Obama is not precisely Mr. Clean -- while the president has championed clean energy technologies, he has also stewarded over the greatest buildup in U.S. fossil fuel production since the 1990s. But Romney insists he will be dirtier: He vows to open more land to oil and gas drilling, approve the import of more Canadian oil sands to Gulf Coast refineries, and allow more coal mining. As for Obama, Romney recently told a Colorado coal community, he isn't dirty enough to deserve a second presidential term. The president has "made it harder to get coal out of the ground; he's made it harder to get natural gas out of the ground; he's made it harder to get oil out of the ground," Romney said.

The approach aligns with a campaign by the American Petroleum Institute, the U.S. oil industry's main lobbying arm, called "Vote4Energy." The API campaign, which consists of big political events and advertisements, targets 15 or so mostly swing states, those that both Obama and Romney will most need to muster the 270 electoral votes required to win.

Marty Durbin, executive vice president at API, told me that the Vote4energy campaign is deliberately not backing any specific candidate or party, but attempting to centrally fix the subject of greater fossil-fuel drilling in voters' minds. "We're using this to highlight the importance of energy to the broader policy, that with the right energy policies we can have job creation, economic growth, energy security, government revenue. If voters have these realities in their mind when they go to the ballot box, that's what is going to move us forward in having a more rational national energy policy," he said. Already, he said, "the energy conversation is no longer just production and energy security. This is about job creation on a state-by-state level."

Notwithstanding Durbin's disclaimer, the API campaign seems to weave seamlessly into the GOP strategy. And Maisano told me that he sees grist for GOP success in the targeted states. "Energy plays a huge role in those states, and I see it as a huge problem for Obama," he said. "It's going to be hard for him to win these states that he has to win, like North Carolina, like Florida and Michigan and Ohio and Missouri and Wisconsin. Energy undercuts him in those economies."

Some analysts think the dirty campaign will ultimately fizzle. "The Romney campaign has positioned itself to beat the job-creation drum better than the Obama campaign has," said Kyle Saunders, a professor at Colorado State University, but an improvement in job numbers could undermine the GOP narrative. In addition, said John Sides, a professor at George Washington University, Obama's incorporation of fossil fuels in his energy policy may muddle the picture for voters. "I'm not sure that there is a lot of daylight between Obama and Romney," Sides told me.

Yet my own impression is that the Republican strategy may be working, at least partly and at least for now. Given the stakes, Obama and the main environmental lobby seem more lethargic than they might be. When I sought comment for this story, API responded almost immediately with an offer to speak with Durbin. Not so much the Sierra Club, the principal bulwark of U.S. environmentalists. A spokeswoman missed a couple of emails sent over a couple of days, then by phone said she would try to scare up someone to speak. Finally, I finally received a message: "I haven't been able to track down our political team today." In an election that may be decided on the margins, advantage: fossil fuels.

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