Weekend Economists Volvemos a Puerto Rico May 22-25, 2015

[Demeter]

26. The London Whale and the real link between the US economy and Cyprus Dean Baker

http://www.theguardian.com/commentisfree/2013/mar/25/london-whale-link-us-economy-cyprus

Many highly-respected Washington types have been running around for the last three years yelling that because of its large budget deficits, the United States is Greece. Then we learned last week that the immediate danger is the United States being Cyprus.

As we now know, Cyprus is a small island country with a financial sector that has run amok, following in the footsteps of Ireland and Iceland. The assets of its banks were eight times the size of the country's economy.

This meant that when the banks' big bets went bad, there was no way Cyprus' government could afford the price of the bailout. As a result, Cyprus was forced to go hat in hand to the European Central Bank and accept whatever offer was put on the table. However the Cyprus crisis is finally resolved, it is not likely to be a pretty picture for the citizens of Cyprus.

As the Cyprus crisis was unfolding last week, we also got to see the report of the Senate Permanent Subcommittee on Investigations (pdf) on JP Morgan's losses at its "London Whale" trading division. The report chronicles a series of bad bets on derivatives that were compounded by traders doubling down their stakes. They concealed the size of their losses both to bank officers and regulators. The end result was a $6bn loss.

JP Morgan is a huge bank and can swallow $6bn in losses, but the incident showed as clearly as possible that the Dodd-Frank reforms are not working. The London Whale's losing trades were all done in the Dodd-Frank era. The bill's provisions did not prevent JP Morgan from making massive bets and misleading regulators about their nature and the risks involved.

If the regulators were not able to catch the London Whale's huge gambles before they went bad, why would we think that they will catch the next crapshoot from the Wall Street gang? It's time that we looked at this seriously: the regulators lack either the will or the competence to rein in the big banks. The big banks are going to get away with everything they want, regardless of the provisions of Dodd-Frank.

If the big banks are too big to regulate and, according to Attorney General Holder, too big to prosecute, then the only sensible course is to break them up. There have been some promising developments in this area.

At the top of the list is Elizabeth Warren's election to the senate. Senator Warren has already made it clear that she will use her seat on the Senate banking committee to try to hold the banks and bank regulators accountable. The other important development is that Warren seems to have an ally in Louisiana Senator David Vitter....


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