JP Morgan Chase 2008 Annual Report Download - page 25

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Accounting policies such as mark-to-market and loan
loss reserving are pro-cyclical. Basel II capital require-
ments are pro-cyclical. Regulatory and legal require-
ments are pro-cyclical. Repo and short-term financing
are pro-cyclical. The one pro-cyclical tendency we
probably can never correct is that of the market itself
(i.e., the cost of capital goes way up in a downturn or
investors refuse to finance less liquid assets). I have
heard many good ideas about how to create some
counter-cyclical policies and will focus on three here.
Loan loss reserving can easily be made counter-cyclical
I find it absurd that loan loss reserves tend to be at
their lowest point precisely when things are about to
get worse. As things get worse and charge-offs rise
dramatically, one must dramatically increase loan loss
reserves, thus depleting capital rapidly. This problem
would be solved if banks were allowed to estimate
credit losses over the life of their loan portfolios.
Reserves should be maintained to absorb those losses.
This would enable banks to increase reserves when
losses are low and utilize reserves when losses are
high. Transparency would be fully preserved because
investors and regulators would still see actual charge-
offs and nonperformers. This would require a rational
explanation about the appropriateness of the lifetime
loss estimates. It also would have the positive effect of
constantly reminding CEOs, management teams and
investors that bad times, in fact, do happen – and that
they should be prepared for such events.
Repo and short-term financing can easily be made
counter-cyclical
All banks now have access to the standard financing
facilities for securities and loans via the Federal
Reserve (i.e., the Fed will lend a specific amount of
money against specific assets). A suggestion is this:
If an institution provides financing to clients in excess
of what the Fed would lend to the bank for the same
securities, it would have to be disclosed to risk commit-
tees and the company’s Board of Directors. The Fed
then would have two major tools to reduce leverage
and in a way that is counter-cyclical – it could charge
higher capital costs to a bank when the bank is lending
more than the Fed would lend or the Fed could reduce
the amount it would lend to the banks. Market players
would still be free to provide credit and leverage as
they see fit.
Banks should have the ability to implement counter-
cyclical capital raising with rapid rights offerings
Banks and possibly other companies would be aided
by having the ability to effect rights offerings at a
moment’s notice. Regulations should facilitate such
offerings – with the proper disclosure – in a matter of
days rather than weeks. This would allow a company
to raise capital and repair a balance sheet that might
have been stretched by unanticipated market events
and to do so in a manner that is fair and does not
dilute the company’s existing shareholder base.
H. The need for policies in health care, pensions,
energy and the environment, infrastructure and
education that will serve us well over time
Beyond the financial crisis, there are several important
issues that will dictate whether or not the United
States will continue to thrive over the next century. We
believe our nation can and should be able to provide
health care coverage for all. It is the right thing to do, it
will help us build a stronger nation, and, if done prop-
erly and efficiently, we believe it ultimately will be
cheaper than the current course we are on. On energy,
we now have experienced our third major crisis, and
we, as a nation, still have not executed a sensible long-
term energy policy. Again, we believe that done right,
an energy policy could be economically efficient, create
great innovation, reduce geopolitical tensions and
improve our environment. Similarly, we need to
improve our nation’s infrastructure and develop an
education system that befits our heritage.
We can’t fall into the trap of institutional sclerosis –
now is the time to act. In the past, this nation has
shown the fortitude to work together to accomplish
great things, and we need to do that again. For our
part, we at JPMorgan Chase are doing everything we
can to be helpful to our leaders on all these issues.