JP Morgan Chase 2010 Annual Report Download - page 23

21
from failure and bankruptcy. These actions
were done to save the economy and to
safeguardjobs.Whileweshouldtrytodo
everything in our power to stop a crisis
from happening again, we should recognize
two critical points. Markets can be rational
or irrational, and fear could freeze markets
again. And when there are severe problems,
only the government, in some form, has the
wherewithal, power and liquidity to be the
backstop of last resort.
Eectively changing our exceedingly complex
global economic system requires great care
Whenthiscrisisbegan,itlookedas“normal”
as any crisis can, but it quickly careened into
a global catastrophe. Most observers pinpoint
the key moment as Lehman Brothers’ failure
in September 2008. But one of the things
that made Lehman’s failure so bad was that
it came after the failure of Bear Stearns,
Fannie Mae and Freddie Mac, among others.
It was the cumulative eect of the collapse
of all these institutions, many of which were
overleveraged,thatwassodamaging.Had
Lehman’s failure occurred at another time,
and been an isolated event, its failure would
not likely have been so devastating.
Complex systems – and our global economic
system surely is one – often oscillate within
relatively normal confines. Our complex
economic system regularly has produced
“normal”recessionsandboomsandocca-
sionally a devastating one like the Great
Depression or the recent economic crisis.
The factors that occasionally and devastat-
ingly derail a system at any point in time
may have contributed only because the
table already had been set; at other times,
the same factor would have had no eect at
all. This phenomenon shows up in complex
systems throughout nature.
Scientists dealing with complex systems try
to isolate the impact of changing one input
while holding all other elements constant.
They know that if they change everything at
once, it may be impossible to identify cause
and eect.
As we try to remake our complex economic
system, we need to be cautious and respectful
of what the cumulative eect will be of
making multiple changes at the same time.
A Great Deal Already Has Been Done to
Improve the System — by Regulators and
Governments — and by the Market Itself
As all the rules and regulations of Dodd-
Frank and Basel III are being completed, a
tremendous amount already has been done
to strengthen the financial system.
Capital and liquidity standards already have been
strengthened
Before the crisis, we believe the thresholds for
capital and liquidity requirements were far
too low. This was one of the key underlying
causes of the crisis (and the reason JPMorgan
Chase always held far more capital than was
required).Itclearlyneededtobexed.
These standards already have been increased
severaltimes:WhentheTreasuryconducted
the stress test in February of 2009, it raised
the minimum Tier 1 Common Capital
requirement from 2% to 4%. The recent
stress test raised the capital requirement
to 5% and imposed a more stringent test:
Banks now must demonstrate that they can
maintain a capital level of 5% throughout a
highly stressed environment. The new Basel
III requirements eectively will raise the 5%
to 10%. (I will talk more about capital stan-
dardslaterinthissection.)
Substantial improvements already have been
made in the standards for residential and
commercial mortgages and secured financing,
among others
The marketplace, investors, banks, regulators
and rating agencies already have signifi-
cantly upgraded the standards by which
many products and institutions operate. For
example:
• Allnewmortgagesarebeingwrittento
comply with standards that existed many
years ago, before the worst of the past
decade’s excesses. These mortgages include
sensible features such as loan-to-value ratios
mostly below 80%, true income verification
and more conservative home-value appraisals.
• Moneymarketfundsnowarerequiredto
disclose more information, hold higher-
rated paper and maintain much more
liquidity as a safeguard against potential
runs. This was a critical systemic flaw
around the Lehman collapse.