JP Morgan Chase 2010 Annual Report Download - page 26

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etc.).Whenmarket-makersareabletoaggres-
sively buy and sell securities in size, inves-
tors are able to get the best possible prices
for their securities.
Derivatives regulation must allow for true end-
user exemptions and for transparency rules that
don’t restrict liquidity
As I already stated, we completely agree with
the creation of clearinghouses for standard
derivatives. That said, clearinghouses do not
eliminate risk; they standardize and concen-
trate it. Therefore, it is essential that these
clearinghouses be strong, operate under
sound rules and have well-capitalized member
institutions.Wedonotwantweakclearing-
houses to become the next systemic problem.
It’s also important to maintain a category
of non-standardized derivatives contracts.
These contracts are not fit for a clearing-
house because the clearinghouse cannot
adequately value, margin or settle them.
However,thesecustom,over-the-counter
contracts are important to very sophisticated
institutions (of course, such contracts should
be fully disclosed to the regulators and prop-
erlyregulated).
Additionally, client margin requirements
need to be clarified. If clients are required
to post margin, either their liquidity will be
reduced or these clients will migrate their
derivatives trades to overseas markets that
do not have such posting requirements.
Regulators also must seek to strike the right
balance between the need for transparency
and the need to protect investors’ interests.
To the extent that transparency rules reduce
liquidity and widen spreads, they actually
can damage the very investors the regula-
tors are trying to help. If market-makers
are required to quickly disclose the price at
which they are buying a large amount of
securities or a small amount of very illiquid
securities, they will necessarily be more
conservative about the amount of risk they
take. As a result, they will bid for less and
price the risk higher since the whole world
will know their position.
Finally, there is a truly misguided element
of Dodd-Frank regarding derivatives. This
so-called“spin-outprovision”requires
firms like ours to move credit, equity and
commodity derivatives outside the bank.
This requirement necessitates our creating
a separately capitalized subsidiary and
requiring our clients to establish new legal
contracts with this new subsidiary. This is
an operational nightmare (which we can
handle)butmakesithardertoserviceclients.
It runs completely counter to recent eorts
by regulators to reduce banks’ exposure to
counterparty default. This provision creates a
lot of costs and nobenets.Webelievethatit
makes our system riskier – not safer.
We need to create a Consumer Financial Protec-
tion Bureau that is eective for both consumers
and banks
It has been widely reported that we were
against the creation of a Consumer Financial
ProtectionBureau(CFPB).Wewerenot–we
were against the creation of a standalone
CFPB, operating separately and apart from
whatever regulatory agency already had
oversightauthorityoverbanks.Wethought
that a CFPB should have been housed within
the banking regulators and with proper
authority within that regulator. This would
have avoided the overlap, confusion and
bureaucracy created by competing agencies.
However,wefullyacknowledgethatthere
were many good reasons that led to the
creation of the CFPB and believe that if
the CFPB does its job well, the agency will
benefit American consumers and the system.
Strong regulatory standards, adequate
review of new products and transparency to
consumers all are good things. Indeed, had
there been stronger standards in the mort-
gage markets, one huge cause of the recent
crisis might have been avoided. Other coun-
tries with stricter limits on mortgages, such
as higher loan-to-value ratios, didn’t experi-
ence a mortgage crisis comparable with ours.
As recently as five years ago, most Americans
wouldhavecalledtheU.S.mortgagemarket
one of the best in the world – boy, was that
wrong!Whathappenedtooursystemdid
not work well for any market participant –
lender or borrower – and a careful rewriting
of the rules would benefit all.