KRUGMAN: JPMorgan debacle is why we regulate banks

One of the characters in the classic 1939 film “Stagecoach” is a banker named Gatewood who lectures his captive audience on the evils of bank regulation—“As if we bankers don’t know how to run our own banks!” he exclaims. As the film progresses, we learn that Gatewood is skipping town with a satchel full of embezzled cash.

As far as we know, Jamie Dimon, the chairman and CEO of JPMorgan Chase, isn’t planning anything similar. He has, however, been fond of giving Gatewood-like speeches about how he and his colleagues know what they’re doing, and don’t need the government looking over their shoulders. So there’s a large heap of poetic justice—and a major policy lesson—in JPMorgan’s shock announcement that it somehow managed to lose $2 billion in a failed bit of financial wheeling-dealing.

Just to be clear, businessmen are human, and they make money-losing mistakes all the time. That in itself is no reason for the government to get involved. But banks are special, because the risks they take are borne, in large part, by taxpayers and the economy. And what JPMorgan has demonstrated is that even supposedly smart bankers must be sharply limited in the kinds of risk they take on.

History tells us that banking has always been subject to occasional destructive “panics,” which can wreak havoc with the economy. Current right-wing mythology has it that bad banking is always the result of government intervention. In fact, however, Gilded Age America—a land with minimal government and no Fed—was subject to panics roughly once every six years.

So what can be done? In the 1930s, after the mother of all banking panics, we arrived at a solution involving both guarantees and oversight. The scope for panic was limited via government-backed deposit insurance, and banks were subject to regulations intended to keep them from abusing the privileged status they derived from deposit insurance. Most notably, banks with government-guaranteed deposits weren’t allowed to engage in the often risky speculation characteristic of investment banks like Lehman Brothers.

This system gave us half a century of relative financial stability. Eventually, however, new forms of banking without government guarantees proliferated, while both conventional and newfangled banks were allowed to take on ever-greater risks. Sure enough, we eventually suffered the 21st-century version of a Gilded Age banking panic.

It’s clear, then, that we need to restore the sorts of safeguards that gave us a couple of generations without major banking panics. It’s clear, that is, to everyone except bankers and the politicians they bankroll—for now that they have been bailed out, the bankers would like to go back to business as usual. Did I mention that Wall Street is giving vast sums to Mitt Romney, who has promised to repeal recent financial reforms?

Enter Dimon. JPMorgan managed to avoid many of the bad investments that brought other banks to their knees. This apparent demonstration of prudence has made Dimon the point man in Wall Street’s fight to delay, water down and/or repeal financial reform. He has been particularly vocal in his opposition to the Volcker Rule, which would prevent banks with government-guaranteed deposits from engaging in “proprietary trading,” basically speculating with depositors’ money. Just trust us, the JPMorgan chief has in effect been saying; everything’s under control.

Apparently not.

What did JPMorgan actually do? As far as we can tell, it used the market for derivatives to make a huge bet on the safety of corporate debt, something like the bets that insurer AIG made on housing debt a few years ago. The key point is that institutions playing a key role in the financial system have no business making such bets, least of all when those institutions are backed by taxpayer guarantees.

Dimon seems chastened. I expect Wall Street to be back to its usual arrogance within weeks if not days.

But the truth is that we’ve just seen an object demonstration of why Wall Street does, in fact, need to be regulated. Thank you, Mr. Dimon.•

• Krugman is a New York Times columnist. Send comments on this column to ibjedit@ibj.com.