2 Easy Ways To Make JPMorgan Behave Better

| About: JPMorgan Chase (JPM)

By a show of hands, how many people thought "here we go again" when the latest news of the $2 billion loss at JPMorgan (NYSE:JPM) came out? By now, most market-watchers are familiar with this bit of news:

"JPMorgan Chase faces intense criticism for claiming that a surprise $2 billion loss by one of its trading groups was the result of a sloppy but well-intentioned strategy to manage financial risk. More than three years after the financial industry almost collapsed, the colossal misfire was cited as proof that big banks still do not understand the threats posed by their own speculation. 'It just shows they can't manage risk -- and if JPMorgan can't, no one can,' Simon Johnson, the former chief economist for the International Monetary Fund, said Friday."

The unsettling possibility that we have Exhibit A demonstrating that the big banks are back to business as usual is troubling news for those of us who prefer stable financial systems and hate to see the way that these banks exploit their underlying asset strength to engage in very risky behavior. For all the talk that we have about the Volcker Rule, the Dodd-Frank Reform Bill, and even the prospect of bringing back the separations found in the Glass-Steagall Act, we will never reach a reasonable solution until it becomes perfectly clear that the actions of the big banks have consequences.

The first thing that we ought to do is remove the implicit guarantee that the government will bail the banks out again if we have a repeat of the 2008-2009 financial crisis. We're not going to get anywhere until we remove the "heads I win, tails you lose" mentality from the TBTF banks. Why would the banks stop aiming for lucrative returns if they know they can land on a soft pillow of bailout dollars from Uncle Sam if it turns out that volcanic $10 billion credit default swap didn't quite work out? If JPMorgan -- the so-called best in breed of the big banks -- can lose $2 billion in a supposed routine hedge, then it should face the possibility of complete wipeout risk and bankruptcy if this behavior continues; the US financial sector is not a game of Who Wants To Be A Millionaire -- there should be no more lifelines from the government.

But that's not the only thing we can do to fix the incentive structure. You want to see Bank of America (NYSE:BAC), Citigroup (NYSE:C), Wells Fargo (NYSE:WFC), and Morgan Stanley (NYSE:MS) act more conservatively? Strip the leadership of most of their directors and officers liability insurance. For example, Warren Buffett (NYSE:BRK.B) offered a compelling case in his 2011 Letter to Shareholders of Berkshire Hathaway explaining why Berkshire directors do not receive D&O liability insurance:

"To start with, the directors who represent you think and act like owners. They receive token compensation: no options, no restricted stock and, for that matter, virtually no cash. We do not provide them directors and officers liability insurance, a given at almost every other large public company. If they mess up with your money, they will lose their money as well."

Sure, enable the directors to guard against frivolous lawsuits. But, in Buffett's words, let's try and create an incentive structure that proves risky actions have consequences: if they mess up with your money, they will lose their money as well. If the top brass at JPMorgan create a catastrophic meltdown that leads to bankruptcy, let them sink with the ship. If the shareholders are going to suffer immensely, so should the folks who cause the shareholders to suffer immensely. Let those directors explain to their kids why they have to leave their private schools. Let them explain to their wives why they have to sell their house. If we can shift the incentive structure so that bankers stop thinking of shareholder capital as putting other people's money at risk and start thinking of it as their own money at risk, then banking practices would become more conservative by choice.

One of my favorite bank mottos from the 1950s was this: "There are no heroes in the trust department." That attitude perfectly encapsulates the stodgy, low-risk culture that made banks blue-chip investments for many decades. But we should do more than merely shake our heads in nostalgia about the days when banking involved taking deposits, making loans, and developing sensible long-term strategies with the spread. Those days can come back again. If we can remove the cover of government guarantees and personal liability insurance so that corporate ruin leads to personal ruin, then the leaders of the big banks might consider leaving the casino to let someone else take a spin at the roulette wheel.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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