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Financial reform

As regulatory agencies and the FBI attempt to unravel JPMorgan Chase's recent $2 billion loss, any number of salient issues need to be addressed by a Congress that remains reluctant to impose strict rules for "too big to fail" investment banks.

JPMorgan, long heralded as "one of the best-managed banks there is" by no less than President Barack Obama, has admitted its failed investment strategy likely will cost more. CEO Jamie Dimon said the loss could be $4 billion by the time the company unwinds its exposed position. Independent financial analysts suggest it could be much higher.

The largest bank in the United States said it was engaged in a hedge to protect itself against potential losses. Heavy investments in corporate debt led JPMorgan to buy insurance against that debt by making bets on credit default swaps. More specifically, although it is difficult to trace these complex derivatives, it appears JPMorgan purchased a large stake in an index that tracks North American corporate debt. And then bet against the index, which in essence was a hedge against the first hedge.

The trouble was JPMorgan's share of that market. The bank apparently sold as much as $100 billion of credit default swaps on that index, when total investment was less than $150 billion. Other investors began betting against the index, knowing JPMorgan would have difficulty unloading the instruments. When the index lost value, JPMorgan was forced to sell at a loss -- which is the $2 billion and counting.

What the bank insists was a hedge, others are saying was an attempt by the bank to make profits. The nuance is critical. After the financial crisis of 2008, which featured worthless credit default swaps and collateralized debt obligations bringing down huge institutions, the Dodd-Frank Act was passed to overhaul regulations of the industry. Part of the law includes the Volcker rule, which still is being finalized.

The Volcker rule is designed to prevent banks from placing bets for their own profit, a practice known as proprietary trading. Since the government insures money that is deposited, the government does not want banks making any wild speculative bets. When banks lose those deposits, taxpayers are on the hook.

Not everybody is in favor of the Volcker rule. JPMorgan's Dimon has been one of the most vocal critics. He also is a Class A director of the Federal Reserve Bank of New York. The group is the primary regulator for banks on Wall Street and is influencing the direction of the Volcker rule. The rule currently allows banks to hedge but not place bets for profit. What is the difference, and who will determine intent? We would offer that will be an impossible task. Dimon and other investment bankers have helped water down this rule to the point of ineffectiveness. It simply has no teeth.

As the FBI, Security and Exchange Commission, Commodity Futures Trading Commission, Treasury Department and the White House all look into JPMorgan's loss, Congress needs to get in gear. Otherwise, the big lending banks are going to continue privatizing their profits and socializing their losses.

First off, the Volcker rule needs to be strengthened without the influence of big banks. Allowing them to write the rules invites corrupt practices.

It is time to end the era of "too big to fail." When a company such as JPMorgan can lose $2 billion-plus at the drop of a hat, disrupting markets and pushing losses to consumers and taxpayers, something has to change.

The regulation-averse Congress also needs stronger laws governing the derivatives market. Estimated at $650 trillion, too much is on the line. Some hedges, such as fuel or grain futures, actually help businesses manage volatile price swings. Others, such as indexes of credit default swaps and collateralized debt obligations, are nothing but casino games capable of bringing countries to their knees.

We understand the task will be difficult. And senators, representatives and even presidential candidates all risk losing very dependable campaign contributions. To this we say: Too bad. The government is supposed to be acting on behalf of its citizens.

Editorial by Patrick Lowry