JPMorgan and the Dodd-Frank Act - Assignment Example

JPMorgan and the Dodd-Frank Act By What were the major factors that led to the recent financial crisis? There are different factors that were responsible for the recent financial crisis. However, the financial system was the root of the financial crisis, as this developed various issues that contributed to the financial crisis. A major factor that contributed to the crisis is banks. It is believed that before the financial crisis happened, most banks experienced increased returns. The banks generated a lot of money within a considerably short period of time. This was unlike the preceding years. Most of the money generated by banks was from loans. When a bank gives out loans to many people, it creates new money. Therefore, just before the financial crisis, banks had created large sums of new money through making loans. It therefore, took the banks a few years to double the amount of money and debt in the economy. The new money created by the banks was directed to various sectors inside and outside the financial sector. These include residential property, commercial real estate, financial markets, businesses outside the financial sector, and credit cards and personal loans. A large sum of the money was used on the residential property and financial markets. The least money was spent on businesses outside the financial sector and credit cards and personal loans. When banks lend large sums of money into the property market, the prices of houses increased. This therefore, also resulted in the increase of personal debts. The loanees were expected to make repayments of the loans together with the accrued interest. However, since the personal debts of people rose faster than their income, this resulted in most people being unable to repay their loans. This therefore, forced them to stop their loan repayment. In this case, therefore, there was a high probability of banks going bankrupt. Specifically, the bankruptcy of the Lehman Brothers starting 2008 contributed highly to the financial crisis1. All this is therefore, considered to have caused a financial crisis. 2. Was the government bailout necessary to prevent a collapse of the financial system? Why or why not? The financial crisis had immense adverse effects on the financial system. The financial system was at risk of collapsing. However, the government intervened in order to prevent the financial system from collapsing. The intervention of the government in the financial crisis was important. This is mainly due to various reasons, mainly as this abated the financial crisis. If the government would have not intervened, the financial situation would have gotten worse. As the crisis affected nearly all organizations, employers started to lay off their workers in order for their organizations to survive the hard financial times then. This therefore, had resulted in considerably higher poverty levels of individuals, as most had lost their source of livelihood. Nonetheless, when the government intervened, most organizations stopped to lay off employees, while some laid off only a small number of employees, as compared to the period before government intervention. Therefore, government intervention can be considered to have slowed things down during the financial crisis. If the government had not intervened into the financial crisis, the situation would have accelerated into an economic depression, which is worse than recession. Although government intervention did not bring the financial crisis to a stop, lack of action from the government would have more adverse effects on the economy. For instance, businesses would have been capable of raising capital for investment and growth. In addition, the level of consumer spending would have decreased due to the loss of jobs by people. Therefore, government intervention helped to create considerable confidence in the economy once again. Government intervention was also important, as it helped to restore stability to the financial system and banking system. Therefore, this helped to reduce the level of panic and distress in the banking and financial systems. This was also important for the US currency, the dollar, which is used in many countries worldwide. Nonetheless, this was also beneficial to countries that transact using the US dollar, as the risk had been lessened. In the contrast, the intervention of the government can be argued to have not been necessary in the financial crisis. This is mainly because it did not bring the financial crisis to an end. Instead, government intervention delayed the effects of the financial crisis, which continue to be felt today. Nonetheless, this was a necessary evil that only provided a short term solution to the financial crisis. Government intervention did not resolve the root causes of the financial crisis. Therefore, it might be possible that another financial crisis might occur, if a long term solution is not obtained. Overall, although government intervention did not succeed in ending the financial crisis, this helped to lessen the effects of the crisis. This saved the banking and financial system, which is the backbone of the economy. Lack of government intervention would have probably led to the collapse of the financial system. When the financial system collapses, the rest of the economy collapses too. Therefore, government intervention in the financial crisis remains beneficial. 3. How appropriate of a response to the crisis was the Dodd-Frank Act? What did it cost? The Dodd-Frank Act was developed as a response to the financial crisis. The developers of this Act considered it appropriate in responding to the financial crisis. However, there are different judgements as to whether the Dodd-Frank Act was an appropriate response to the crisis or not. Nonetheless, although this was an important response to the financial crisis, it lacked the capability of ending the effects of the financial crisis completely. However, this Act would only reduce the frequency of future financial crises, and make future financial crises have a lesser impact on the economy. In the case study, it can be seen that the Dodd-Frank Act played a regulatory role in the financial system. The Act introduced new regulations and restrictions in the financial system2. Therefore, this was important, as the new regulations allowed for changes in regulations, thus the weaknesses of the past regulations, which contributed to the financial crisis were eliminated. This aspect therefore, makes the Dodd-Frank Act appropriate as a response to the financial crisis. A major weakness of the Dodd-Frank Act is that it did not lead to an overhaul of the financial system; instead, the main target of this Act was to preserve the financial system. For a financial crisis to happen as the recent one experienced, it means that there are a considerable number of weaknesses or faults in the financial system. Therefore, for prevention of future occurrences of financial crises, it is important to fix the flaws in the financial system. Nonetheless, the Dodd-Frank Act did not take this into account. Therefore, instead of overhauling the financial system, the Dodd-Act was only interested in regulating the financial system that was still founded on past principles that contributed to the financial crisis. The Dodd-Frank Act made no changes to the pre financial structure of the financial system, but held that regulation of the financial system was sufficient to prevent future financial crises. For this reason therefore, the Dodd-Frank Act can be considered as having been weak. Therefore, this was inappropriate to prevent the occurrence of future financial crises. By leaving the initial structure of the financial system unchanged, the Dodd-Frank Act did not reduce the risk of the financial system collapsing in future. 4. What is the Volker rule? How will it affect JPMorgan? The Volcker Rule was part of the Dodd-Frank Act. This rule prohibits banks from using FDIC-insured money that belongs to their clients. This rule therefore, prevents depository institutions that are federally insured from trading money in their depositors’ account for profit. This protects the taxpayers from being responsible for paying up the losses the banks might experience. Nonetheless, the Volcker Rule mainly applies to the derivatives and investment activities of financial institutions. A major effect that the Volcker Rule will have on JP Morgan is that it will limit the investment activities of the bank. This might therefore, result in the scaling down of JP Morgan. In addition, the trading position of JP Morgan will change under the Volcker Rule. Overall, there will be the disruption of important activities at JP Morgan due to the Volcker Rule. In JPMorgan, the total net loans decreased to $656370 in 2010 from $721,734 in 2008. Additionally, the liabilities of the company increased from $1,866,624 in 2009 to $1,967,7653. The Volcker Rule might therefore, lead to the considerable deterioration of JP Morgan. For instance the Volcker Rule might prohibit some of the asset-liability trades that JP Morgan is engaged in4. However, with regard to total assets of JPMorgan, the Act has had a positive influence on them. The total assets experienced an increase from$2,031,989,000 in 2009 to $2,141,595,000 in 20105. Overall, the Volcker Rule might have positive impact on JPMorgan, as compared to smaller banks. However, effective strategies should be employed by JPMorgan. 5. What effect will Dodd-Frank have on JPMorgan’s ongoing capital requirements and profitability? The Dodd-Frank Act will have different effects on JPMorgan’s capital requirements and profitability. These include both negative and positive effects. This is mainly because, as seen, the Dodd-Frank Act comprises various rules, which have different effects on profitability and capital requirement. Therefore, it cannot be argued that the Dodd-Frank Act is purely beneficial or disadvantageous to JPMorgan’s capital requirements and profitability. With regard to capital requirement, the Dodd-Frank Act will force JPMorgan to make changes to that regard to capital-requirements. Since the Dodd-Frank Act requires capital requirements to be countercyclical, this means that JPMorgan has to adjust. In addition, since the Dodd-Frank Act calls for the elimination of the TRUPS6, this will also have an effect on the capital of JPMorgan. Furthermore, the contingent capital in the Dodd-Frank Act will impact on the capital structure of JPMorgan. Nonetheless, the Act has resulted in higher capital requirement for JPMorgan. For instance, the total equity of JPMorgan increased in 2010 to $173,830,000 from $165,365,000 in 2009. Additionally, the leverage ratio, Tier 1 Common Capital Ratio, and the Risk-based Capital Ratio of JPMorgan was highest in 2010 since the year 2006. This therefore, shows that JPMorgan had to increase its capital requirements in accordance with the Dodd-Frank Act. The Dodd-Frank Act will also have an effect on the profitability of JPMorgan. While some of the rules in the Act might promote profitability of JPMorgan, others might decrease the ongoing profitability of the bank. Overall, the Act shields the bank from future losses. This can be considered positively on productivity. However, the fact that the Act limits the trading activities of the bank has adverse effects on the productivity of the bank. For JPMorgan, it can be seen that the net interest income decreased in 2010, as this stood at $38899000, as compared to 2009’s $51,152,000. Additionally, the noninterest income dropped from $48,246 in 2009 to $34,946 in 2010. However, the net income of the company increased from $8,774,000 in 2009 to $11,353 in 2010. This therefore, shows that the Dodd-Frank Act has had a positive impact on the productivity of JPMorgan. 6. What is the purpose and structure of TRUPS and CoCos? Compare and contrast advantages/disadvantages of TRUPS and CoCos from JPMorgan’s point of view, Investors point of view and Regulators point of view. Trust Preferred Securities are those securities that are treated as debts for reasons related to taxes. TRUPS has a long structure. First, a bank holding company creates a special purpose vehicle, which would then issue the preferred securities to investors. The special purpose vehicle then takes the proceeds of the preferred security issuance and loan such funds to the bank holding company. Debentures would be issued by the bank holding company to the special purpose vehicle as evidence of its indebtedness. On the other hand, CoCos are a type of bonds, whose likelihood of converting to equity is “contingent,” unlike the regular bonds7. In the point of view of regulators, CoCos are important, as they clear up the uncertainties of existing hybrids by converting into equity at a pre-set trigger and price. Therefore, for JP Morgan these act as a form of capital, thus help to lower the risk of losses in tough financial times that the bank might go through. For investors With regard to JP Morgan, TRUPS are a fast way of raising cash quickly. However, a disadvantage is that since the interest rates dropped, this has scared away investors. On the other hand, for investors, the TRUPS are advantageous as they can result in increased corporate bonds. In addition, the have longer maturities, and this might enable an investor to have long-term yield. A disadvantage to investors is that the interest rates have decreased since 2008. From the regulators’ point of view, TRUPS offered an important opportunity for banks to raise capital easily. 7. Is JPMorgan a winner after Dodd-Frank Act? Why or Why not? The Dodd-Frank Act would have various effects on JPMorgan. It thus cannot be stated whether JPMorgan will be a winner or a loser after Dodd-Frank Act. The Act introduces stringent rules and regulations that apply to financial institutions. Most likely, this Act limits the freedom of financial institutions in their operations, as high level of regulation is introduced. For JPMorgan, this will also limit its freedom in operations, as the regulations and rules will dictate what needs and what needs not to be done. JPMorgan might fail or win after the Dodd-Frank Act, depending on the strategies that the bank will adopt to counter the negative effects of the new regulations and rules in the Act. The Act has a greater impact on integrated financial institutions such as JPMorgan. Therefore, this would lead to uncertainty among the institution’s shareholders, if the institution does not strategize well. JPMorgan could win after the Dodd-Frank Act, if the strategies it adopts are highly effective. For instance, given the nature of the Dodd-Frank Act, it is quite costly to implement. For this reason therefore, most small financial institutions might be unable to adopt it, thus rendering them incapable of operations. If JPMorgan will capitalize on this situation, it would become a winner after the Dodd-Frank Act. For instance, JPMorgan could take advantage of this situation and acquire such small financial institutions that implement the Act8. On the other hand, JPMorgan could be a loser after the Dodd-Frank Act, if the institution adopts ineffective strategies. For instance, the Dodd-Frank Act comes with increased regulatory costs. Therefore, in order to minimize these costs, JPMorgan might decide to shrink or scale down in scope9. This would lead to the institution losing out, due to its ineffectiveness. Nevertheless, given the history of JPMorgan, it is more likely that the company will cope well with the Dodd-Frank Act, and emerge a winner after this Act. References Risell Adam and Allayannis George. “JPMorgan and the Dodd-Frank Act.” University of Virginia, Darden Business Publishing. March 13, 2012. Read More