A UNIFIED BANK REGULATOR IS A GOOD START / THE WALL STREET JOURNAL OP EDITORIAL ( RECOMMENDED READING )

OPINION

JUNE 27, 2009.

A Unified Bank Regulator Is a Good Start

Government must recognize that credit is good and capital is mobile

By JAMIE DIMON


With clear signs of stability returning to the U.S. financial system, this is an appropriate time to look ahead to the rebuilding process and to the steps that must be taken to prevent the recurrence of another such crisis. The restoration of our financial system to health does not give anyone the permission to return to "business as usual."

The Obama administration has laid out a plan for regulatory reform that offers a strong platform for moving forward. I especially support the creation of a single bank regulator, which is long overdue. It never made sense that a credit-card product offered by Chase was overseen by one regulator according to one set of standards, while a virtually identical product offered by a competitor would be overseen by a completely different regulator according to different standards.

Also welcome in the administration's new proposals is the focus on strong capital and liquidity requirements -- not just for traditional banks but for a broad range of financial institutions. We now know that "once-in-a-generation" swings in the business cycle are anything but. All financial institutions, wherever they're regulated, must stand ready with strong capital reserves to serve as a cushion during times of unexpected market and economic difficulties. This must be combined with adequate loan loss reserves, to cover the expected losses from the growing number of borrowers who likely will default, and necessary liquidity, in case credit markets freeze up as they did last fall.

In a similar vein, regulatory oversight must extend to sectors of the financial system that have long fallen outside the scope of any agency. A big chunk of the activity that led to the current crisis took place in the shadows at financial institutions that weren't as carefully watched as banks. One ugly example that came from these companies: certain adjustable rate mortgages with absurdly low introductory "teaser" rates that didn't even cover the monthly interest on the loan and resulted in rising principal balances. These loans are now a poster child for the meltdown. What many people forget is that hardly any commercial bank regulated by the Office of the Comptroller of the Currency offered these products. Rather, these loans sprang from lightly regulated mortgage brokers and thrifts.

This is just one example of how sectors once deemed too insignificant to regulate have grown in size and importance. Another example is hedge funds and their growing role as major counterparties. Restoring stability to the entire financial system is going to require the ability to look at all systemically important activities, regardless of the type of institution, and to better oversee all institutions that are heavily connected to the system. This can be accomplished without compromising flexibility or disclosing confidential positions, while allowing these vehicles to move capital as they see fit.

Providing greater oversight and transparency for key markets, including derivatives, is another vital step. We applaud the administration's plans to expand the use of the central clearing house for standardized "over-the-counter" derivatives traded between significant financial institutions. However, let's not forget that businesses large and small still need customized derivative products to hedge risk. These products are not easily traded on an exchange, and there are serious economic, competitive and systemic consequences for doing so. Regulation of derivatives must be smart and effective, and done in a manner that reduces the risk of manipulation or abuse without choking off access to a needed product.

As we adopt these sweeping changes, we must also be cognizant of the danger of the pendulum swinging too far. A reformed financial system must be in a position to create value for all of its stakeholders -- customers, shareholders, employees, our communities -- and for the economy as a whole.

For that to happen, there are a number of key conditions that must be met. First, we must preserve the ability to innovate and to steer capital toward the most promising innovations. This does not mean a return to overly complex financial instruments. It does mean creating sufficient space for the responsible development of products and services that meet the needs of a fast-changing market.

Ensuring the ability to innovate is also fundamental to U.S. competitiveness. The financial industry is global and highly mobile. If innovation is stifled in America, then capital will simply flow to other nations where it is welcome. That would translate to the loss of jobs, tax revenue and growth at a time when we can least afford it.

Second, any regulatory overhaul should ensure that governmental oversight of the financial system is efficient. We should avoid the temptation to have multiple regulators just for the sake of having them. Three or four different regulators all looking at (and fighting over) the same issue is not a wise use of taxpayer money. Companies can't operate that way. Neither should the government.

Third, the financial system must be in position to provide consumers with credit on reasonable terms. I absolutely agree with the need to strengthen consumer protection. Some of the most abusive practices involving mortgages and other financial products for consumers who could not afford them came from parts of the industry that were either poorly regulated or wholly unregulated.

Before creating an entirely new federal bureaucracy, policy makers should first examine ways to strengthen and refocus the authority of existing regulators. The primary regulators of financial institutions must be responsible and held accountable for protecting consumers. Creating duplicative and overlapping functions could increase costs and reduce credit opportunities for the consumers we are trying to protect.

Finally, no discussion of the future of the financial system can be complete without an acknowledgment of the industry's responsibility to re-earn the trust of the American people. How do we earn trust back? First, company leadership must foster a culture within their institutions that focuses on integrity, strong execution, quality products, long-term value creation, and doing the right thing. Rewards have to track real, sustained, risk-adjusted performance. Golden parachutes, special contracts, and unreasonable perks must disappear. There must be a relentless focus on risk management that starts at the top of the organization and permeates down to the entire firm. This should be business-as-usual, but at too many places, it wasn't.

Above all, no matter what the regulatory framework is, it means recognizing that our accountability is not only to our shareholders, customers and employees, but also to the broader public. The gulf that grew between Wall Street and Main Street has hurt everyone. Americans must see that the work we are doing is not just about earning a profit, but also about creating value that helps consumers, small businesses, government agencies, nonprofits and the whole economy. At their best, that is what financial institutions are all about.

The steady restoration of stability is an important step forward for the financial system and the economy. By instituting needed changes in how financial institutions operate and are regulated, I'm confident that the system will once again play its vital role, efficiently and safely providing the capital and credit upon which our nation's economic growth depends.

Mr. Dimon is chairman and CEO of J.P. Morgan Chase & Co.

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