When JP Morgan Chase & Co. announced a two billion dollar loss in its main investment office earlier this month, there were increased calls for the U.S. federal government to regulate trading by big banks and to ban speculative trading. Why should we reject such calls?
JP Morgan is a privately owned (publicly traded) company. People who choose to invest in it, or in any other private companies, do it voluntarily, based on their assessment of facts about the company, hoping to earn a return on their investment. However, such investment is never without a risk, as a return (in the form of increased share price and/or dividends) is not guaranteed. Any company you invest in may perform better or worse than expected, and you as an investor will decide whether to hold onto the stock. The investors—the market—have already penalized JP Morgan for its bad performance, as its share price has declined. If JP Morgan wants to recover and win investors’ confidence back, it has to quickly find a way to fix whatever the problem was that led to such a massive loss—or risk losing more investors to its competitors. The market provides a strong incentive for striving to do better and to avoid mistakes in the future.
If the government regulates banks and tells them how they can or cannot do business—whether it involves derivatives trading or anything else—for the sake of “protecting” investors or customers or both, it takes away the incentive that the competitive market provides to the banks for striving to perform better. In other words, by regulating banks the government stifles innovation for new, better, cheaper products—their means of higher profits and the source of investors’ returns. If investors think that government regulation of banks (or of any business) “protects” their investment, they should think twice. Regulation severely limits potential return on investment by stifling competition and innovation.
The role of the government is not to regulate banks or any other business but to protect individual rights against those who initiate physical force or fraud–and to let markets operate freely. We would all benefit.