When the banking system reached the precipice of a total collapse in 2008, the U.S. government bailed it out with direct cash infusions as well as a system rigged to allow the banks to “earn” their way out of the mess. They were allowed to borrow for nothing and the Fed jacked up returns on invested reserves.
The alternative response might have been to seize the bloated institutions that were bankrupt, in the substantive sense if not technically so, and break them into smaller units that would fulfill their purpose in the economy prudently.
Instead, the policy makers decided to reward their incompetence. The government believed that the cash infusion to bank balance sheets would be applied to finance business activity that would stimulate growth and, critically, generate jobs and earnings to help solve the underlying mortgage crisis that they had helped create. Restructuring the banking industry was left for later, in particular through the Volcker Rule that is designed to bar banks from the risk taking businesses that led to the crisis.
That plan did not work out so well. A trader at JP Morgan Chase has inadvertently provided us with an instructive illustration of the folly of the earn-out policy, as reported by Bloomberg over the weekend. His name is Bruno Iskil, but he is perhaps better known by his well-earned nom de guerre, Voldemort that recalls the evil sorcerer that was Harry Potter’s nemesis. Voldemort works in the London office of JP Morgan in a group that is tasked with hedging bank risks and investing cash. But like any eager employee, he has shown great initiative by expanding his job quite impressively.