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Why large fines are the wrong fix for Wall Street reform

November 14, 2013: 11:07 AM ET

Bank fines are little more than a mechanism for transferring wealth from the bank's workers and customers to public coffers, and they fail to address the problem of how to rein in Wall Street excess.

By Sanjay Sanghoee

130114091939-jpmorgan-monsterFORTUNE -- Here is an odd thing. Despite the massive legal problems JPMorgan Chase (JPM) is facing, including a potential $13 billion payout looming in its future, and blistering criticism by the press and the public of the bank's excesses, JPMorgan's shares are not down but up. The current stock price is, in fact, close to both its one- and five-year highs, and very likely to move further in that direction. It seems hard to explain, until you view it in terms of the simplest market principle of all: profitability.

JPMorgan is a highly profitable bank, and the fines being levied (or about to be levied) against it will make little difference to that profitability. Take, for example, the $5.1 billion settlement that the bank has reached for misleading Fannie Mae and Freddie Mac about the quality of mortgages it sold them prior to 2008. That is a big number, except that the bank is concurrently laying off 15,000 workers in their mortgage servicing unit, which will save the bank an estimated $3 billion. While the layoffs may be due to greater ability by homeowners to refinance mortgages and fewer home foreclosures, the fact remains that JPMorgan's mortgage business will take a net hit of only $2 billion thanks to them. That is a pittance for a bank that had net income of $20.5 billion last year, especially given that the settlement is a one-time expense whereas savings from cost-cutting will benefit its business every year.

In addition, up to $9 billion of the $13 billion total settlement might be tax deductible for JPMorgan, which will give it an additional cushion against its regulatory losses.

MORE: Lloyd Blankfein: Financial crisis taught me a lot about myself

All this is related to how shareholders really value a stock, which is on the basis of its prospective future earnings and not on the past. By aggressively settling the various criminal and civil charges now, JPMorgan can leave them in the rearview mirror in 2014, and that is why the stock is doing so well despite the big settlements and despite the hint of serious historical problems at the bank, including poor risk management, ethical lapses, questionable marketing practices, market manipulation, and many other things. The stock market is looking ahead, and all it sees are more dollars for the nation's largest bank vs. a handful of short-term problems that will get wiped out in one quarter's write-offs.

And that brings me to my bigger point that even though headline-grabbing bank fines might impress the public and suggest that financial regulators are finally waking up, they are ultimately useless in changing the behavior of Wall Street, and possibly even harmful. The rationale behind large bank fines is to mete out painful punishment for bad behavior. But that only works if shareholders care, and as demonstrated above, that is not necessarily the case if the bank can credibly promise oversize profits in the future. The government's thesis on this is clearly flawed; and even in terms of the direct cost of settlements, those costs are ultimately borne by junior and mid-level employees -- who see pay cuts or layoffs, and by consumers -- who are hit with higher fees, to fund the fines.

Without punishment of the actual individuals involved in making bad decisions, and the corporate leaders whose responsibility it is to oversee them, the deterrent is false. Bank fines then become little more than a mechanism for transferring wealth from the bank's workers and customers to public coffers and fail to address the problem of how to rein in Wall Street excess. Moreover, to tackle an industry fortified behind airtight legal indemnifications and corporate liability shields for executives, the Justice Department's time would be much better spent finding ways to hold those executives responsible for wrongdoing rather than shooting pointlessly at faceless institutions. If anything, penalizing banks rather than bankers sends a message to the latter that it is possible to be reckless and bill the fallout to someone else. Coming back to the JPMorgan example, other than the resignation of one executive, Ina Drew, and the prosecution of two low level traders after the London Whale loss, senior management has escaped mostly unscathed from the messes of the past five years.

MORE: How JPMorgan's settlement could boost its profits

In the wake of the financial crisis, which wiped out 39% of the wealth in the United States, financial reform is imperative, but the current solution is off base. It is better to focus on fixing the regulatory framework that allows errant bankers to pass the consequences of their actions onto their employers, and on enforcing higher standards for corporate governance overall -- than to keep looking backwards.

The stock market already knows this, which is why it is refusing to punish JPMorgan for the past, and the government would be smart to do the same.

Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein. He is the author of two thriller novels, including Killing Wall Street.

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