Washington's Blog: The Truth About JP Morgan's $2 Billion Loss‏

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    May 20, 2012 2:46 PM GMT

    The Truth About JP Morgan’s $2 Billion Loss

    By Washington's Blog

    Global Research, May 16, 2012

    Washington's Blog

    Before we can understand what’s really going on with JP Morgan’s loss (which will probably end up being a lot more than $2 billion), we need a little background.

    JP Morgan:
    •Is the world’s largest publicly-traded company
    •Is the largest bank in the U.S. ... the biggest of the too big to fail banks which are killing the American economy
    •Is the largest derivatives dealer in the world (and see this), and derivatives are inherently destabilizing for the economy
    •Essentially wrote the faux “reform” legislation for derivatives, which did nothing to decrease risk, and killed any chance of real reform
    •Is the creator of credit default swaps – which caused the 2008 financial crisis, and is the asset class which blew up and caused the loss
    •Has had large potential exposures to credit default swap losses for years
    •Has replaced the chief investment officer who made the risky bets with a trader who worked at Long Term Capital Management ... which committed suicide by making risky bets
    •Went completely insolvent in the 1980s

    •... and again in 2007 ( and was saved both times by the government at taxpayer expense)
    •Heads – with Goldman Sachs – the Treasury Borrowing Advisory Committee, which helps set government financial policy
    •Has a reputation of being the most risk-averse of the big Wall Street players
    •Was kept alive by a huge government bailout ... but used the money to invest in India and other projects which won’t really help Americans
    •Has made a killing by kicking companies (and see this) and governments (and here) when they are down, engaging in various types of fraud (update), allegedly manipulating the silver market, and profiting on misery by acting as the largest processor

    In addition, JPM’s CEO Jamie Dimon:
    •Is a Class A Director of the Federal Reserve Bank of New York, which is the chief bank regulator for Wall Street (including JPM). Indeed, Dimon served on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and was used by the Fed as a clearing bank for the Fed’s emergency lending programs. In 2008, the Fed provided JP Morgan Chase with $29 billion in financing to acquire Bear Stearns. At the time, Dimon persuaded the Fed to provide JP Morgan Chase with an 18-month exemption from risk-based leverage and capital requirements. He also convinced the Fed to take risky mortgage-related assets off of Bear Stearns balance sheet before JP Morgan Chase acquired this troubled investment bank
    •Has a reputation of being the “golden boy” and smartest guy on Wall Street
    •Has been the chief spokesman and advocate for deregulation of banks, and has lectured, scolded and cajoled everyone who has questioned his banking practices
    •Jokes about a new financial crisis happening “every five to seven ye

    What Does It Mean?

    Pundits and consumers alike are reacting to JP Morgan’s loss like a startled herd of sheep.

    They somehow believed that the “best of the breed” bank and CEO – the biggest boy on the block – was immune from losses. Especially since JPM has been so favored by the Feds, and Dimon was so favored that he was being groomed for Secretary of Treasury.

    And the fact that the head cheerleader for letting banks police themselves has egg on his face is making a lot of people nervous.

    And that the biggest of the too big to fails could conceivably fail.

    The government says its launching a criminal probe into JPM’s trades.

    Ratings services have downgraded JPM’s credit, and many commentators have noted that other banks may be downgraded as well.

    Elizabeth Warren is calling for Dimon to resign from the New York Fed:

    iEven CNBC is now calling for Glass-Steagall to be put back in place.
    Banking expert Chris Whalen writes:

    Someone at the Fed should have at least secondary accountability for the JPM losses if the VaR model/process was faulty. Is there any accountability for incompetent, badly managed federal bank regulators? As our colleague Janet Tavakoli wrote in the Huffington Post: “The U.S. can count on JPMorgan to continue both long and short market manipulation and take its winnings and losses from blind gambles. Shareholders, taxpayers, and consumers will foot the bill for any unpleasant global consequences.”

    We think that the loss by JPM is ultimately yet another legacy of the era of “laissez-faire” regulation and even overt Fed advocacy for the use of OTC derivatives by US banks. Fed officials such as Pat Parkinson, who retired as head of the Fed’s division of supervision and regulation in January, were effectively lobbyists for the large banks and their derivatives activities. It seems a little ridiculous for the same Fed officials who caused the problem over the years to now be tasked with investigating JPM, much less regulation of large bank dealings in OTC instruments

    Talk about conflicts of interest, why in Hell is Dimon in decision making positions affecting the bank/investment firm he is over? When are we going to learn, conflicts of interest lead to failure.

    Is it not time for Glass Stiegal to be reinstated in its entirety ?
  • maxferguson

    Posts: 321

    Jul 01, 2012 2:15 AM GMT
    Great post -- a nice break from the usual fuck or pass. And a shame nobody has replied icon_sad.gif.

    Before I reply, I should qualify that I don't have any particularly strong opinions (yet) regarding Glass Stiegal. Dodd-Frank and the Volker Rule on the other hand, I do. Given that, I openly acknowledge that I could be wrong and hope for a good discussion afterwards ☺

    Glass- Steagall - I think you're right on the money, but how it is reinstated it is likely to be overlooked by policy makers, favouring the convenience of the general public mood that follows when government reacts to the bad guy. Society has a terrible tendency to find reprieve in punishment or reduction in the number of activities one (one being a bank in this case) is allowed to partake in. This leads to temporary satisfaction, but when we zoom out on the timeline of the last century of financial history, it is very clear that most legislation regarding banking has not achieved what it set out to do. Hence, I'm not sure a point-blank reinstatement of Glass-Steagall would result in a different result. Rather than the Volker Rule (which Wikipedia dubs Glass-Steagall Lite), which eliminates activity, I think separating the activities and sources of risk from what the Volker Rule attempts to protect is a better approach.

    Hugh Hendry, a Scottish hedge fund manager (Eclectica Asset Management) nails it in this youtube clip: http://www.youtube.com/watch?v=bGBLO8hu5o4
    He says, "We need to separate commercial/retail banking from investment banking...." While the Volker Rule seems more akin to the punishment a child would receive for misbehaving; perhaps having playtime revoked. Invariably, the child can, and will, find other ways to be amused. Then what, Volker 2.0? When do we stop? It’s

    Personally, I I don't mind JPMorgan as a corporate citizen, at least not as much as Goldman Sachs, Citi, DeutschBank, Commerzbank, SocGen, etc.... The latter 3 (and others) are levered beyond belief (particularly SocGen) and that's when shit gets crazy. To the credit of both Jamie Dimon and JPMorgan, he took ownership of the $2b loss in plain language in front of a congressional and senate committee on banking. Also to JPM’s credit, they bought WaMu and Bear Stearns using TARP funds at the request of the U.S. Gov't. Their balance sheets were also safe throughout the entire crisis from 2008 forward without TARP money, but the Federal Reserve requested they take it in order to instill confidence in markets and make those purchases. That's not the sequence of events in its entirety, but for sake of extending them credit (pun intended), it should suffice icon_razz.gif

    Just to outline Jamie Dimon and JPM’s state of affairs, beliefs and forthcomings before I lean into him a bit, Dimon openly agrees that the idea of "too big to fail" cannot exist. It's not a sustainable financial paradigm. The minute anything is "too big to fail," a number of things happen:

    1.) Implicit tax-payer protection against failure (at no direct cost to the oversized entity)
    2.) There is a new incentive to get that big in order to 'warrant' such protection against failures.
    3.) Given that the protection against failure is at the expense of the public in a “too big to fail” world, the entity instantly has no incentive to control risk, and will likely fail…. A self-fulfilling prophecy of sorts.

    I believe he is correct in saying that large institutions ought to be allowed to fail. It is the only sure way to minimize public damage. The minute you let the public help them out, it’s like lending your 16 year old daughter the credit card. Or better yet, like puncturing a water balloon, where the water is financial cost to whomever it touches. You can carefully drain the balloon and let the shareholders and other financial stakeholders eat the loss, or you can puncture it with public rescue. The water will spread thin, but it is more likely to spread this way.

    Dimon also makes a point that not only do big American institutions have to be allowed to fail, but the also explains that there is a strong need to formalize the procedure for dismantling businesses of this size without damaging the American economy. This is detailed in the hearing tapes, but one part of what such a plan would include is a "living will" that details what happens to every legal entity under the defunct corporate structure. He also mentions that JPMorgan now has such a will and what could be described as dismantling instructions in order to prevent taxpayers from paying a dime.

    In the end, the $2B is spare change given the immense capital that JPM has on reserve, but it is a yellow light for congress to slow down and think harder, as well an excellent call option play (ironically, I played the loss and subsequent 15% stock recovery right with options and paid the remainder of my tuition). Although “small,” I hope it isn’t overlooked, as it is a clear sign that the deposit-taking and lending side of a bank ought to be separated (operate in complete financial independence of) from the investment banking functions that incur risk. I think that financial separation is a much better solution that the Volker rule, which eliminates a chunk of what an investment bank does. To what extent prop-trading is essential in market-making, I haven’t the foggiest, but there is something to be said for providing liquidity. There’s also something to be said for the nature of a trade – it’s voluntary, and absent of miscalculations, trades only occur when they a profitable, or loss minimizing. Generally, the profits from prop trading come from other banks who are exiting/entering a position that is ideal for them (again, in a world with now miscalculations). In the event of a miscalculation, this separation would leave taxpayers and deposit account holders at ease. This is where Hugh Hendry's accuracy is bang on. Prop trading need not be stopped, it simply needs to be separated, and then federally insured deposits are safe. This is also where my odds with Frank-Dodd start.

    Dodd-Frank is 2400 pages of political drivel. After watching all of the congressional hearing and senate committee who ha with Dimon, I drew several conclusions about the act and legislators:

    1.) Roughly 2/3 of the people who are quizzing him are drastically uninformed in general capital markets knowledge. The other 1/3 are very well informed and ask reasonable, meaningful questions that shed light on the holes in Dodd-Frank, JPMorgan’s prior risk management systems, and other regulation. One such individual is Mrs. Hagan, who asks, "How could the trades have been so large that regulators and shareholders could not have known until it was too late?" Mrs. Hagan is also one of the few committee members who accepts that nothing can be modeled to perfection and that you can’t run a business off of a model. There are real time considerations that might not fit the model. (http://www.youtube.com/watch?v=EQY9J5d2nMo&feature=related)

    2.) The uninformed proportion of law makers are verbally assertive with their assumptions, which may or may not be true and are mistaken by the individual to be observable fact. In contrast, the well-informed portion is curious, not assertive. The scary thing is that the former are taking assumption as fact and writing legislation. While they may be correct, taking legislative action on what is falsely presumed as fact leads to ineffective legislation. The underlying cause this ineffectiveness is writing legislation without knowing when you will be wrong (ironically, the very pitfall in the VaR model that allowed the $2B loss to happen icon_razz.gif). One clueless senator, Mr. Bennet asserts that JPMorgan have gone down in 2008 if it weren't for the massive federal intervention. After Dimon'
  • maxferguson

    Posts: 321

    Jul 01, 2012 2:16 AM GMT
    After Dimon's reply (which was factual, except for the estimation of loss in the event that AIG failed), Bennet says, "You have quite a difference of opinion with many of the analysts who say JPM benefited hugely from the AIG bailout" For one, equity analysts aren't privy to private information, only the information that the entire market has. Secondly, a Senator is suggesting that the information provided by the subject is false, favouring information that isn’t cited and without addressing the conflicts of interest typically borne by equity analysts. Lastly, Dimon estimates that the loss in the event of AIG not receiving a bailout at about $2B. Bennet continues to steamroll the discussion, without realizing that Dimon has somewhat verified his claim that JPM benefited in about the same sum as the loss that sees them in this hearing. Lol, sorry for the rant, but my point is that legislators are relatively clueless about how to write effective legislation, and for reasons beyond lack of knowledge about what they are legislating.

    In summary, neither congress, the Fed, private banks, or anyone involved to date can honestly say they set aside politics, money and popularity in order to have a reasonable discussion to find out what is true, false and uncertain. Then and only then can we start to write effective legislation.

  • maxferguson

    Posts: 321

    Jul 01, 2012 2:49 AM GMT
    In the hearing, Dimon does suggest a rough framework for legislating the financial system. Personally, I tend to agree with it. Rather than the thou-shalt not nature of Dodd-Frank and the Volker Rule, Dimon’s alternative is a much simpler, much more flexible idea that could be written on the back of a napkin.

    The idea is that you can’t eliminate risk without eliminating the liquidity provided by the market-making nature of prop trading. While there is definitely some truth to the market making argument, I’m not sure how much or how little – we’ll never know precisely. Given that, it is possible to eliminate risk from federally insured deposits, and to salvage the benefits of prop trading.
    1.) Have separate capital requirements for the deposit/lending arm of the bank and the investment bank. As well, make each arm a separate legal entity owned by the Corporation.
    a. Right away, this ensures that the federally insured deposits are safe from any risk taken by the investment bank. The iBank could falter completely (Lehman style ;p) and not a single dime of federally insured deposits was ever at risk.
    2.) Eliminate this idea of “too big to fail.” It isn’t a sustainable financial thought process. If an entity has the unspoken guarantee of being too big to fail, then it will inevitably take either too much risk, or lose competitiveness (for example, GM vs. VolksWagen).
    3.) Don’t bar certain activities or investments, set limits on the risk that those activities incur.
    a. Set limits for each entity and portfolio.
    b. Critical to the success of this point is the legislation of (by the SEC) “risk reports” and:
    i. Their contents (limits, procedures, etc…)
    ii. What each group/portfolio’s limits are and written investment statement policies.
    iii. The concentration risks – what % of capital can be tied up in a specific type of risk and for how long.
    iv. How frequently these reports are to be created and to whom they are to be distributed and in what time frame (i.e., such that the information is still relevant).
    v. Who is responsible in the event of error.

    That solves most of what Dodd-Frank and Glass Steagall attempted, but is much easier to enforce than the 2400 page act of confusion.

    Finally (phew…. Long post ;p), you’re right on about that Washington Blog and being a startled herd of sheep!

    - As of Friday, June 29, 2012, Apple is exactly 4.01x larger than JPM, and is the world’s largest publicly traded company.
    - Banks screw up time and time again, but for the economy to grow, the growth rate in private sector credit demand must be higher than the nominal interest rate. Banks facilitate this – but should be managed according to the above (which of course is definitely open for debate and discussion).
    - Derivatives don’t destabilize the economy, not inherently anyway. When misused (i.e, falling out of the above list).
    - Credit default swaps would have saved your ass if you owned Greek sovereign debt. Also, CDS do not influence what yield bonds trade at. Bond yields and the credit risk of the issuer influence what CDS trade at.
    - The “CDS market” is insurance on debt. However, you do not need to own the underlying. People have assumed for sake of argument that this must be true to be defined as insurance. However, consider the following argument: GEICO doesn’t own your car; if you buy insurance from GEICO, then GEICO sold you insurance, but didn’t own the underlying. Similarly, when you buy a CDS (naked), you would be insured if you owned the underlying debt instrument. But the CDS contract doesn’t care if you own it or not, it still trades at the same spread and is good for the same amount of debt whether or not you own it.
    o The logic behind having to own the underlying asset is best demonstrated with housing insurance. I cannot buy insurance on my neighbors house because it would be too easy to burn their house down and collect.
    o By contrast, if you own a CDS and do not own the bond, you can resell that insurance as “the salesmen.” Also, the only entity that can “burn down” a bond issuance the way you could burn down a house and collect the proceeds is the issuer. Nobody but that entity can destroy (for the better part) it’s ability to pay those bonds down. The notion that a CDS ruins bonds is ridiculous. That’s like saying because GEICO is willing to sell more car insurance that the price of cars will increase.
    - They do make a very peculiar point about the appointment of some LTCM dickbag. I hate LTCM and the academics who ran it. It’s academics like that who rely on models and believe they can model even what they don’t know. This is the cause of the LTCM collapse.
    - JPM probably kept more of the American Gov’t alive than the reverse; Bear Stearns and WaMu are not cheap…. Unless of course Chairsatan Benzebub brings out the old laser jet.
    - The only known manipulation of the silver market (in any material way) is the Hunt Brothers who learned that it’s not possible. They cornered the market briefly, and then the market ate their asses for supper.
    - I think that if uninformed law makers continue to write policy to regulate banks, that there will be a financial crisis every 7-10 years. They don’t know when they are wrong and need to engage the SEC more and industry.
    - Personally, I think they are write about Dimon and Fed. I would like to see him resign.