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May 11, 2012 7:53 pm
Amid turmoil in the eurozone, it has been some time since we heard an American voice apologising for a financial disaster. It has been even longer since that voice belonged to Jamie Dimon.
Mr Dimon has been best-known in the past year or two for his punchy, sometimes angry, defences of JPMorgan Chase, the banking group of which he is chairman and chief executive, and of the social value of “too big to fail” banks. The man who used to be the Obama administration’s favourite banker (and a tip for Treasury secretary) has tussled with regulators and berated journalists.
Mr Dimon changed his tune abruptly on Thursday evening, on a hastily convened conference call during which he disclosed a $2bn financial trading loss and ate a great deal of humble pie. The offending trade had been “flawed, complex, volatile, poorly reviewed and poorly monitored ... there are many errors, sloppiness and bad judgment,” he said, concluding unhappily: “It plays right into the hands of a bunch of pundits out there.”
You can say that again. Mr Dimon has resisted regulators’ efforts to impose higher global capital standards as “anti-American” and had been grappling with US regulators on the “Volcker rule”, which is intended to stop proprietary trading at large banks. Losing $2bn within a $360bn portfolio backed by customer deposits while doing that is awkward timing, to say the least.
The implications for the depositors and taxpayers who implicitly support JPMorgan and other such banks are gloomy in several respects. One is that JPMorgan, which was regarded as having tougher, more effective risk management under Mr Dimon than many other institutions – and came through the 2008 crisis better – has proved to be as vulnerable as any to a trading blunder.
The bank was clearly, and publicly, warned. Indeed, the activities of Bruno Iksil, a London trader in JPMorgan’s chief investment office – the unit that was supposed to hedge its balance sheet risks – had become notorious. His outsized use of synthetic credit indices to shield against a severe downturn in corporate credit had roiled the UK derivatives market and brought him the nickname “the London whale”.
Mr Dimon at first tried to brush it off as a standard bit of interest-rate hedging that any large bank is bound to do – it has the money and it has to deploy it in some way (depositing it in the bank is not enough, since it is already in a bank). Last month, on another conference call, he decried the publicity about Mr Iksil as “a complete tempest in a teapot”.
This now sounds ridiculous, but in a sense Mr Dimon is still right. A loss of $2bn is indeed a very small proportion of the total $360bn at risk – about half a per cent. What would have happened if JPMorgan’s balance-sheet wizards had been really creative and lost half of the money – the magnitude of loss that some hedge funds have suffered? A $180bn loss would wipe out its $183bn in shareholder’s equity.
There is little doubt that the US government would then have to step in and bail it out, since the financial costs of one of the largest deposit-taking institutions in the world collapsing would be too great. Spain this week took control of Bankia, a troubled savings bank, by taking a 45 per cent equity stake.
Given that banks such as JPMorgan are systemically important, the obvious response is to stop them taking such risks. This idea motivated the US regulation named after Paul Volcker, former chairman of the Federal Reserve, which is due to be put into force soon. Carl Levin, a Democrat senator, described the debacle as one of the “risky bets ... that too big to fail banks have no business making”.
JPMorgan would clearly be barred under the Volcker rule from placing Mr Iksil within its investment bank and giving him anything like the same amount of capital to play with as a proprietary trader. Indeed, if its chief investment office were a hedge fund, it would easily be the biggest in the world – six times the size of Bridgewater Associates.
Furthermore, Mr Dimon is on weak ground in claiming the portfolio was being invested merely as a hedge for its balance-sheet risk. As he said on Thursday: “It actually did quite well. It was there to deliver a positive result in a credit-stressed environment. And we feel we can do that and make some net income.” In other words, it was seen inside the bank mostly as a hedge, but partly as a profitmaking trade.
The term “hedge fund” originated from the same hybrid – that an investment fund could aim to remain market-neutral and take low risk, while still making money. In that sense, Mr Dimon, who oversaw the chief investment office, is himself a hedge fund manager – as is the chief executive and chief financial officer of every large bank.
But disentangling active oversight of a bank’s assets and liabilities from strict “proprietary trading” in order to eliminate the latter would be a fiendishly hard, if not impossible task. Any bank with billions of dollars in deposits inherently takes a trading position by investing them in assets, no matter how safe.
The best that can be said of JPMorgan’s trading loss is that, as Mr Dimon noted, it can absorb it. Nick Leeson’s trading loss of £930m brought down Barings in 1995 but JPMorgan’s “fortress balance sheet” will only be dented: it will still make $4bn in post-tax profit this quarter.
The obverse is that there is little a regulator or anyone else is likely to be able to do to stop this sort of thing happening again. They may swarm all over the central investment offices of banks and try to force them into the most cautious possible strategies for hedging their assets and liabilities, but they cannot outlaw the activity.
As the debacle at JPMorgan once again demonstrates, any bank with a highly leveraged balance sheet (in other words, all of them) is one big “risky bet”. That is the nature of the financial beast, whether or not it employs a whale.
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