Ed's Blog

JP Morgan Chase: $2 Billion Debacle Shows It May Be Too Big To Manage

By Ed Mierzwinski
Senior Director, Federal Consumer Program

UPDATE: Paul Krugman has a view, too, in his latest NY Times column.

ORIGINAL POST FOM YESTERDAY: Last week the nation's largest -- and to date least vulnerable to attack for stupid bank tricks  -- bank, JP Morgan Chase, lost two billion dollars in a very bad derivatives bet it claims was a hedge, not a soon-to-be banned proprietary trade. Now Chase's until-now-Teflon-coated CEO Jamie Dimon faces increased scrutiny over his own and his firm's loud and arrogant opposition to the Volcker rule regulating proprietary trading and additional reforms requiring exchange trading of derivatives -- two Dodd-Frank Wall Street reforms not yet implemented due to the obstinacy of bankers like him that might have prevented the loss. The episode also raises the question: Are the big banks too big to manage?

In her column "At JPMorgan, the Ghost of Dinner Parties Past" today at the New York Times, Gretchen Morgenson interviews professor Michael Greenberger, a reformer who previously worked to rein in risky derivatives trading as a senior official at the U.S. Commodity Futures Trading Commission (CFTC), an agency that was given important new authority to put shadowy derivatives deals onto transparent exchanges by the Dodd-Frank Wall Street Reform and Consumer Protection Act but has become the whipping boy of U.S. House of Representatives reform opponents whose memory does not seem to include the year 2008. Greenberger tells Morgenson:

“If the trades at issue were proprietary trading, as now appears to be the case, they would be banned by the Volcker Rule,” Mr. Greenberger said. “And if derivatives rules under Dodd-Frank had been in effect, these trades would almost certainly have been required to be cleared [on public exchanges] and transparently executed. The losing nature of the trades, therefore, would have been obvious to market observers and regulators for quite some time and the losses would not have piled up opaquely.” [I added the words [on public exchanges] for clarity to non-geeks].

Morgenson also quotes Chase chief Jamie Dimon from a recent party for high-rollers, where he apparently attacked both former Fed chairman Paul Volcker and Federal Reserve Bank of Dallas president Richard Fisher:

"One guest asked about the problem of too-big-to-fail banks and the arguments made by Mr. Volcker and Mr. Fisher. Mr. Dimon responded that he had just two words to describe them: “infantile” and “nonfactual.” He went on to lambaste Mr. Fisher further, according to the attendee. Some in the room were taken aback by the comments. Neither Mr. Fisher nor Mr. Volcker would comment on the remarks. But it appears to have been a classic performance from Mr. Dimon. In-your-face. Pugnacious. My way or the highway."

Over at the PIRG-backed Americans for Financial Reform, policy director Marcus Stanley explains the debacle in a long blog post. Marcus makes many important points, but a key one is this:

"...instead of trying to raise returns by seeking out real economy lending opportunities, JP Morgan instead tried to increase its return by trading derivatives on synthetic credit default swap indexes – pure paper speculation. To make things worse, because it was hoodwinked by its own mathematical models (JP Morgan now admits its VAR model was ‘inadequate’) the bank apparently did not even understand that this speculation involved risks at least as great as it would have incurred had it made real economy investments."

Over at his Huffpo blog, professor Simon Johnson explains that "The lessons from JP Morgan's losses are simple. Such banks have become too large and complex for management to control what is going on. The breakdown in internal governance is profound." Professor Nouriel Roubini has making the point for years, as in this HuffPo video, that the big banks are too big to manage. Thomas Hoenig, a Republican and former head of the Kansas City Fed and newly-confirmed as a member of the FDIC board, has also campaigned to break up the big banks. This Reuters story explains the SAFE Act to limit the size and leverage (translates to "risk") of big banks, as recently introduced by Senator Sherrod Brown (OH) and others, which is discussed in the Simon Johnson blog link above and in this support letter from the PIRG-backed AFR.

And as I told US News and World Report about the Chase debacle, "Hopefully it will give the Federal Reserve the spine that it lacks to implement a strong Volcker rule." Here is a link to the AFR, AFL-CIO, U.S. PIRG comment to regulators on the proposed Volcker rule, which the regulators have hemmed and hawed about implementing. Senator Carl Levin (MI), with Sen. Jeff Merkley (OR) one of the authors of the Volcker rule, is not impressed. Also, here is a link to the latest letter from AFR, U.S. PIRG, state PIRGs and 50 others opposing cuts sought by House reform opponents to the budget of the tiny CFTC. So far, the Senate has rejected their industry-backed proposals.

Finally, at an AFR seminar last week, CFTC commissioner Bart Chilton had some choice words, as quoted by Bloomberg:

“They want us to write off the 2008 financial crisis as an aberration and ignore countless reputable scholars who’ve found that the costs of opaque, unregulated derivatives markets are borne by the public,” Chilton said in remarks prepared for an event today in Washington held by policy groups including Americans for Financial Reform. “There is more trash talk and more action regarding litigation related to financial regulation than ever before.” The court challenges based on cost-benefit analysis are part of a “D.C. Quadrikill” strategy of confronting regulations: “1. kill the bill; 2. defund it; 3. regulate it; and, 4. litigate it.”

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