By JOE NOCERA
New York Times News Service
Let’s begin by stipulating the obvious: Nobody outside of JPMorgan Chase knows for sure what really happened with those trades that have cost it so much money and done such severe damage to its once stellar reputation.
In his conference call last Thursday, Jamie Dimon, the bank’s chief executive, characterized the trades as “stupid,” but refused to get into any specifics. Even hedge fund managers on the other side of the JPMorgan trades have been able to cobble together only bits and pieces. Most of the emphasis has been on the credit derivative business managed by one Bruno Iksil in JPMorgan’s London office — aka the “London whale.” Yet from what I hear, his losses probably won’t total more than $600 million — while the bank’s total losses have reached $2.3 billion, and could well hit $4 billion, according to The Wall Street Journal. Where are the rest of the losses coming from? As I say, nobody knows.
Still, we know enough to be able to make some informed judgments. We know that JPMorgan, awash in taxpayer-insured deposits, took some of that money — around $62 billion at last count — and decided to invest it in corporate debt, which had the potential to generate higher returns than, say, old-fashioned loans. Citigroup and Bank of America, chastened by the financial crisis in ways that JPMorgan was not, had far less invested in such securities.
We know that JPMorgan’s chief investment office, which had orchestrated the debt purchases, decided to hedge the entire portfolio by selling credit default swaps against a corporate bond index. You remember our old friends, credit default swaps, don’t you? Three years ago, they nearly brought down the financial world. Not content with its hedge, it then hedged against the hedge. It was all very complex, of course, and all done in the name of “risk management.”
We also know that Ina Drew, a JPMorgan veteran who headed the chief investment office — and who departed on Monday — made $14 million last year. Wall Street executives who make $14 million are not risk managers. They are risk takers — big ones. And genuine hedging activity does not cost financial institutions billions of dollars in losses: their sole purpose is to protect against big losses. What causes giant losses are giant, unhedged bets, something we also learned in the fall of 2008.
Thus, the final thing we know: At JPMorgan, nothing changed. The incentives, the behavior, even the trades themselves are basically the same as they were in the run-up to the financial crisis. The London whale was selling underpriced “credit protection.” Isn’t that exactly what AIG did?
Whenever I heard Dimon defend derivatives, he cast it as something banks had to offer their clients. Caterpillar needed to hedge its exposure to foreign currency shifts, which JPMorgan’s derivatives made possible. But what client was being served with these trades? They were done for the bank, by the bank, solely to the bottom line.
Which brings us, inevitably, to the Volcker Rule, that part of the financial reform law intended to prevent banks from doing what JPMorgan was doing: making risky bets for its own account. JPMorgan executives have insisted in recent days that the London trades did not violate the Volcker Rule (which, for the record, has not yet taken effect). But that is only because the banks have lobbied to protect their ability to hedge entire portfolios. A letter to regulators written in February by a top JPMorgan lobbyist describes a trade that sounds exactly like the ones that have just caused all the problems. Such trades need to be preserved, the lobbyist argues.
What banking most needs is to become boring, the way the business was before bankers became addicted to trading profits. But if that were to happen, Drew wouldn’t make $14 million. Safer banking means lower profits, which means smaller compensation packages. That is precisely what JPMorgan’s London traders were trying to avoid.
“Paul Volcker by his own admission has said he doesn’t understand capital markets,” Dimon has famously said. What Volcker understands is far more important: the behavior of bankers.
Happily, the recent behavior of JPMorgan’s London traders could well cause regulators to put in place a Volcker Rule so tough that it would make banking boring again. One can only hope.
