I’ll come back shortly to the troubles at JPMorgan Chase, the bank Mr. Dimon runs. First, however, let me talk about Mr. Romney, whose remarks about those troubles were so off-point that they constitute a teachable moment.
Here’s what the presumptive Republican presidential nominee said about JPMorgan’s $2 billion loss (which may actually have been $3 billion, or $5 billion, or more, but who’s counting?): “This was a loss to shareholders and owners of JPMorgan and that’s the way America works. Some people experienced a loss in this case because of a bad decision. By the way, there was someone who made a gain.”
What’s wrong with this statement? Well, suppose that someone — say, Jimmy Stewart in the movie “It’s a Wonderful Life” — runs a bank that takes in deposits and invests the money in various ways. And suppose that one of those investments is a risky bet on some complex financial instrument, with Mr. Potter, the evil plutocrat, on the other side.
If Jimmy Stewart’s bet pays off, we’re in Romneyworld: he’s made money, Mr. Potter has lost money, and that’s that. But suppose Jimmy Stewart loses his bet. If the bet was big enough, he no longer has enough assets to pay off his depositors. His bank collapses, probably in a chaotic bank run that takes down the whole town’s economy as collateral damage. Mr. Potter makes money on the deal, but so what?
The point is that it’s not O.K. for banks to take the kinds of risks that are acceptable for individuals, because when banks take on too much risk they put the whole economy in jeopardy — unless they can count on being bailed out. And the prospect of such bailouts, of course, only strengthens the case that banks shouldn’t be allowed to run wild, since they are in effect gambling with taxpayers’ money.
Incidentally, how is it possible that Mr. Romney doesn’t understand all of this? His whole candidacy is based on the claim that his experience at extracting money from troubled businesses means that he’ll know how to run the economy — yet whenever he talks about economic policy, he comes across as completely clueless.
Anyway, it goes without saying that Jamie Dimon is no Jimmy Stewart. But he has, in a way, been playing Jimmy Stewart on TV, posing as a responsible banker who knows how to manage risk — and therefore the point man in Wall Street’s fight to block any tightening of regulations despite the immense damage deregulated banks have already inflicted on our economy. Trust us, Mr. Dimon has in effect been saying, we’ve got this covered and it won’t happen again.
Now the truth is coming out. That multibillion-dollar loss wasn’t an isolated event; it was an accident waiting to happen. For even as Mr. Dimon was giving speeches about responsible banking, his own institution was heaping on the risk. “The unit at the center of JPMorgan’s $2 billion trading loss,” reports The Financial Times, “has built up positions totaling more than $100 billion in asset-backed securities and structured products — the complex, risky bonds at the center of the financial crisis in 2008. These holdings are in addition to those in credit derivatives [ http://topics.nytimes.com/top/reference/timestopics/subjects/d/derivatives/index.html ] which led to the losses.”
And what was going on as these positions were being accumulated? According to a fascinating report in Sunday’s Times [ http://www.nytimes.com/2012/05/20/business/discord-at-jpmorgan-investment-office-blamed-in-huge-loss.html ], the reality behind JPMorgan’s facade of competence was a scene all too reminiscent of the behavior that brought down firms like A.I.G. in 2008: arrogant executives shouting down anyone who tried to question their activities, top management that didn’t ask questions as long as the money kept rolling in. It really is déjà vu all over again.
The point, again, is that an institution like JPMorgan — a too-big-to-fail bank, not to mention a bank whose deposits are already guaranteed by U.S. taxpayers — shouldn’t be engaged in this kind of speculative investment at all. And that’s why we need a return to much stronger financial regulation, stronger even than the Dodd-Frank regulations passed back in 2010.
Will we get that kind of regulation? Not if Mr. Romney wins, obviously; he wants to repeal Dodd-Frank, and in general has made it clear that he would do everything in his power to set us up for another financial crisis. Even if President Obama is re-elected, getting the kind of regulation we need will be an uphill struggle. But as Mr. Dimon’s debacle has just demonstrated, that struggle remains as necessary as ever.
The number being bandied about now is closer to a range of $6 billion to $7 billion, according to several people working on trading desks that specialize in the derivatives JPMorgan Chase (JPM, Fortune 500) used to make its trades and from two sources with knowledge of the bank's positions.
JPMorgan Chase declined to comment on its trading activities. Of course, it is impossible to know with absolute certainty just how high the losses are at any given moment.
But experts said there are few scenarios in which hedge funds on the other side of the bank's giant bet will let JPMorgan Chase out of it without significantly more pain.
"The market knows roughly what [JPMorgan] has and what the sizes are," said a source with knowledge of the bank's positions.
Since last Thursday, the U.S. and European stock markets have dropped significantly. The S&P 500 (SPX) is down roughly 3.5%, and the main European indexes are down between 4% and 6%.
JPMorgan Chase's trades were built around contracts tied to corporate bonds. Specifically, JPMorgan Chase sold huge amounts of protection on an index of 125 highly rated corporate bonds. Simply put, JPMorgan Chase's massive trade stood a better chance to pay off if the market had continued to rally.
JPMorgan and the politics of financial reform
Now as the overall market has worsened, it costs even more for JPMorgan Chase to sell protection against possible bankruptcies on corporate bonds.
Since JPMorgan Chase is basically the only one on its side of the bet, a worsening market makes it even more expensive to keep this position and more difficult to find other places to offset these losses.
JPMorgan Chase's main bet has been on an index, known as IG9, of 125 U.S. investment grade companies. Shares of three of the 125 companies -- retailer J.C. Penney (JCP, Fortune 500) and insurers MBIA (MBI) and Radian (RDN) -- have taken big hits since last week, driving up the cost of offering protection against a default.
Additionally, since Dimon's announcement, more hedge funds have piled into the index, further driving up the cost of selling protection.
It's clear from public data filed with The Depository Trust & Clearing Corporation that JPMorgan Chase hasn't sold any of its positions yet. The DTCC tracks trading activity and sizes of positions on the IG9 and other indexes, and there haven't been any big moves since last week.
"Whatever the size was, it's clearly not something that you can call one or two dealers and sell," said Garth Friesen, a co-chief investment officer at AVM, a derivatives hedge fund that's not involved in these trades.
As soon as it becomes clear that JPMorgan Chase is unwinding its position, it will be obvious to players on every major trading desk. Hedge funds will immediately start piling into that index and buying protection, driving up the bank's losses.
Until then, it won't cost the hedge funds much to sit and wait.
"There will be a stare-fest between the hedge funds and JPMorgan," said James Rickards, former general counsel at Long-Term Capital Management, a hedge fund that required a $3.6 billion bailout from the Federal Reserve because of its massive losses from its trading activities.
"It will cost JPMorgan an unimaginable fortune to push the spread back in their direction," he added.
But JPMorgan Chase may blink first. It could face pressure from U.S. government regulators to start selling some of its positions.
The bank's shareholders may grow increasingly anxious as well, which could force JPMorgan Chase's hand. Shares are down 18% nearly since the company announced the loss.
Video [embedded] Geithner: JPMorgan loss a call for reform
"It's not just a battle between Dimon and the hedge funds," said Rickards. "It's been JPMorgan and the regulators, the FBI, Congressional committees and stock holders. It's not clear that their tolerance for pain will be as high as Jamie Dimon."
For now, the one thing working in JPMorgan Chase's favor is the market's bet that the bank is too big too fail, making it dangerous to push too hard on the other side of its trade.
But the dangers are far greater for JPMorgan Chase.
"Part of the problem of what they were doing is that they were too big in the trade to ever be able to trade out of it," said Friesen, who is also a member of the Federal Reserve Bank of New York's advisory group.
JPMorgan’s Home-Loan Debt in Europe Increases Anxiety: Mortgages
A pedestrian passes JP Morgan Chase & Co. headquarters in New York, U.S. Peter Foley/Bloomberg
By Jody Shenn and Esteban Duarte - May 20, 2012 5:00 PM CT
JPMorgan Chase & Co. (JPM)’s holdings of home-loan bonds from outside the U.S. soared 35-fold in the past three years. Now, with its chief investment office facing scrutiny after a $2 billion trading loss, investors are raising concern the European market’s biggest buyer will pull back.
The largest U.S. bank by assets accelerated its purchases last quarter, adding $8.5 billion to lift its total to $74.5 billion, according to regulatory filings. The New York-based company’s investments approached 9 percent of the size of the Dutch and U.K. mortgage-bond markets it’s been focusing on.
“If they stop buying, it would be pretty bad as they are one of the major buyers at the moment,” said Frank Erik Meijer, head of asset-backed securities at The Hague-based Aegon Asset Management, which manages 220 billion euros ($280 billion). “If they need to sell, that would certainly give rise to quite some” increases in yields relative to benchmark rates.
JPMorgan bolstered prices and issuance when Europe’s lenders were forced to shrink and other potential buyers shunned asset-backed notes after U.S. subprime mortgage debt sparked a global credit crisis, according to six people at banks and investment firms active in the home-loan bond market who declined to be identified because they were speaking about a competitor. Chief Executive Officer Jamie Dimon, 56, last month described the securities as part of the chief investment office’s “very conservative” holdings, four weeks before announcing an unrelated $2 billion derivative loss that highlighted the division’s influence in certain credit markets.
Brian Marchiony, a spokesman for JPMorgan in London, declined to comment.
Deposits Incresed
As the global economic slump limited loan demand and increased deposits across the banking industry, securities held in JPMorgan’s chief investment office and treasury more than tripled to $374 billion as of March 31, from $76.5 billion since 2007, filings show. The European mortgage investments began to jump in 2009, starting that year at $2.1 billion and rising to $47.1 billion by the end of 2010.
The bank has been the lead investor, or among the biggest buyers, of deals backed by loans from banks including Royal Bank of Scotland Group Plc (RBS), Lloyds Banking Group Plc (LLOY), Banco Santander SA (SAN)’s U.K. unit, ING Groep NV (INGA) and Aegon NV (AGN) in the Netherlands. Transactions, particularly in 2009 and 2010, often began with potential issuers calling the bank, three of the people said.
Revived Market
Lloyds revived the European securitization market in September, 2009, after a more than yearlong freeze. JPMorgan bought or committed to buy 2.25 billion pounds ($3.6 billion) of notes issued by Lloyds vehicles and Nationwide Building Society issuance entities.
JPMorgan approached Lloyds to issue the bonds and “provided the catalyst for us to start work on a new transaction as we then knew there was a deal to be done,” Robert Plehn, the London-based head of securitization at Lloyds’s Bank of Scotland unit, said at the time. The U.S. bank’s order “probably provided other investors with some confidence” to buy, he said.
JPMorgan has also bought outstanding securities tied to home loans originated by Northern Rock Plc, the British lender rescued by the Bank of England in 2007, two of the people said. Those purchases meant it was bolstering the market even more than the volume of its buying suggested because the debt, among the most liquid of its type, is used as a market benchmark.
‘Large Player’
“They have been since the crash a very large player in the market,” said Ronald Thompson Jr., a Greenwich, Connecticut- based consultant on asset-backed securities, and former head of strategy on the debt at Knight Libertas LLC. “You’ve always got to be concerned if there’s a large player that it’s a potential problem if they go away.”
JPMorgan’s chief investment office, which invests its excess cash and hedges its risks, failed in using synthetic credit bets to protect against a “stressed credit environment,” the bank says, such as a deepening of Europe’s debt crisis. Dimon announced its loss on May 10, describing the handling of the positions as “flawed, complex, poorly reviewed, poorly executed and poorly monitored.”
The disclosure has prompted investigations by the U.S. Department of Justice, the Federal Bureau of Investigation, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the U.K.’s Financial Services Authority.
Senate Testimony
Dimon has been asked to testify before a U.S. Senate committee on the loss, which has prompted the Federal Reserve Bank of New York to examine how banks across its district are managing a wave of deposits that has flooded the financial system since the credit crisis, according to a person familiar with the matter.
At JPMorgan, Ina Drew, 55, the chief investment officer starting in 2005 who reported directly to Dimon, retired this month. Matt Zames, 41, replaced her, shaking up the division’s leadership and announcing in a May 14 memo a “sharp, renewed focus on our hedging strategies, risk management and execution.”
Dimon has sought to allay investor concern that the bank will do something “stupid” as a result of the upheaval.
“We will do what we have to do to maximize the shareholder value,” Dimon said on a May 10 conference call, talking about unwinding the derivative bets. “We’ve got staying power and we are going to use it.”
Unlike the company’s derivatives positions, gains and losses on the securities holdings typically don’t affect its earnings because of accounting rules.
Unrealized Gains
While it had about $8 billion in unrealized gains within its bond portfolio at the end of March, and sold debt to reap $1 billion of those this quarter, sales are usually “tax- inefficient, so we’re very careful about taking gains,” Dimon said.
JPMorgan may at least test the liquidity of its European mortgage bonds with sales, even if it doesn’t otherwise shift its strategy, one of the people said.
The chief investment office’s push into risk-taking was led by Achilles Macris, 50, according to three former employees, Bloomberg News reported on April 13. He was hired in 2006 as its top executive in London and led an expansion into corporate and mortgage-debt investments to generate profits, they said. The bank said May 14 that Macris would hand off his duties.
Those in London given the task of adding European mortgage- backed securities include Anthony Brown, Francois Brochard and Swen Nicolaus according to two of the people.
Unrealized Losses
Analysts such as Morningstar Inc.’s Jim Leonard and investors including John Kerschner, Janus Capital Group Inc.’s head of securitized products, said when Bloomberg News reported the expanded holdings on Feb. 23 that the types of bonds JPMorgan targeted represent generally safe long-term bets, since they are among the most senior-ranked in deals.
The bank had unrealized losses of $273 million on the bonds as of March 31, down from $530 million on Sept. 30, according to its filings. “Substantially all of these securities” carry ratings of AAA, AA or A, and they are “primarily” from the U.K. and Netherlands, it said in the filings. Those figures were “gross” amounts, meaning similar holdings could be worth more than purchase prices. Unrealized gains totaled $657 million.
Its portions of deals can withstand losses of about 10 percent on the underlying mortgages because other classes will take writedowns first. JPMorgan said it projects lifetime losses of 1 percent. The so-called credit enhancement on U.K. bonds it bought in October was 22.4 percent of losses.
U.K., Dutch Markets
The market for U.K and Dutch home-loan bonds totals 691 billion euros, according to the data from the bank’s analysts. The broader European market’s size is 1.2 trillion euros.
Homeowners from the U.K. and Netherlands are considered the most creditworthy in Europe by bond investors, even with the U.K. returning to recession in the first quarter and Dutch home prices set to drop about 5 percent this year because of the region’s debt crisis and stricter mortgage lending rules, according to a January forecast by Nederlandse Vereniging van Makelaars, which represents property brokers.
Investors are demanding 138 basis points more than benchmark rates to hold Dutch mortgage notes and 132 basis points extra for British securities. That compares with a spread of 600 basis points for Spanish bonds. A basis point is 0.01 percentage point.
While JPMorgan remains important to issuance, a shift to structuring U.K. deals with U.S. dollar-dominated classes through the use of currency swaps may mitigate the impact of any retreat by the bank, one of the investors said.
Citigroup Emerging
“Reliance on JPMorgan has been declining since the investor base is expanding especially in the U.S. but still it’s a big player,” Aegon’s Meijer said.
Citigroup Inc. (C) is emerging as a bigger buyer from the U.S., increasing its holdings of residential-mortgage securities from elsewhere by $1.7 billion in the first three months of this year to $9.8 billion, according to a company filing. Shannon Bell, a spokeswoman for the New York-based, declined to comment.
The market got a test with a May 16 sale of about $3.6 billion of securities by Santander’s U.K. unit, with slices in pounds, yen and U.S. and Australian dollars. The lender’s Fosse Master Issuer’s $700 million portion with an average life of 5 years was priced at 150 basis points above the London interbank offered rate, or Libor, according to Bloomberg data.
That was in line with marketing guidance from underwriters and compares with a spread of 155 basis points on $1.25 billion of bonds with a similar expected duration sold in April by the lender from its Holmes program.
The transaction “shows that it is possible to sell a deal without one particular anchor investor,” said Patrick Janssen, a fund manager at M&G Investments in London, which manages 20 billion euros of asset-backed securities. Top-rated “U.K and Dutch RMBS are perceived as a safe haven with a yield pickup so the investor base is growing.”
Bob Paterson, head of asset-backed securities syndication at Lloyds, said the market has been “rather stable in terms of performance and pricing. With strong structural support and sound asset quality we don’t anticipate this changing.”
To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net; Esteban Duarte in Madrid at eduarterubia@bloomberg.net To contact the editors responsible for this story: Rob Urban at robprag@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net: Paul Armstrong at o parmstrong10@bloomberg.net
I WAS traveling last week on my book tour and landed at the John Wayne Airport in Orange County, Calif. Because I am geographically challenged and probably need LoJack implanted under my skin, my publisher kindly provided a car to take me from the airport to the hotel. The car wasn’t there.
I called the car service. The dispatcher said: “Go outside the terminal to the curb. Your driver is there.” I went to the curb. Still no driver. After 10 minutes I called back, and the dispatcher said, “I talked to the driver, he’s circling the airport.”
I said: “This airport is really small. That’s not possible.”
A few minutes later, the dispatcher called me to say that the driver had locked his keys in the car. He would be there shortly. I took a cab.
I mention this because of the loss of at least $2 billion — maybe even $3 billion — at JPMorgan Chase. I mention this because of the question it raises: what is your job?
If you’re a driver, don’t lose your car keys seems fairly basic. If you’re a banker, don’t lose my money.
When I was young, in the early 1970s, my college crowd disdained the students at business school. We didn’t trust them. Life was not about money. It was about justice: ending the war, civil rights, women’s liberation, mattresses on the floor covered in Indian cloth bedspreads.
Then the ’80s came. Everyone fell in love with money. Everyone wanted it, lots of it, and not just because we were getting older and realized we might need it for retirement, but because of what it would buy: bigger cars, bigger houses, summer houses, clothes stamped “Gucci” in gold letters. We started to admire anyone who made money. People like JPMorgan’s chief executive, Jamie Dimon. Like Ina Drew, JPMorgan’s former chief investment officer.
Ms. Drew, blamed for the loss, resigned. She earned roughly $14 million last year while Chase currently pays depositors as little as .01 percent on a savings account and charges as much as $35 a month for checking. She earned $14 million, and she didn’t know what her job was: Don’t lose our money.
Of course that was not really her job. Ms. Drew’s job was to make as much money as she could for the bank, which, under the guidance of Mr. Dimon, would pass on as little as possible to its depositors. Depending on which news report you read or see, Mr. Dimon is either “cocky” or “arrogant.” He said on “Meet the Press”: “We made a terrible, egregious mistake. There’s almost no excuse for it.” Almost? I love that. I really do. There is no excuse for it, Mr. Dimon. Don’t you know what your job is? Don’t lose our money.
Another recently ousted JPMorgan employee, Bruno Iksil, was nicknamed the London Whale. Why did a reckless banker get a nickname long before he got the ax? Doesn’t anyone there know what his job is?
We were smart back in the ’60s and ’70s. We were young and often stoned, but we were right about those people in business school.
When I was returning to the airport to fly home, waiting for the car to pick me up at the hotel, I got a call from the driver saying that she was going to be five minutes late. I didn’t believe her. Why would I? There had been nothing but lies before. So I took the airport shuttle. At least I had an alternative.
JPMorgan’s oversight of risk in its chief investment office has become a key issue as U.S. authorities examine the incident. Photographer: Peter Foley/Bloomberg
By Lisa Abramowicz on May 20, 2012
Irvin Goldman, who oversaw risks in the JPMorgan Chase & Co. (JPM) (JPM) unit that suffered more than $2 billion in trading losses, was fired by another Wall Street firm in 2007 for money-losing bets that prompted a regulatory probe, three people with direct knowledge of the matter said.
JPMorgan appointed Goldman in February this year as the top risk official in its chief investment office while the unit was managing trades that later spiraled into what Chief Executive Officer Jamie Dimon called “egregious,” self-inflicted mistakes. The bank knew when it picked Goldman that his earlier work at Cantor Fitzgerald LP led to regulatory sanctions against Cantor, according to a person briefed on the situation.
JPMorgan’s oversight of risk in its chief investment office has become a key issue as U.S. authorities examine the incident and lawmakers debate how to prevent banks from making wagers that might endanger depositors. Goldman was given the risk- oversight job after his brother-in-law, Barry Zubrow, 59, stepped down in January as JPMorgan’s top risk official, according to a person briefed on the matter. Less than a week after the loss became public, the bank stripped Goldman of those duties, appointing Chetan Bhargiri to succeed him.
The Cantor case culminated in 2010 when the enforcement arm of NYSE Arca Inc. fined Cantor $250,000 after finding it failed to supervise Goldman, 51, who was buying and selling the same stocks in personal accounts that he traded in a proprietary account at the New York-based brokerage. His stock investments, one of which plunged in December of 2006, presented a conflict of interest that could have affected his investment decisions, NYSE Arca found, according to a settlement document on its website.
No Admission
Cantor settled the case without admitting or denying wrongdoing. The NYSE document identified Goldman only by his former title as CEO of debt capital markets, and Goldman wasn’t directly accused by the watchdog of misconduct. People with knowledge of his dismissal spoke on condition of anonymity because the reasons for his departure were private.
Kristin Lemkau, a spokeswoman for JPMorgan, declined to comment on Goldman’s actions at Cantor. He didn’t immediately respond to messages seeking comment.
To contact the reporter on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net
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