“Questions swirl around the character and timing of Dimon's disclosures to shareholders. Given the widespread speculation about JPMorgan's potential losses, which proved to be accurate, it raises the question of why people outside of JPMorgan were more aware of JPMorgan's risk and potential losses than Jamie Dimon claims to have been. His public estimates of losses have been a fraction of reality, and it raises the issue of whether he has materially misled stockholders.”
“JPMorgan Raises Fraud Questions: Rising Trading Losses Top $5.8 Billion”
July 16, 2012
Coming out of the JPMorgan analyst meeting, two thoughts were top of mind. First and foremost, the surreal, “we’re in command” perspective that still governed at JPM despite the teapot tempest. Second, the face of Ken Langone, sitting in the front of the room as CEO Jamie Dimon and his traveling circus buried us in “facts” about JPM’s massive breakdown in internal systems and controls.
Langone, who we will always love because of his defiance of the hypocrite Elliott Spitzer and also his defense of Dick Grasso, looked like a worried baseball team owner fretting over his starting pitcher, i.e. Jamie Dimon. The JPM CEO is a prized asset in the view of many JPM shareholders, but let’s ask ourselves what kind of asset. Is Dimon really the hands on operator guiding JPM through a sea of risk, or rather the source of instability in the enterprise by tolerating the bank’s heavy dependence upon derivatives?
To say that Dimon typifies the corporate “cult of personality,” to steal the phrase from Living Color, is an understatement. As I noted in a discussion with Lauren Lyster on RTV, the officers and directors of public companies have no duty to shareholders under Delaware's medieval laws:
The numerous corporate and individual customers of JPM’s “fortress” balance sheet have also become the bank’s cheerleaders, openly mocking anyone who would suggest that the House of Morgan is anything less than invincible. This was very much the tenor of last week’s meeting, but it also made us think back to some recent history.
A risk trader we know as Nom de Plumber writes:
“Counterparties were asking why different parts of JPM were internally valuing the same CDS index differently, and then requesting inconsistent margin postings. If true, this would reinforce how VAR risk modeling was irrelevant to the controls breakdown, and how the CIO culture barring independent risk-management scrutiny enabled financial reporting and employee compensation on an unchallenged assertion of ‘one plus one equals three’. This internal-controls breakdown is most fundamental and simple, explaining the turnover of CIO senior risk managers, years before this London debacle.”
You see, if you accept the latest version of reality from JPM that the CIO losses were caused 1) during actions taken during 2012 and 2) that traders mismarked trades deliberately in an effort to evade JPM risk management, then the whole notion that VAR models are somehow relevant to this process is seen to be a tissue of lies. This raises the more interesting question, namely did JPM management know the risks they were taking? More, even if you accept the timeframe in the latest JPM investigation, the question still remains how this “trading” operation somehow escaped the notice of Dimon and his CSUITE. The CIO office contributed significantly to income over the years, so how does this profit center somehow fly below the radar screen?
You see, we keep coming fact that a number of “traders” who worked in the CIOs office were let go by JPM because, they were told, their activities were not consistent with the Volcker Rule. JPM personnel who were engaged in legitimate hedging activity were not fired, but the traders who were managing leveraged principal trading positions in the CIOs office were fired. The London Whale and his rogue hedge fund was left intact, so the story goes, because the counsel at JPM believed that the UK domicile of these principal trading activities somehow escaped the as-yet incomplete Volcker Rule.
So let’s work on another hypothesis, namely that Dimon knew entirely what was happening in the CIOs office and that a good bit of the profit from this small, heretofore unnoticed business unit came from principal trades. This is not such an unusual position for JPM nor is it uncommon for Dimon to literally bet the proverbial farm with the bank’s derivatives activities. In fact, Dimon has a history of rolling the dice and missing risks that beg the question as to why he had not been removed by the bank’s board (and regulators). Consider the failure of Bear Stearns & Co.
It is widely assumed that JPM acquired the crippled broker dealer in March 2008 because it was the clearing bank for and credit provider to Bear Stearns, and this is true. But the real reason, we have always believed, was that JPM had been aggressively selling credit default protection on Bear Stearns to its clients. When the broker-dealer started to fail, the discussions with JPM became intense. This intensity came not just because JPM holders were panicked, but also because JPM’s short book in CDS on Bear could have reportedly cost the bank tens of billions of dollars. Instead, by purchasing Bear, JPM kept all the fees from the CDS sales on Bear’s default – and all of the nasty legacy of the Bear Stearns RMBS business.
So the story goes, JPM bit the bullet and paid $10 per share for Bear Stearns and thereby avoided a default against the CDS position. Saving Bear was not about systemic risk or saving civilization, as then Fed President Tim Geithner has us believe, but a more basic desire to avoid an event of default for JPM. Bear management had leverage, in other words. That JPM was willing to write default protection on Bear Stearns in the weeks before the firm failed might be considered a bold, if not reckless gamble. But this assumes that the JPM CSUITE knew about the exposure and the open-ended risk in OTC products. And had Bear filed bankruptcy, JPM would have suffered a large CDS loss in such a scenario.
In the case of Bear Stearns and the CIO trading scandal, the senior management of JPM clearly should have known what was happening and who was taking the risk. And in both cases, it is unclear whether the JPM CSUITE even knew what risks were being taken. These decisions caused great financial and reputational loss to the bank. The willingness of Dimon to put JPM in the path of vast, potentially catastrophic risk is something that the bank’s customers and investors ought to consider. This is why, incidentally, I asked Dimon during the analyst meeting about his ability to risk manage these complex OTC derivative products. Had to get that on the record.
Far from being an isolated event that was limited to the CIO office, JPM’s behavior in the credit markets seems to be part of a deliberate culture of risk taking by Dimon and his lieutenants. One has to wonder, do the good citizens of the Wall Street establishment broadly defined understand the risks taken by the House of Morgan with their money? And does Dimon himself fully comprehend these risks? That is really the scary question.