JPMorgan: What's the Fuss?


Watching the media frenzy around JPMorgan, one is reminded how much of life is an illusion, a running cognitive deficit we all share and contribute to in our own way.  Politicians such as Senator Carl Levin (D-MI) solemnly proclaim the need for more regulation.  But never once does this deficit spending liberal from America’s rust belt ever admit that the destructive fiscal behavior of Washington ultimately sets the example for Wall Street. 


“What they're saying now is that the hedging by JP Morgan, if that's what it was, was okay, but the execution was poor,” notes one long-time Washington observer of the banking industry.  “If this crisis were ever going to wind down, which it isn't, there would have to be accountability for failure.  Even in the Freddie case, when Freddie said, look, we made more money than we thought, it didn't wash.  And BTW, Bandit at Citigroup is the Dr. Stragelove of banking.  This is obvious.”


The same Washington sage continues, reflecting the conventional wisdom: “The problem with the Volcker rule is that there should be no exceptions.  If someone wants to run a hedge fund, and someone in CT will give them the money, they should do it.”


Unfortunately what JP Morgan was doing is precisely how the bank makes more than half of its annual profit.  The creation, trading and arbitrage of risk exposures is a big business for JPM and one that the bank has done well – albeit from the position of market monopoly in OTC derivatives.  When the bank admits to a $2-4 billion loss, how big was the notional amount?  Three digits. 


One financial markets professional who operates under the moniker Nom de Plumber puts the situation in perspective:


“The CIO has earned tremendous net profits over the past several years, despite this $2BLN loss.  How?   The core business of JPM is taking calculated risks.   Shareholders and regulators would be irrational to expect gains without also accepting inevitably occasional, albeit sizeable, losses.”


But going back to the point about cognitive dissonance in the media and political realms a la our brother Barry Ritholtz, the fact is that neither Paul Volkcer, nor regulators nor the Big Media seems to understand that the activities of the CIO at JPMorgan was pretty much SOP at the bank for years.  What JPM wants you to believe is an isolated error was and is in fact the single largest profit center in the bank.  Again Nom de Plumber


“The CIO is essentially a proprietary trading desk, funded with retail branch deposits.   Proprietary trading desks, like those at JPM, Merrill Lynch, Deutsche Bank, and even Lehman, actually generated substantial profits throughout the credit crisis.   By contrast, their presumably “safe” customer facilitation businesses, like home mortgage origination, CMBS lending, and ABS warehousing, generally suffered the critical---sometimes fatal---losses.   Examples include Bear Stearns, BofA, Countrywide, Citibank, WAMU, Wachovia, RBS, and Lehman.   (Fannie Mae, AIG, and Freddie Mac were in this camp, via their guarantee franchises.)     History, ironically, simply dispels the Volcker-rule bias against proprietary trading.”


While JPM spins this tale as a outlier and the media complies in this task perfectly, in fact this is really how a lot of the market generates profits.  Thus not only will implementation of the Volcker Rule have no impact on the risk taking and true risk exposures of the largest banks, but the reduction in liquidity in many markets in the short run may actually cause the next systemic crisis.  


The fact is that the vast expansion of the US money supply over the past three decades makes such financial alchemy necessary for the TBTF banks to generate even nominal profits.  In risk adjusted terms, all of the TBTF banks such as JPM have negative equity returns.  And the Fed keeps these zombies alive in order to preserve the Treasury’s ability to issue debt.  In that sense, nothing has changed in Washington since Abraham Lincoln created national banks to finance the Civil War.  Again the Washington sage:  


“You're close to unveiling how the cartel administered by FRBNY channels money to these chronically insolvent thieves. Corzine managed to get admitted to this club and was building a house of cards along the Hank Paulson model when he slipped up… This is why the crisis will continue to grow and never end.  These people are in charge, and they know it.  Henry Blodgett and others have touted Jamie Dimon as the ideal Secretary of the Treasury, and in a sense he is.  He would follow the tradition of Don Regan, Robert Rubin, and Hank Paulson, all of whom caused and sustain this destructive circumstance that has built derivatives exposure up to $14 trillion.”


That $14 trillion in exposure exists because the financial world cannot earn sufficient returns on all of those little green pieces of paper printed by the Fed by investing solely in the real economy.  That is why the real takeaway from the JPM disclosures is not that it was an aberration, but that this is the core business of Wall Street today.  So when you hear Joe Nocera, Paul Krugman and others waxing effusive about the need for regulation, beware.  Again Nom de Plumber:


“This JPM loss, whether $2BLN or even $5BLN, is modest in both absolute and relative terms, versus its overall profitability and capital base, and especially against the far greater losses at other institutions.  In practical current terms, the hit resembles a rounding error, not a stomach punch.    As either taxpayers or long-term JPM investors, we should be more grateful than sorry about the JPM CIO Ina Drew.   If only other institutions could also do so “poorly”………”