Facts about JP Morgan

The banking unit of JPMorgan Chase alone made $12.4 billion last year. The holding company has over $2.26 trillion in assets and is the largest U.S. bank and 8th largest in the world. The holding company made $29.9 billion in operating income and just over $20 billion in net income for 2011.

So, this initial loss of $800M [TC: with more to come] represents approximately 4% of its total net profit for all of 2011, less than 2.7% of its operating income. Certainly it’s not a good thing. But the reported losses, in and of themselves, are not likely to have a dramatic impact on JPMorgan’s long-term financial stability.

Here is more, hat tip to Angus as well.  A $2 billion loss is about one percent of their equity and about 0.1% of their assets.

Addendum: Sober Look adds a good point.

Comments

So, what's your point?

isnt it obvious? any regulation is evil. duh!

That the initial chicken little reports are silly. No risk, no reward. Know risk, know reward.

The banks have work to do. The government also has work to do. For example, let's stop pretending we have riskless assets when they are highly risky behind the curtain.

There's nothing left to regulate. With the Fed/Treasury as ultimate buyer, seller, borrower and lender, regulatory capture is complete.

And these guys are supposed to be the smart ones. If one guy can lose 4% of profit, it only has to be scaled up a little bit by Wall Street standards to cause serious problems. All it would take to re-create systemic risk is several banks, with maybe a dozen traders each doing this kind of thing, plus some force-multipliers like CDS.

My money is on another serious financial crisis before 2020. Maybe not as bad as 2008, but major. And I bet JPMorgan will be bailed out. If I lose, I'll donate a nickel to George Mason U.

Always the contrarian, even when it's not clear why you bother.

JPMorgan, you haven't learnt anything, have you?

They've learned that they're To Big To Fail

"Past performance is no guide to future performance," as JPMorgan would say in their prospectus.

2 trillion in assets? Their money or clients?

You don't know what bank assets are? Loans, securities and derivatives.

Yes, it's all their assets. On the other side of their balance sheet are their liabilities, aka deposits.

For a bit of classic humor on this:
http://www.jumbojoke.com/how_banks_work.html

It's a good joke, but it's predicated on Lou Costello not understanding that balance sheets must balance. I'm surprised no one has programmed it into

Of course bank customers make money - interest on their savings and CD's which is guaranteed not to lose nominal value. Alternatively, people could take their savings and buy pork belly futures contracts.

Bank customers also get the economic benefit of borrowing from their own future income at competitive interest rates. Unless, of course, we would prefer that no one under the age of 60 could afford a house.

Now suppose you had half a million dollars and you wanted to earn interest comparable to that of banks. Well, you could lend $100,000 to ten people so they could buy houses. But then your ten new assets would be relatively illiquid. You'd have to service these loans.You'd bear all of the risk of default and rising interest rates. Unless you loaned money to people with uncorrelated credit risk, you would have poor diversification of your assets, aka idiosyncratic risk.

The risky part of banking is not a confusion about assets and liabilities. The risk is the component that isn't mentioned - shareholder equity - which is usually a small proportion of assets. Banks have unusually high leverage which is why they are subject to regulation and capital requirements.

Banking seems very easy until you actually have to do it yourself.

Why do they have high leverage?

I suspect it is because we keep the interest rates low and try to commoditize banking by pretending everyone has the same reliability so they can't compete on reputation. So, they have to lever up and chase yield.

They have high leverage because they are financed by deposits - aka short-term loans. A low general level of interest rates doesn't matter, because it's the spread between what they pay and what they collect that they care about.

Someone must not have noticed JPMorgan was downgraded today.

"We continue to view JPM's broad lines of businesses and its geographic diversification as positive factors...and we note that losses from the hedging strategy are unlikely to weaken the company's customer relationships or its core banking businesses." - Standard & Poor's added.

This is about as cheap as you're going to see JPM debt and equity for years. It could go a little lower on momentum, but generally this is a BUY rec. There are downside risks from broader market conditions, but if that happens your money isn't safe anywhere.

Willi, Fitch downgraded them, not S&P.

I'm aware of that. I'm putting the downgrade in its proper perspective given the opinions of another rating agency. I'm refuting the "Downgrade=Doom" implication.

Losses, gains, etc are beside the point. Moral of the story is a hedge is not a hedge when its clearly prop trading. My own 2c: The Fed should lend directly to Americans. Anybody with a brain can conservatively (aka little to no black swan risk) make money playing the yield curve. You don't need an MBA or a PhD in rocket science to borrow short and lend long. Another benefit: no bailouts because nobody's too big to fail.

You have absolutely no idea that it was "prop trading" since you have no idea what their other exposures are.

The only thing that's clear is that the spread moved (or failed to move) against them, and they closed out a losing position before they lost more. As Tyler Durden of ZeroHedge points out, if you have a loss from a hedge you should be booking a gain on the underlying. However, your hedge is still subject to basis risk, and it appears that is EXACTLY what happened here.

I'm not saying JPM or a rogue trader wasn't speculating. I'm just saying that there isn't smoking gun evidence that they were.

People are too quick to blame CDS or prop trading, but almost every knowledgeable analyst is saying that the product wasn't the problem here. If people want to ban CDS, then be prepared for across-the-board increases in default risk premiums.

Given what happened to AIG, shouldn't default risk premiums be much higher anyway?

AIG was a very different case. They were in the business of selling insurance and didn't gauge their own risk. The investors who relied on the protection of their wraps didn't conduct their due diligence to determine the loss of principle by AIG's default on the wrap. When AIG had a credit downgrade, they had to post more collateral on their CDS for CDO's. This put them in a liquidity crisis. JPM is not similarly situated; they have sufficient liquidity.

Default risk premiums are what the market says they are. In this case, though, the large position of JPM caused a price response. As spreads moved against them, they had to move to cover their positions. Their trades signaled their positions, and the hedge funds swooped in for arbitrage profits.

It's hard to know what really happened with all the noise being generated about this, but it appears that JPM lost because the spread over Treasuries on their initial position didn't fall as much as they believed or hoped. This is a classic case of basis risk - one for the textbooks.

I don't pretend to know 1% of what you know about the market, but it seems to me that if an AIG can happen once, it can happen again. And were they not part of "the market" who was saying what the prices should be, albeit a fool? If not this particular market, they sure played in a huge market somewhere.

Maybe JP Morgan wouldn't make that mistake... but how is the average taxpayer to know?

JPM is a regulated financial institution and a SIFI. It gets 24/7/365 coverage.

AIG fell into a regulatory gap:

http://www.npr.org/templates/text/s.php?sId=104979546&m=1

If an "average taxpayer" doesn't understand the risks, then the "average voter" won't have a clue how to vote to stop it. Other than getting a PHD in Finance, I don't know what to suggest to you. One way or another you're at the mercy of people who know more than you and who have more political influence than you.

When my private wealth clients get into these moods, it's very hard to explain. The best I can do is tell them that every time they fly, they put their lives into the hands of thousands of people of varying levels of competence, with varying motivations, in an environment full of risks and asymmetric information. It doesn't stop them from flying, and very few planes crash. So sit down, put on your seat belt, order a drink, and enjoy the in flight movie.

@Willits

Transparency is one strategy that makes such situations (e.g. flying) more trustworthy. A fair certainty that third parties are scrutinizing what you do, and will even more if you do it wrong, mitigates some of these risks.

Their is no doubt propitiatory information in airlines, but not to the extent that their whole competitive advantage is based on secrecy and obfuscation.

On a transparency metric, flying is completely different from JPM or AIG.

Flying isn't like investing? You don't say? I guess that's why they call it a metaphor. Thanks for stating the obvious.

It isn't the proprietary information that should concern airline passengers, but rather the idiosyncratic risks that even the airlines don't know about or can't perfectly control, e.g. weather, air traffic control, other airplanes, tired pilots, bird strikes, icing, turbulence, metal fatigue, manufacturing defects, maintenance, etc. Risk management can reduce but not eliminate these.

Banks aren't under any less third party scrutiny than airlines. And transparency would NOT have helped here; it was the identification of JPMs position by hedge funds that initiated the losses. More openness would have exposed them to more risk. Derivatives are zero sum instruments you know.

If you don't want them in derivatives, then how do they hedge risk? If you don't want them to take risk, then risk gets priced back into the underlying.

Metallgesellschaft lost a billion dollars in the early 90s from basis risk. They shorted 150 million barrels of oil over ten years at guaranteed prices. They hedged their exposure by going long in stacked futures and swaps. In 1993 the market was in contango and their roll yield was negative. With each margin call they became more illiquid. They had to cancel their contracts and close their derivatives at a loss. It happens.

If we no longer are going to trust structured finance, the market bears the risks and costs anyway. It's just spread out more. The reason we have banks and markets are for their risk sharing properties. There will be tail risk even when it's not baked in like the crisis. We can't view every big loss as a portent of the next financial meltdown any more than we view a Russian airline crash in Indonesia as a reason to halt all air travel for safety inspections.

Regulators will investigate, JPM will tighten risk management and internal controls, and we move on. The chapter on basis risk gets another case study.

Great, so AIG fell into a regulatory gap. Again, how are taxpayers supposed to know that? In the meantime other commenters here are arguing there should be no regulation to begin with.

So making net $20 billion off of $2.26 trillion in assets is:

20 billion / 2.26 trillion = 0.00884955752

0.8% return? That is worse than a grocery store. And less than inflation. Certainly $2.26 trillion can make better money somewhere else.

The real comparison is the $2 billion loss to the $12 billion profit from last year. That is either a 17% drop in profits (12 down 2 to 10, massive) or a 117% drop in profits (12 down 14 to -2, staggering). It doesn't matter what your assets are -- if you lose profits, you're not a viable company.

I'm pretty sure this will be reflected in their earnings per share and dividends.

Calculating an array of metrics for a one-time loss is pointless. And there is no question that JPM is a viable company. You're acting as though they are going to repeat this loss. The very fact that they realized this loss is because they closed out their position to prevent further losses. If they hedged, the initial position just lost its hedge though and is subject to risk.

My comment was in reference to Tyler's implication that a $2 billion loss is no big deal and that the figures in the quote are somehow supposed to be representative of past performance. We can react in two ways:

1) The figures are not representative and so are meaningless.
2) Assume the figures are representative of past performance and draw out implications.

I did the latter, and the implications are ridiculous. Therefore the quote is either meaningless or ridiculous.

OK, I agree with that.

I think I'm going to surrender attempting to add either signal or noise to all the noise on JPM. There are still so many unknowns, so much confidence in ignorance, and too many proud proclaimers of prognostication.

Usually return is calculated as a % of equity for banks and their equity was 130 billion in dec 2011
20 billion / 130 billion = = 0.0769230769

The discourse around this event is a demonstration of the tenuous ground a free society stands on. I would expect events like this to happen in a functioning system. When I manage to lose millions of my or my clients' dollars (and if I'm successfully trying to grow assets, eventually I should) I hope that nobody but us considers it any of their darn business.

I'm sorry, but this appeal to a free society overlooks a key feature of this JP Morgan Chase foolishness. If JP Morgan Chase wants me as taxpayer to insure their deposits, then I expect the bank to tolerate some oversight to make sure it is not squandering the money on speculative bets. If you want a really free society, then don't make taxpayers insure JP Morgan Chase accounts. If JP Morgan Chase wanted to be an investment firm instead of a bank, with no government insurance, nobody in this free society is preventing them. I just find it outrageous that they play this "heads I win, tails you lose" nonsense as if we were all six years old.

Exactly. There are plenty of ways to have a robust system that don't involve public insurance. The problem is that it's usually the people compaining about the banks who insist that we have to have it. I say get rid of it. If you say that I'm unrealistic and that we have to have it, that's fine. But, from my perspective, it sounds like a "Stop me before I kill again" argument.

With good reason. A lot of people lost huge portions of their productive lives to the Great Depression thanks to reckless banks.

That problem can and sometimes has been solved without resorting to taxpayer bailouts.

Oh really? Can you give me an example? Not the S&L crisis. Not the most recent wave of bailouts. The Great Depression had no bailouts.

Man, the damn thing that eats your comments when you're posting too much, even though you haven't posted in hours, really pisses me off. I'll try again.

Anyway, it is my understanding that for a period in the 19th century, banks belonged to trade associations that would issue alternate scrip when there was a run on a bank. But, at any rate, all of these scenarios are question begging. None of this would be an issue if there weren't regulatory limits against banks issuing currency. You might find that idea unsatisfactory, but the point remains that these issues aren't the result of an inherent instability in banking. They are the result of regulatory limits against banks issuing IOU's when, in a reasonable, free system, the worst that would happen would be small losses among subordinated bondholders.
In a system without that limit, and with private deposit insurance, insurers would have many obvious tools which could be applied to limit the possibility of systemic crises.

Oh come on. Banks were very unstable in the 1800s. And it wasn't long ago that the unregulated Long Term Capital Management almost singlehandedly created a new panic.

Taxpayers do not insure JPM deposits. JPM insures JPM deposits through premiums paid to the FDIC. Those deposits are not at risk because of this.

Banks take on substantial risks in normal operations, and these risks must be hedged. This can't be done with traditional assets and must be done with derivatives. Their IB functions are another earnings engine and don't put their CB functions at risk. This isn't about "oversight" or lack thereof. It's about a hedge the basis for which went in the opposite direction of the underlying. It happens.

As kebko says, the ONLY people who JPM has to apologize to are its own shareholders.

Unless you own more than 10,000 shares of JPM, your rant about "foolishness" is a foolish prayer to Glass-Steagall, the god of regulatory ignorance and obsolescence.

Is it valid to ask who underwrites FDIC?

Yes, it's foolish because there was no loss of depositor funds, they weren't using depositor funds, and JPM remains well capitalized. Capital is exactly the buffer this situation needed, not some stupid one-size-fits-all-banks-and-all-situations Volcker Rule.

Actually I think Parke is right here, there is an implicit, incestuous guarantee that they will be bailed out, quite apart from FDIC guarantees. He's describing the moral hazard issue, which is a real problem.

I know a lot of very smart people think TBTF is acceptable because larger banks are more stable, but this has always struck me as fallacious -- better to have a thousand banks competing with each other, each capable of failing and causing us a little pain, than a few big banks whose failure is a systemic risk.

@TallDave,

Parke specifically referred to JPM depositors three times (deposits, accounts, government insurance). Twice he specifically referred to taxpayers providing insurance on the depositors. He doesn't say or imply a single word about systemic risk unless the two concepts are hopelessly muddled in his mind. You don't need to come to his rescue with an argument about TBTF that I agree with. I don't support superjumbo banks per se.

I don't see any connection between any implicit government guarantees and this particular trade. It was either a hedge that went wrong (they do that sometimes) or a rogue trader who made a speculative bet (that happens too). In the former case, they closed their positions and took the loss. In the latter case, their internal routines and controls failed. The net result was painful and embarrassing, but hardly catastrophic.

I don't see JPM teetering on the brink of needing a capital or liquidity injection because of this. Do you?

Systemic risk, including TBTF, isn't solved by applying a single arbitrary risk regimen on the entire industry - it's caused by it.
So, here we are, picking up today's papers, and the lead story is, "Look! A single entity took an investment strategy that didn't pay off for them and had no net effect on the industry. This is evidence that we need to make stronger rules that push the entire industry into the same risk management paradigm."

Well, I'm not sure whether he means implicit or explicit insurance, but really in either case the moral hazard issue is real, though I'm not sure "more oversight" is necessarily the answer -- the corruption can work both ways.

Maybe I really just wanted to pound that particular drum again -- imho the reasons regulators and politicians loooooove TBTF are laziness and opportunities for rentseeking -- fewer companies are easier to manage and larger companies offer more lucrative revolving doors from regulator to regulated. Incentives matter!

I don't see them teetering on the edge, but when they lose a lot of money very fast I wonder just where the edge is. I don't see curiosity about this sort of thing is ipso facto bad or ignorant.

@Willitts

How much in advance had you seen AIG or Citibank teetering on the brink?

My point is that the total lack of transparency of the sector makes it impossible for outsiders to ever know where the cliff edge is.

Jesus, every time a hedge goes wrong from a divergent basis, chicken littles are going to scream "the sky is falling!"

JPM could not be more different than AIG. JPM has constant supervision, while AIG lived in a regulatory netherworld.

JPM lost on a hedge of CDS. AIG lost on CDS of CDOs and became illiquid from collateral calls.

2012 is not 2008.

No Volcker Rule was going to stop this from happening.

Call me Chicken Little. When LTCM exploded it was only because of direct intervention by the Fed that it unwound in an orderly manner. Moral hazard.

Yes, I know that JPM is not LTCM, but about every 3-5 years we get stories like this, and about every 20 years we get an S&L-style crisis. It's hard to tell one from the other.

" If JP Morgan Chase wants me as taxpayer to insure their deposits, then I expect the bank to tolerate..."

This is the great fiction.

"We" REQUIRE THEM TO "LET" US INSURE DEPOSITS. And by "We" I don't even mean me.

Now move the same logic to everything including medical services and you get the downward spiral.

So... you're saying what? It's ok to put 1% of your equity at risk on a single trade? Oh wait, to put it at risk on a hedge trade where the anticipated upside would have been... what? The low millions? Maybe low tens of millions?

Or, if you want to go with the "merely" framing, the loss of not $800 million but two billion represents what, roughly 16% of the banking division's earnings ("alone!"), 10% of the company's net profit, and 6% of their operating income.

On a single trade.

A single hedge, no less. A hedge allegedly placed in compliance with the Volker rules expressly in mind.

Let's put it this way, Tyler, would you or any of the the men you cite have been so sanguine if it had instead been an EU, ECB, Freddy/Fanny, Fed, Treasure, etc. @#*&-up? I dunno. Maybe you would. I one other hand would think it was a stupid, reckless, irresponsible play if someone in government did it. Just like I think it was stupid, reckless, and irresponsible when a too-big-to-let-fail private firm did it.

figleaf

You've got no idea how big a position they were covering with that hedge. They were certainly protecting more than a few million dollars. It's a surprise to no one that a short position has unlimited losses, and liquidity can be a binding constraint before you can close your position on the upside of a solid bet.

Every small business in America puts 100% of their capital at risk every day. Many of them lose 100%, maybe not in a day but certainly within a brief time period, say 1-3 years. They can certainly lose 16% of earnings (or more) on a single deal gone bad. Their debt, sometimes insured by the federal government, is a loss to taxpayers.

There was a post on here not too long ago about a blackjack player who took a casino for a huge loss in one day at the table. The casino had all the odds in its favor, and it still lost. It happens.

When you evolve the ability to see into the future, maybe you could spare us your internet indignation over a busted deal that cost you...absolutely nothing...and spend your time instead buying and selling derivatives without risk. In the meantime, take your zero VaR complaints someplace else.

Evidently Jamie Dimon didn't know either.

Maybe, maybe not.

Even the perfect hedge is subject to basis risk, and Dimon can't predict that any better than anyone else.

A small lesson on basis risk. This is for commodities, but there is an analagous case for CDS spreads and spreads for the underlying:

http://m.youtube.com/watch?v=9Nd1sj_Y2Uo

I'm just saying that while, yes, the downside was very large the upside was probably considerably smaller.

Also, Mitt, if ever spend a little more time around small business people who are actually in business you'll notice we rarely put 100% of our capital at risk. And not to put too fine a point on it, but whereas yes, a lot of ill-prepared and occasionally downright unlucky people who start a business fail in 1-3 years, it's not much of a vote of confidence for Mr. Damon that you're comparing J.P. Morgan's success rate with theirs.

figleaf

I'm curious now, what proportion of assets did Corzine's company lose before they descended the Plank curve?

.1% does seem small, one would guess it would affect neither liquidity nor perception.

The loss itself is not a good reason for calling for bank regulation. You would expect a bank from time to time to suffer a loss.

The problem is: JP Morgan gets a large subsidy from the implicit guarantee of its debts through TBTF, this trade was moved to England to avoid American rules even though the ultimate risk came back on America, senior management has admitted that the trade was not properly understood and was poorly executed.

The two billion dollar loss does not prove JPM is incompetent. Senior management's comments about the loss ADMIT that they are incompetent and such people should not be backstopped by government guarantees.

What American rules did it violate? The Volcker Rule doesn't even go into effect until July, and this trade wouldn't have violated the Volcker Rule because it was a hedge. All the statements that it was "moved to England" for this purpose are pure noise. There are no government backstops for this and there won't need to be.

Here is a much more knowledgeable analysis of what happened and why the Volcker Rule is exactly the wrong medicine.

The issue here is NOT that JPM is Too Big to Fail. Systemic risk is not the problem.

The issue here is that their position in this trade was so large that it revealed their position to the market, and hedge funds exploited it. JPM is keeping mum on their exposures because revealing their existing positions would expose it to additional attacks and losses. Those losses wouldn't be large enough to sink JPM.

How exactly is JPM supposed to hedge their risks if they can't trade in derivatives? If they are transparent about their hedging instruments, they expose their positions. If you want them to stay away from CDS, then credit risk will be priced into instruments. Wider spreads will cost consumers, and small banks cannot hedge these risks.

Irrational fear about structured finance is going to cause its own crisis of confidence as spreads widen.

That link doesn't work.

Sorry. It seemed to work before. Thanks for looking.

For the original article I linked, google: Seeking Alpha JP Morgan Snafu Argues Against Tighter Volcker Rules by Tanya Azarchs

Found a better article to explain what happened from Felix Salmon, google: Seeking Alpha When Basis Trade Blows Up

Salmon raises the best of the informed criticisms of JPM: how did they get such a large short position of corporate bonds that they needed such a large hedge?

I still don't see how this is a TBTF problem. Big firms make big numbers. I still think people are suffering from Carl Sagan Syndrome, shocked by absolute rather than relative losses.

This is the financial media equivalent of Snooki Polizzi smashing up her car in Italy. It's meaningless to almost everyone and we're probably not going to learn anything from it, either.

Leaving aside the societal issues, I wouldn't be happy with this if I was a JPM shareholder. The employees are being paid more than enough to ensure the risk management of their business units is up to scratch. If senior management was pointing out CIO was a problem area to Dimon before this as press commentary suggests, why wasn't something this fixed? Somebody's head needs to roll.

"The holding company has over $2.26 trillion in assets and is the largest U.S. bank and 8th largest in the world."

That's not an especially comforting or illuminating line given it doesn't mention the company also has $2 trillion in liabilities.

Lehman had a lot of assets until one day they didn't.

Which leaves them with $260 billion in equity and a capital ratio around 11.5%.

This economist exhibits complete lack of understanding of tail risk like most economists which is why no one listens to them any more.

I always trust Marginal Revolution to place events in perspective as they unfold.

The credit snobs fear that capitalism just isn't for the rich

Credit Snobs II

And yet the stock market is almost back.

The market over-reacted despite the fact that the government has made sure that a business failure that happens to be in banking explodes into a threat to civilization.

The stock market is almost back after massive government intervention to keep the banks afloat.

(Although I believe JPM was not one of the problem banks in 2007-08.)

How is a negative return on the stock market over a three-and-a-half year period proof that the market over-reacted or that government assistance was not necessary to stem systemic risk?

In other news, I have flown on commercial airlines dozens of times and never experienced a plan crash. Clearly, all these safety protocols and standards for pilot training and aircraft maintenance are just an overreaction.

Willitts

I have enjoyed reading your comments here and agree with many of them. Even so, you make a couple of points that, in my opinion, are half-truths at best.

To say that JPM (and not the taxpayers) pays the cost of its' FDIC insurance ignores the fact that those premiums would be much higher if they reflected the true risks to the taxpayers. The larger implicit government guarantees to the financial industry and the history of government bailouts are the reasons why FDIC insurance can be priced so low.

No doubt it is true that a ban on CDS would result in an increase in across the board risk premiums. In my opinion that is a feature not a bug. It would force investors to make investments they truly believed in and fully researched. Investments SHOULD carry an appropriate risk premium. This is a big part of the reason why the 50 years before it became fashionable to hedge every investment saw much more systemic financial stability than the period after.

@Greg G

Those are well reasoned responses and, to a large extent I agree with you.

With respect to TBTF, although the Volcker Rule is not in effect the TBTF Rule of Dose-Frank is in effect. The implicit guarantee has been explicitly banned. You maybhave no faith in such proclamations, and I doubt them too, but if we are worshipping the god of regulation, a bailout of JPM is already off the table.

On that same point, what did the bailouts cost taxpayers? The FDIC absorbed the bank losses without taxpayer assistance. TARP was a loan, and all the SIFIs have paid it back with interest, unless I'm mistaken. The bailouts of the GSEs were the bailout of a government made problem. Same with FHA. So when we toss around "bailouts", we are equivocating about this particular case. It appears from the other comments that it is only the fear and possibility of a bailout of JPM that causes worry, and I'm not sure where they are going with it. Is it just whining or is there a policy they desire? Volcker Rule? I think it's well established that the Volcker Rule is not in effect and would not have prohibited this trade even if it were. After the investigation, maybe we will discover differently.

On bearing the risk, there is some wisdom in pricing risk into the market, but understand the loss in efficiency. High spreads are an indicator of inefficiency, risk and uncertainty. Market competition brings these down. Spreads will widen over risk free assets, but bid-ask spreads will also widen. This transfers risk and wealth precisely to the people you don't want to have it. Diffuse risk is not controlled risk. It also becomes opaque risk.

In this case, JPM took the risk and they got burned. But others here are suggesting the counterparties to these CDS should have kept their risk. The whole idea of insurance is to shift risk from relative risk averse people to risk lovers. Risk lovers, in this case, are more efficient hedgers of risk. But they can't eliminate ALL risk. This is the reason we have banks in the first place.

Dodd Frank banned prepayment penalties on mortgages, so now prepayment risk will be priced into fixed rate products. People who never intended to prepay their mortgage will have to pay for people who do.

The elimination of credit card fees means that everyone will have to pay higher rates or annual fees even if they never went over the limit or defaulted on other debt. This is not good burden shifting. It's putting other people's risks onto the responsible.

I'm not hostile to the counterarguments here and frankly I don't know all that happened with JPM. Maybe we can and should come up with smart regulation. I'm still a bit shocked about the size of JPM's position, not the hedge but the position they had to hedge. There's just a lot of fearmongering and hand wringing going on that bugs me. Dodd Frank has some good stuff in it, a lot of bad stuff, and stuff that will have unintended consequences.

The FDIC was created to protect banks from bank runs. You could do other things that would offer a large measure of protection to depositors, for example make the owners of banks, libel for depositor losses like Lloyd's of London or even that employees in decision making positions guilty fraud if they lose depositors money. We put Bernie Madoff in prison, but our law protects the the CEO's of financial institutions no matter reckless they invest the money entrusted to them for safe keeping.

We can save the discussion of the moral hazard of deposit insurance for another time.

As for your other statement, it's not true that bankers get away with it "no matter how reckless." Our laws protect EVERYONE with a presumption of innocence, and proving the difference between crime and incompetence is difficult.

There are and have been investigations, civil money penalties, removal orders, and jail sentences. Maybe we haven't hung them from the nearest tree to your satisfaction, but that is entirely OT.

How much did Dimon, Drew, Macris and Iksil lose when the value of their JPM equity and options went down? Answer: far more than they could have hoped to gain by this trade. When this is all over, it will probably cost them more.

We were talking about hedging vs. proprietary trading and the size and risk of these transctions.

Willitts

Again, I agree with most of what you say here but have more of a problem with what you leave out. And again, I feel you are being too easy on the banks. It's fine to say that the GSE's were a government made problem but they were a government made problem that, for many years, benefitted the banks and had the banks' support.

And it's fine to point out that TARP was paid back with interest but bailing out AIG and the GSE's was crucial to saving the banks. I would argue that QEI and II were also, although I realize that is a much more controversial claim.

As for resulting policy conclusions, my opinion is that we were better off before the law governing financial derivatives was "modernized."

If it appears like I'm defending banks, that's not the case. I defend the banking system because I believe it leads to a more efficient allocation of capital and provides risk diversification and risk sharing properties. When I jump into these frays, I'm beset on one side by the people who think fractional reserve banking is legalized fraud. On the other side I'm attacked by the statists who want government to micromanage financial services. I suppose it's dangerous to live in the middle ground.

I wasn't at all happy about TARP, QE, or any other bailout. I wasn't happy about the policies that led to the crisis. I did not and do not support the GSEs or the mortgage interest deduction.

But wherever you go, there you are. Taking the crisis as a given, bail outs were necessary to avert systemic collapse. I'm highly sympathetic to the "just desserts" or "market discipline" theory; unfortunately that doesn't work too well with banking. When the money supply begins to evaporate, the economy goes with it.

As for resulting policy conclusions, my opinion is that we were better off before the law governing financial derivatives was “modernized.”

Which law was that?

"Which law was that?"

Was thinking of the Commodities Futures Modernization Act of 2000. Anyway Willetts I do appreciate your efforts to "live in the middle ground" and that is one reason I find your comments a lot more interesting than most. Many on these sites are unconstrained by needing to worry about how their ideas would work out in the real world.

Thanks. I appreciate your comments. I think I vowed to someone else about 30 posts ago to leave the fray, but it was irresistible. :)

I understand your concerns about CFMA, but it was really a mess before that. The CEA, CFTC, FTPA, etc. and disputes between regulators caused a lot of problems. The JPM deal would have been exempt under laws prior to CFMA.

Sure, but this saga indicates the bank can have large bets (insert your preferred term here) go awry and suffer very large losses when nothing much is going on -- i.e. no big new precipitating event.

Sure, the Eurozone is in crisis, but it's been that way for years and nothing really unforeseen has happened. Sarkozy lost. Greece threw everybody out. We're squeezing Iran, and oil prices are going up. These weren't inevitable, but they weren't surprising either.

So what happens if there's a BIG event?

"A $2 billion loss is about one percent of their equity and about 0.1% of their assets."

There are two ways of interpreting the phrase "too big to fail."

Could we also conclude that with its $16 billion hole, Gov. Jerry Brown's California needs to be carved up, also?

Tyler is just getting paid. It is big business to play hack for speculators. They need people to keep the curtains hung. People might start to call b.s. on "hedging".

Koch Supply & Trading, LP
http://www2.isda.org/about-isda/

As Tyler will have noticed by now,

"Dimon said in a TV interview aired Sunday that he was "dead wrong" when he dismissed concerns about the bank's trading last month.

"We made a terrible, egregious mistake," Dimon said in an interview that was taped Friday and aired on NBC's "Meet the Press." "There's almost no excuse for it."

Dimon said he did not know the extent of the problem when he said in April that the concerns were a "tempest in a teapot."

Source: http://www.businessweek.com/ap/2012-05/D9UO50IO1.htm

Angus and Sober Look may dismiss the effects but it doesn't sound like Damon does. Also from the article it sounds like Ina Drew and Bruno (the London Whale) Iksil might be "spending more time with their families."

figleaf

In his recent column, Felix Salmon sheds both light and shadows on this event.

First, he informs us that JPM hedged against possible European debt default, and after the world didn't explode, they needed to unwind their position. Considering how much hand wringing there was over European default, this position seems reasonable.

The problem came with their exit strategy. They faced two sources of risk: liquidity risk and basis risk. First, their positions were so large, they began to move prices and soon became the market. This also revealed their position to the hedge funds. Basis risk was the result of not having a perfect hedge for their risk exposure.

Salmon is dead wrong about the rest of it. First, a firm like JPM is going to use Enterprise Risk Management, a centralized approach that takes a top down approach. If business units each managed their own risk, two units of the same firm could take opposite positions, also known as Stupidity Risk or Throwing Money Away which is worse than Risk. CIO was perfectly positioned for centralized risk governance. I'm quite sure Dimon knew what was going on, and his prior statements, though false, protected the firm from more attacks.

Salmon also says that JPM gambled with depositor funds. Wrong. When the cash is deposited with JPM, it becomes THEIR assets and it's their job to earn the most they can subject to risk and constraints. Cash is earning almost nothing, and negative net of inflation. Salmon says they should be lending. TO WHOM FOR WHAT? Loan demand is low and their are few profitable lending opportunities.

Morons like Elizabeth Warren want to reinstate Glass Steagall, not understanding that that regulation wouldn't have precluded these trades. Warren doesn't have 1/1000th of the knowledge of Ina Drew who took the blame for this. Warren never had the stones to make a tough financial decision. She knows less about finance than a sophomore Finance major at a state college. She was a speech pathology major as an undergrad, and worked in PERSONAL bankruptcy and finance after her JD. She made her career with credit card and mortgage debt as the biggest liabilities she's ever had to manage, and her objective was to get deadbeats out of debt for the unsound risks they took. She is a bailout queen.

Had the European debt crisis unfolded as many had feared, Ina Drew would be Time's Person of the Year in 2012.

Glass Steagall isn't about preventing trades. It's about preventing trades being made by organizations that are also responsible for depositor cash. Financial companies can take any positions they want, as long as it's with investor capital, instead of commercial banking capital. Utility banking companies have no business trading. Your deliberate misrepresentation of Glass Steagall betrays you as a lying insider.

Depositor cash is safe and sound. CB/IB combinations have been operating around the world without problems for decades.

Only one CB/IB even close to failure: Citigroup. All of the other massive bank failures had no investment banking business, and all the investment banks that went under has no commercial banking operations.

If anything, CB/IBs did better through the crisis than entities with only a single business line.

I'm very familiar with Glass Steagall, being an attorney in financial services for the past 16 years. It was antiquated nonsense written by barbarous ancestors who didn't understand modern finance. It was a knee jerk reaction to Depression Era hysteria. Ironically, the one good thing it did was establish the FDIC which creates precisely the moral hazard you are whining about.

Glass-Steagall was rolled out as part of the left wing narrative of how the crisis unfolded. It's a fanciful tale, told by an idiot. The repeal of the last remnants of Glass-Steagall was supported by both parties and signed into law by Bill Clinton. Grammy-Leach-Bliliey passed the Senate 90-8 and the House by 362-57.

Wachovia? Washington Mutual? No need to say more about CB/IB. You live in a fairy tale universe.

The FDIC prevents banking runs. If I think my bank will fail, I will run to the bank and withdraw my savings. Then other people will do the same. Then the bank becomes insolvent, and other institutions follow the same path. Banking runs can occur due to self-fulfilling expectations. That is what caused the Great Depression. That's why the FDIC is important. Once again, you live in a fairy tale universe where any regulation is a sin.

Hi Willitts,

You've put a lot of time into this thread. How is a neutral supposed to know if you are paid by JPM or not? PR campaigns aren't too expensive, especially in comparison to an unimportant $2 billion dollar loss.

Yeah, I knew that one was coming. Maybe you would "know" from the hundreds of other posts I've made in the past year that had absolutely nothing to do with JPM. Unless of course you believe Jamie Dimon put me here a year ago in anticipation of this horrible financial loss (that he planned) so I could produce JPM propaganda on this one economics website.

1. Plant mole in Tyler's website
2. ???
3. Profit!

http://delong.typepad.com/sdj/2012/05/fiction-about-jp-morgan-from-tyler-cowen.html

"The revelation that JPMC did not have control over its derivatives book--even though accompanied by promises of multiple firings and deep reforms--destroyed 1/7 of JPMCs franchise value. Current betting by informed sources is that Jamie Dimond has only a 50-50 chance of keeping his job"

"Morons like Elizabeth Warren want to reinstate Glass Steagall, not understanding that that regulation wouldn’t have precluded these trades."

As though this specific incident were the only reason for a new Glass Steagall regime. I enjoy how you spend your first 20 trillion words on this post deflating the precedent-setting importance of this colossal failure by JPMC, yet somehow the fact that an inchoate set of regulations may be inadequate to handle this specific fuck up is sufficient to reject any future regulations.

If people want to continue dumping money into the hands of managers that take their commission and will get paid whether they make money or lose shit-tons of it, I have no problem with that. I don't care when people take their pay-check down to the casino. Go for it.

It turns out that consequences of these dumbass games the Chosen Ones play are not limited merely to the people that give them arcade tokens. The purpose of a reconfigured Glass Steagall is to limit the damage that can be done by exotic financial instruments, unregulated derivatives trading, and irresponsible, insane leveraging. You'll notice that not only did the tax payers have to bail out these so-called geniuses, but our country still hasn't recovered from the chaos they caused.

If any policy lesson should be taken from this loss, it's not that magical regulations can be drafted that will forever keep people from losing money, it's that the markets are not to be relied upon. Social Security exists to make sure that people past the age of participation in the labor force have some measure of stability and comfort. For years now we've had to deal with a constant assault on the program driven by a bunch of salivating financial wizards that want to play in the casinos with that huge trust fund. If Democrats want to use this mess for political aims, set aside the regulations--they need to be supported on other grounds--and point out what happens to people who stake their retirement on Enron stock or generally believe that the market will provide security.

Wipe the drool from your face.

The financial sector is full of risks, and managing them isn't for the faint of heart. The financial crisis wasn't merely a series of gambles by 13 (or so) bankers. Thousands of banks all across the country dived into residential and commercial real estate. Millions of home buyers leveraged up for houses they couldn't afford without a thought toward their cyclical employment. Real estate agents, appraisers, lawyers, carpenters, electricians, etc all got involved in this fiasco. Norway and Finland and other sovereign wealth funds bought MBS churned out by government sponsored enterprises for more than 15 years. Other government sponsored enterprises called FHLBs loaned money to banks to fund asset growth.

Absolutely none of this leverage cycle would have been stopped, stalled, or slowed by an antiquated relic of Depression Era legislation that wasn't in any shape to regulate complex financial derivatives. The problem with people like you is that youbhold too much nostalgia for FDRs dictatorial powers. You long for the days when gold prices are set by the president at his breakfast. You can't fathom that it was government interference that fed the leverage cycle in housing.

Social security is another relic of that ancient era - a program that can't carry its own weight. What is the "trust fund?" It's an IOU to pay future SS recipients from future revenues, the very same revenues that are an IOU to pay future recipients. You have faith in a fiction within a fiction. What's worse is that you attach emotions to it. It's as if you're crying about a sad story told by a character in a story.

The lesson to be taken from this is the lesson you've been ignoring. This shit happens! Whenever you live in a world of uncertainty, bad things eventually happen. Financial managers, no matter how prudent, cant eliminate risk from the world. But the free market does a much better job than government tinkering can. People in government, frankly, are those whose talents, intellect, and courage never would have measured up in the real world. Neither Obama nor Warren could successfully manage a real business. They are empty suits with empty words for people with empty minds.

There was no "precedent" set by this. As I spent a trillion words saying that you didn't grasp, this was typical liquidity risk and basis risk, and that the trades had a firm reason for being: threat of a European meltdown.

Wipe the drool from your face.

The financial sector is full of risks, and managing them isn't for the faint of heart. The financial crisis wasn't merely a series of gambles by 13 (or so) bankers. Thousands of banks all across the country dived into residential and commercial real estate. Millions of home buyers leveraged up for houses they couldn't afford without a thought toward their cyclical employment. Real estate agents, appraisers, lawyers, carpenters, electricians, etc all got involved in this fiasco. Norway and Finland and other sovereign wealth funds and pension funds bought MBS churned out by government sponsored enterprises for more than 15 years. Other government sponsored enterprises called FHLBs loaned money to banks to fund asset growth.

Absolutely none of this leverage cycle would have been stopped, stalled, or slowed by an antiquated relic of Depression Era legislation that wasn't in any shape to regulate complex financial derivatives. The problem with people like you is that youbhold too much nostalgia for FDRs dictatorial powers. You long for the days when gold prices are set by the president at his breakfast. You can't fathom that it was government interference that fed the leverage cycle in housing.

Social security is another relic of that ancient era - a program that can't carry its own weight. What is the "trust fund?" It's an IOU to pay future SS recipients from future revenues, the very same revenues that are an IOU to pay future recipients. You have faith in a fiction within a fiction. What's worse is that you attach emotions to it. It's as if you're crying about a sad story told by a character in a story.

The lesson to be taken from this is the lesson you've been ignoring. This shit happens! Whenever you live in a world of uncertainty, bad things eventually happen. Financial managers, no matter how prudent, cant eliminate risk from the world. But the free market does a much better job than government tinkering can. People in government, frankly, are those whose talents, intellect, and courage never would have measured up in the real world. Neither Obama nor Warren could successfully manage a real business. They are empty suits with empty words for people with empty minds.

Thank you for reiterating your dumb claim: there is nothing to be learned from this EXCEPT that no regulations are useful.

Just a simple loss, but also proves that rules meant to limit actions in completely unrelated circumstances are totally wrong. Nice work.

You know nothing about finance. Setting limits on the ability of banks to hedge their positions is precisely what will cause liquidity crises. Deregulation occurred because the poorly crafted, one size fits all, obsolete laws were driving banks into the ground.

Yes, it was just a simple loss in a very uncertain time. If you spent more than a minute reading, you'd understand this position was built up because of the very real threat of a European debt crisis. You haven't got the slightest clue how risk management is conducted. Like Obama and Warren, you are long in criticism and short of knowledge.

I never said that no regulations are useful. Those are the voices in your head talking to you.

Yes, how could I be so silly. It was hedging, the desire to provide security, that caused the banks to leverage financial instruments based on sub-prime mortgages so many times that it required governments to cover their failed bets. Some risk management, indeed.

If it was security they wanted, there wouldn't be millions of dollars hinging on the ability of an unemployed single mother in LA's house payment. Such utter nonsense.

"Absolutely none of this leverage cycle would have been stopped, stalled, or slowed by an antiquated relic of Depression Era legislation that wasn’t in any shape to regulate complex financial derivatives."

That is stupid and false. It was the dismantling of specific regulations beginning in the 80's (and going through Clinton as well) that allowed the insanity to occur. Again, the issue is not about eliminating ALL risk, it's about containing the damage. The 2008 mess was massive because it wasn't contained. Stricter regulations concerning mortgage lending, for example, would have made a rather large difference in outcomes. The "ownership society" had to be pushed, though.

"Social security is another relic of that ancient era – a program that can’t carry its own weight. What is the “trust fund?” It’s an IOU to pay future SS recipients from future revenues, the very same revenues that are an IOU to pay future recipients. You have faith in a fiction within a fiction. What’s worse is that you attach emotions to it. It’s as if you’re crying about a sad story told by a character in a story."

This is stupider and falser. It betrays a basic lack of understanding of how SS is funded as it repeats the idiotic lie that it can't carry its own weight. Although it is nice that every hack has bought into this transparent nonsense about social security. It makes it really easy to spot the people that are totally full of shit.

But now we're back to the Galtian Overlords and their magical business managing skills. Yes, it's so, so difficult. It requires such agile genius. Truly, these are the greatest people in the world. We must caress them and tell them how wonderful they are, otherwise they will punish us with their foul moods and refuse to create jobs.

This sort of cock-slurping hero-worship is just embarrassing. Remember when Enron was run by the smartest people in the world?

You're too dumb to realize when someone is in agreement with you. The leverage cycle I was talking about is EXACTLY the "ownership society" of Bush and the National Home Ownership Strategy of Clinton. The 2008 crisis didn't start in 2008. It began in 1996.

No, social security cannot support its own weight. In case you missed it, last year SS taxes fell short of benefits paid. That will continue into the future and get worse. The system was not designed for population bubbles. Social security accounts are a work of fiction, and the trust fund is smoke and mirrors. The system is grossly underfunded. This is what happens with runaway benefits granted by Congress.

I am a retirement adviser by trade. I understand social security better than you ever will. I actually manage private wealth portfolios to meet retirement needs, so I think I understand how to balance assets and liabilities. And you are...what? Where do you get this tremendous knowledge of retirement finance?

I make my living FIXING what social security has broken. Most of my clients will get a negative rate of return on SS. It is a waste of their money and a hazard to their retirement needs. And while they have far more in retirement assets than the average Joe, by no means are they secure. They risk superannuation. They will have tax complications and unforeseen family needs. Meanwhile, tens of millions of Americans live with SS as their sole source of retirement funding, something the program specifically stated it should not become. People are making decisions based on false security and promises that will ultimately be empty. Millions more are going to find themselves in grossly underfunded public sector pensions. I hope they like cat food.

Again, regulations meant to deal with the source of the financial crisis are not rendered irrelevant by their inability to prevent poor management by JPMC.

"Social security accounts are a work of fiction, and the trust fund is smoke and mirrors."

No, they really aren't. There's a trust fund paid through payroll taxes. Money was borrowed from that fund. The money will be paid back by income taxes. It's a perfectly viable system, unless you anticipate the United States defaulting, which, you know, Republicans. Any shortfalls can easily be corrected, as they have been in the past, by altering the cap or other means. The shortfall over the next 75 years, for example, happens to be almost equivalent to the amount of taxes Bush cut on income over $250,000. There's an easy solution. It's also a one-time bump, not a scary curve like health care costs:

http://voices.washingtonpost.com/ezra-klein/2010/11/the_social_security_shortfall.html

The social security bullshit attacks are the most loathsome form of class warfare: the fund built by payroll taxes paid in higher proportion by blue collar workers as income above $110,000 is exempt, was looted to supply unfunded tax cuts that disproportionately benefited the wealthy. Rather than paying that money back in through federal income taxes, the most progressive tax scheme, the people who benefited from the looting of blue collar tax dollars now want to end the program. It's malicious and disgusting.

As for Social Security itself, it keeps 20 million Americans out of poverty.
http://www.cbpp.org/cms/index.cfm?fa=view&id=3260

But then we're back to the issue of what "security" means. SS is not a way to become wealthy, it's a way to make certain that we don't have a massive glut of unemployable elderly people whose savings accounts were wiped out because JPMC fucked up, or the company that every financial wizard was beating-off to turns out to be a massive fraud, living on the streets.

Just like Paul Ryan and his Medicare vouchers, the question is what you do with an old person who looses their money in the stock market. We just let them suffer? If your answer involves somehow making sure that our elderly population does not spend their last years in abject poverty and misery, pre-funding their retirement with money secure from the whims of the stock market is the most sane policy imaginable. It also turns out to work really, really well in practice.

You don't have the faintest idea what you're talking about, and quoting CBPP doesn't enhance your credibility.

Social Security revenues are absorbed by the federal government and expenditures are paid by the federal government. The surplus is SPENT every year, not just since the trust fund was established but every year.

Since the trust fund was established, the value of the surplus is covered with nonnegotiable, interest bearing bonds.

Those bonds are promises to pay back the so-called "trust fund" with future revenues. But those same future revenues are already committed to a future budget that is overbloated with social security obligations. The same source of funds, sparky, are repaying the bonds and paying social security obligations. It's an IOU paid with an IOU.

You can't magically make an unviable system viable by imagining that there is some other expenditure we can cut or some other source we can tax. That's not self sufficiency. The fund will be insolvent within twenty years.

The federal government will be bankrupted under all its promised obligations, and there won't be a bigger government to bail it out. SS will and already is creating poverty in retirement because people are dependent upon it rather than saving. The savings rate in our society is poor because people like you punish income earners and reward undeserved consumption.

God, such bullshit. The only problem with our budget moving forward is health care costs. That's it, that's all we have to deal with.

Social Security is fine. Again, the "IOU's" are no different from any other debt owed by our nation. Unless you think America will default or cease to exist, then there's nothing remotely frightening about the way the trust fund will be repaid. It's perfectly appropriate to borrow that money--of course, we should have used it for things other than unfunded tax cuts, unfunded wars, and unfunded prescription drug plans, but that's what happens when fiscally irresponsible Republicans are in charge.

As for moving forward, again, Social Security just does not have an impact on future budgets. It goes through a small bump in 2035 based on demographic shifts, a bump no larger than the revenue lost by cutting the top marginal tax rate by 3%. It levels out after that. It's not a budget concern moving forward no matter how much bullshit you try and spew. Medicare is an issue, social security is not.

The Trust Fund has $2.6 trillion of government bonds (the safest investment on planet Earth, by the way, notice the rates). Right now Social Security is using the interest on those bonds, as required by law when it needs more money than collected on taxes in a given year: it draws on bonds purchased with past SS taxes. It's self-financing.

This is exactly similar to you or anyone else cashing in bonds they purchased in the past. If SS sells bonds to pay for benefits, it does not affect the debt. Just adjusting, say, the exemption cap would allow SS to stop selling bonds and keep it going at full capacity for the rest of the century. This is just not a budgetary concern of any significance. Do NOTHING and it will pay out full benefits until 2035, then roughly 70-80% until the 2080's. Ooooo, scary.

Social Security may only be able to fund something like 85% of benefits several decades from now, though that 85% benefit level will still be more money in real dollars than what beneficiaries receive today.

Therefore, we must cut Social Security now to ensure that we will not have to maybe cut it in the future or raise the payroll tax cap.

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