A quick note on the disastrous news emanating from J.P. Morgan Chase, whose unflappable (well, unflappable until yesterday) CEO Jamie Dimon yesterday disclosed that the bank suffered $2 billion in trading losses this quarter.
Here’s the summation from the New York Times:
Jamie Dimon, the chief executive of JPMorgan, blamed "errors, sloppiness and bad judgment" for the loss, which stemmed from a hedging strategy that backfired.
The trading in that hedge roiled markets a month ago, when rumors started circulating of a JPMorgan trader in London whose bets were so big that he was nicknamed "the London Whale" and "Voldemort," after the Harry Potter villain.
I’m still not entirely clear on what the trades by Bruno Iksil, the so-called "London Whale," were exactly. According to the excellent Felix Salmon at Reuters, Iksil had taken a massive long position on corporate CDS, and when word of this leaked out, the market turned on him and beat his brains out. From Salmon’s piece:
Whenever a trader has a large and known position, the market is almost certain to move violently against that trader — and that seems to be exactly what happened here. On the conference call, when asked what he should have been watching more closely, Dimon said “trading losses — and newspapers”. It wasn’t a joke. Once your positions become public knowledge, the market will smell blood.
If you’re wondering why you should care if some idiot trader (who apparently has been making $100 million a year at Chase, a company that has been the recipient of at least $390 billion in emergency Fed loans) loses $2 billion for Jamie Dimon, here’s why: because J.P. Morgan Chase is a federally-insured depository institution that has been and will continue to be the recipient of massive amounts of public assistance. If the bank fails, someone will reach into your pocket to pay for the cleanup. So when they gamble like drunken sailors, it’s everyone’s problem.
Activity like this is exactly what the Volcker rule, which effectively banned risky proprietary trading by federally insured institutions, was designed to prevent. It will be argued that this trade was a technically a hedge, and therefore exempt from the Volcker rule. Not only does that explanation sound fishy to me (as Salmon notes, it's unclear just exactly how Iksil's trade could be a hedge), but it's sort of immaterial anyway: whether or not this bet technically violated the Volcker rule, it definitely violated the spirit of the law. Hedge or no hedge, we don’t want big, federally-insured, too-big-to-fail banks making giant nuclear-powered derivatives bets.
This incident is certain to reignite the debate about Dodd-Frank and may undermine the broad effort to roll back the bill, which we wrote about in the latest issue of the magazine. Staffers on the Hill started mobilizing the instant the Chase news hit the airwaves yesterday, and you can bet we'll hear more debate in the next few months about not only the Volcker Rule but the Lincoln Rule, which was designed to wall off risky swaps from the federally-insured side of these banks. I’ve heard from all sides today, with some thinking the Chase trade was Dodd-Frank compliant, and others saying it probably violated both the Volcker and the Lincoln rules.
Either way, the incident underscored the basic problem. If J.P. Morgan Chase wants to act like a crazed cowboy hedge fund and make wild exacta bets on the derivatives market, they should be welcome to do so. But they shouldn’t get to do it with cheap cash from the Fed’s discount window, and they shouldn’t get to do it with money from the federally-insured bank accounts of teachers, firemen and other such real people. It’s a simple concept: you either get to be a bank, or you get to be a casino. But you can’t be both. If we don’t have rules to enforce that concept, we ought to get some.
UPDATE: University of Maryland professor and former regulator Michael Greenberger, who worked with Brooksley Born at the CFTC in the Clinton years and was an early opponent of the Commodity Futures Modernization Act and the repeal of Glass-Steagall, wrote in yesterday with some observations on the Chase debacle. Michael was involved in the negotiations over the Volcker rule and understands the derivatives world better than anyone I know; I thought it might be useful to reprint his thoughts on this at length:
The JPM episode touches on all the major protections of D-F, which at the behest of Wall Street lobbying will not go into effect for months if not years and therefore did not apply to the JPM trades in question.
If the trades at issue were proprietary trading (as now appears to be the case), they would be banned by the Volcker Rule. Even if these trades were not proprietary, but, as they almost surely were, uncleared, they would have been banned by the Lincoln or push out rule. There is now a bi-partisan effort in the House to dump the Lincoln Rule.
If Dodd-Frank had been in effect, these trades would almost certainly have been required to be cleared and transparently executed. So they would have been priced by objective clearing operations on at least a weekly basis for purposes of collecting margin against the losing nature of the trades. As the trades lost value, margin would have been called for on a regular and systematic basis. (The losses would never have reached $ 2B without much earlier and corresponding regular calls for margin.) The losing nature of the trades would have been transparent to market observers and regulators for quite some time and the losses would not have piled up opaquely. It is almost certain that, at the very least, the Fed (not wanting to exacerbate its reputation for throwing taxpayer money at TBTF problems), would have backed JPM off these trades long ago.
Even if the trades were not required to be cleared, they still would have had to be reported to the public and to the regulators.
The bottom line is that this episode underscores the need either for a strong, loophole-free Volcker rule, or an outright return to the Glass-Steagall Act.