With a $2 to $3 billion trading loss and about $20 billion in market capitalization erased, there are really the only two likely conclusions facing JP Morgan CEO Jamie Dimon: at best, he’s incompetent; at worse, laws may have been broken.
True, so far, it is very difficult to know what really happened because JP Morgan – or more accurately, it’s CEO — is saying a lot, but disclosing very little. In fact, there appears to be a disinformation campaign designed to confuse and mislead regarding what really happened at the bank and how it happened. Nevertheless, cutting through that spin, what we do know raises very serious questions about the bank’s conduct and that of its vaunted and lionized CEO.
In summary: in early April the Wall Street Journal and Bloomberg reported specific facts about the bank’s high risk trading operation in London, which the CEO claims he didn’t learn until early May. But, the CEO had previously transformed the bank’s London operation (it’s Chief Investment Office or CIO) from low risk hedging to high risk derivatives betting. Confirming the concerns many have had, former traders from the bank’s proprietary trading business were moved into the CIO. While the new high risk CIO generated billions in profits, concerns about the risks were raised with senior officers including the CEO personally, who were told that the CIO was an “accident waiting to happen.”
Ignoring those many internal warnings and red flags apparently resulted in this big loss, but it also required JP Morgan and its CEO to ignore the prominently reported facts in early April. The timing couldn’t have been worse for JP Morgan. It’s annual meeting was only a month away and there were two very controversial shareholder proposals that the bank was dealing with: one was to approve CEO Dimon’s pay package and the other was a proposal to take away the Chairman of the Board position from him. The bank had been soliciting major shareholders and campaigning for months to make sure it won the first proposal and beat back the second.
Conveniently, the $2-$3 billion May bombshell dropped by the CEO was merely two business days before the annual meeting, after almost all the ballots were cast and way too late for anyone to organize a response or even raise questions at the meeting. Like most annual meetings, the votes were in the bag; it was scripted, tightly controlled and went off without a hitch. But, imagine if Dimon said on April 13th what he finally said on May 10. Very difficult to believe that the annual meetings would have happened the same way and there’s a good case to be made that the shareholder proposals would have come out differently. Motive? Not a bad one.
So, the facts show that the public, regulators, shareholders, voters at the annual meeting and everyone else were mislead about critically important information that goes to the core issues of competence and integrity at the nation’s largest bank. None of the key issues or questions raised by all of this have been addressed by the bank and remain unanswered.
Inaccurate Dimon Statements in April Reveled as True in May Cost $20 Billion Market Cap Loss
Here are some of the facts that are known:
- In early April, the Wall Street Journal and Bloomberg reported detailed information about JP Morgan’s London trading operation (it’s Chief Investment Office or CIO), that it was making massive, high risk bets in illiquid derivatives, and it included the name of the trader, some information on the types of trades (i.e., credit default swaps or CDS), and how the trades were so big that they were causing a multi-trillion dollar index to move;
- On an April 13th teleconference announcing JP Morgan’s first quarter earning (as of March 31), JP Morgan’s CFO and CEO Dimon were asked about these press reports and they both dismissed them as being baseless; Dimon personally went so far as to say it was “a complete tempest in a teapot”; such definitive statements from a very high profile CEO known for his attention to detail and risk management is given tremendous weight in the markets;
- On May 10, CEO Jamie Dimon disclosed, in substance, that the media reports of early April were right, that the bank’s London operations had in fact entered into very high risk bets in illiquid securities and that, thus far, those bets had lost more than $2 billion, but that the losses could increase by another billion; Mr. Dimon, in effect, disclosed that the teapot he dismissed a month earlier had blown up.
A key question is why did it take JP Morgan’s CEO and management team more than a month to find out what was going on inside its own bank when the Wall Street Journal and Bloomberg knew since early April? None of Mr. Dimon’s statements, including that they were too defensive, answers this question.
There are also lots of unanswered questions about this timing, including how helpful it was to JP Morgan and Dimon personally that none of the April information was confirmed until May 10th when the annual meeting was on May 15. Not only were the public, regulators, shareholders and the media mislead, but so was everyone who voted on the proposals presented for the annual meeting.
Here are some other facts that are known:
- More than 850 million shares of JP Morgan stock traded between Mr. Dimon’s statements on April 13 and his bombshell disclosure on May 10; it is reasonable to believe that those shares were traded in reliance on Mr. Dimon’s comforting statements that all was well on April 13;
- During this month, traders in the London CIO made matters worse by increasing their bets, thereby increasing the losses;
- About $20 billion in market capitalization has been lost since Mr. Dimon’s disclosures on May 10.
If, as he claims, Mr. Dimon had no idea on April 13 what he disclosed on May 10, then it is very difficult to draw any other conclusion than there is significant incompetence at this bank. There were particularized, prominent, public reports that detailed what was going on in the London operation. Where was risk, operational, legal and financial management? What did they think was happening in London and how did they get the false comfort that they claim they had?
This undoubtedly is one reason the stock has dropped so much in value. It’s not just due to the $2-$3 billion loss. It’s that people rightfully are questioning the capability of management generally and risk management in particular. After all, if this huge surprise could be sitting literally under the nose of the CEO and he didn’t’ know it, what else is percolating unseen in other parts of the vast bank which has $2.3 trillion in assets and more than 270,000 employees?
Contrary to many statements, JP Morgan’s multi-billion dollar loss doesn’t just raise concerns about other allegedly less well managed banks (although it certainly does that). This raises very real concerns about other loss surprises at JP Morgan.
Dimon Transforms Conservative Hedging Operations into a Trading Profit Center
It has been reported that CEO Dimon personally directed the transformation of this conservative bank operation from a low risk hedging operation focused largely on liquid securities into a derivatives trading profit center. This transformation, it’s reported, caused an exodus of the traders who specialized in hedging “in more-liquid markets where risk was easier to measure” and an influx of, you guessed it, traders skilled in proprietary trading: “the CIO… housed a lot of former traders from the bank’s proprietary trading business, according to people who work there.” (“How JPMorgan Shock Hit the War on Volcker,” Financial Times, May 11, 2012)
This was reportedly something that Mr. Dimon not only directed and “nurtured,” but was deeply involved in:
“Dimon pushed [the CIO], which invests deposits the bank hasn’t loaned, to seek profit by speculating on higher-yielding assets such as credit derivatives, according to five former executives. The CEO suggested positions, a current executive said. Profits surged over the next five years as assets quadrupled to $356 billion and employees were given proprietary-trading accounts, current and former executives said.” (“Dimon Fortress Breached as Push from Hedging to Betting Blows Up,” Bloomberg, May 14, 2012)
The Bloomberg article reports that Mr. Dimon gave “traders the green light to make investments in riskier products” and that the head of the unit appointed by Mr. Dimon was “hedging for profits as opposed to hedging just to counter losses.”
This strategic change from hedging to betting proved to be very profitable: “The London team …book[ed] a profit of $5 billion in 2010 alone – more than a quarter of JP Morgan’s net income that year, one senior executive said.” There can be no doubt that such high income generation was well known by everyone at the bank and that it was an endorsed corporate strategy.
Dimon Ignored Red Flags and Warnings
But, that doesn’t mean that everyone agreed with it or didn’t raise serious questions. Indeed, it has been widely reported that other senior officers of JP Morgan were very concerned about the high risk betting going on in the CIO. In fact, “Staff from the bank’s investment banking arm privately told management – including chief executive Jamie Dimon – that the bank’s CIO was an ‘accident waiting to happen.’” (“JP Morgan’s $2bn loss was an ‘accident waiting to happen,’” The Telegraph, May 11, 2012) Also, “managers were also told of concerns about the quality of risk management in the unit.”
Put another way, as a May 15th front page article in the New York Times put it, “Red Flags Said to go Unheeded by Chase Bosses” about the “size and complexity of the bets” as early as 2007. Yet, “despite these concerns, the scope of the chief investment’s offices trades widened sharply following the acquisition of Washington Mutual.”
Stupid, Spinning or Lying about Hedging and the Ban on Proprietary Trading
JP Morgan, its CEO and all the other big Wall Street banks that have made tens of billions of dollars from proprietary trading have fought ceaselessly to kill, weaken or create loopholes to evade the key financial reform prohibiting proprietary trading, the so-called Volcker Rule.
They have claimed that trading for permitted activities of market making and/or hedging isn’t prop trading or that they nonetheless require them to proprietary trade, which therefore can’t be impermissible. In fact, at one point or another, they or their paid mouthpieces have claimed that virtually everything they do is either permissible non-prop trading or requires “permissible” proprietary trading, which is an oxymoron.
The latest claim is that the Volcker Rule allows “portfolio hedging,” which is yet another label the banks want to slap on an activity that is in fact no more than proprietary trading. The Volcker Rule does not allow it. This very issue was specifically discussed during the legislative process and the law was written to include that within the ban on prop trading, as the plain language of the statue makes clear:
‘‘(C) Risk-mitigating hedging activities in connection with and related to individual or aggregated positions, contracts, or other holdings of a banking entity that are designed to reduce the specific risks to the banking entity in connection with and related to such positions, contracts, or other holdings.” (Emphasis added)
“Portfolio hedging” is, by definition, not tied to “specific risks” or related to specific “positions, contracts or other holdings.”
Another claim that has come up in connection with the $2-3 billion loss is that hedging can still generate large profits and losses. If someone is generating large profits or losses and they claim to be hedging, then they are either grossly incompetent and should be fired or they are lying. Hedging by definition is not supposed to and should not generate large profits or losses.
Hedging means having an offsetting position such that gains in one position are offset by losses in another and vice versa. It is true that not all hedges are perfect, but that doesn’t mean that real hedging generates large profits and losses. Generating profits and losses requires taking positions with the banks money and that is exactly what the ban on prop trading prohibits. It is also why hedging is a permitted activity: by definition it cannot be a prop trade.
The latest Orwellian claim about what happened at the bank is that the trade “morphed” into something that wasn’t intended. It is as if it was some living organism that changes without the intervention of human beings. Of course, that is absurd. The trade did not “morph” into anything. Traders, with the review and approval of many others, place bets and changed them intentionally with for the purpose of making money. That is to say, they placed large prop trades in violation of the Volcker Rule.