Without even waiting a decent interval for mourning, JPMorgan Chase Chairman Jamie Dimon launched his defense campaign over the disclosure that he presided over a $2-billion trading loss in derivatives within days of the disclosure itself, choosing the comforting confines of NBC’s “Meet the Press” for the campaign kick-off.
Dimon’s theme was essentially as follows: “Hey, everybody makes mistakes -- sure, we lost $2 billion, but we’ve still got billions more, and we’ll figure out this one ourselves without the need for any further regulations, thank you.”
His argument is plainly designed to distract from the right way to think about JPM’s fiasco, which is that it’s exactly the sort of thing that regulations should forbid banks from doing, lest they destroy the financial system -- again.
Dimon certainly showed supreme skill in choosing his venue. In “Meet the Press” host David Gregory he had a questioner who is expert in the honored television tradition of taking interviewees at their own level of self-esteem. Also someone who is so clueless about how banks and investment markets work that he hasn’t got the slightest idea of what questions to ask, much less how to follow up on an answer.
Here, for example, is how Dimon answered Gregory’s question, “How did this happen?”
“First of all, there was one warning signal -- if you look back from today, there were other red flags. That particular red flag -- you know, we made a mistake, we got very defensive and people started justifying everything we did. You know, the benefit in life is to say, ‘Maybe you made a mistake, let’s dig deep.’ And the mistake had been brewing for a while, so it wasn’t just any one thing.” (The words are verbatim; punctuation is added.)
If you didn’t know anything about what happened at JPMorgan Chase before, now you know less.
For most of the interview Dimon allowed a pained smile to play on his lips, like someone who is suffering a mild case of indigestion but is confident that the Tagamet will soon take care of the discomfort. Dimon could pose as having been taken to the woodshed by the stern questioning of David Gregory. But this more resembled being taken to the woodshed for a cool, companionable drink.
Gregory didn’t press Dimon to explain how the blown-up trade fits in with the ongoing debate over the Volcker Rule, a federal proposal designed to forbid banks from making risky trades for their own books. Here’s the answer to that unasked question: It illustrates how Wall Street’s campaign to eviscerate the rule will allow exactly this sort of trade to happen.
There’s not that much mystery about the actual trade. Leaving aside the sophistication of the transactions themselves, JPMorgan’s trader, a London-based derivatives expert whose portfolio was so outsized he became known in the markets as the London Whale, essentially bet that corporate debt was becoming less risky as corporations were getting stronger -- in trading parlance, he was long corporate debt. But he did so in a way that even a tiny hiccup in the index he was trading could be exploited by rival traders. And that’s what happened.
Dimon continues to explain this trade away as a “hedge.” It may not have been anything of the kind. First of all, a hedge reduces risk: If one investment might lose a lot of money if markets move in one direction, you create a hedge that will make money under those circumstances so your losses are limited.
Yet JPMorgan already is massively long corporate debt as a result of its normal course of business, which is lending money to corporations. A “hedge” that replicates that same position isn’t a hedge at all. There’s evidence that the department where the Whale worked was, in fact, replicating Morgan’s real-life business of lending to corporations, but using fancy derivatives to do so -- creating a “synthetic” bank, as traders would say, without actually lending to corporate customers as real banks do.
If that’s true, the question is why? To put it another way, if JPMorgan had $350 billion sitting around idle (the sum the Whale’s department appeared to have to play with), why not use it to do something that helps the economy -- such as, you know, lending it to businesses? Instead, JPMorgan used the money to buy chips to play in the derivatives casino, which doesn’t help the economy one bit.
Gregory didn’t ask Dimon that, so he didn’t get an answer.
If this was a hedge, it looks like a “portfolio” hedge -- that is, one not tied to any specific Morgan investment, but to a broader swath of it business. That’s something that drafters of the Volcker Rule such as Sen. Carl Levin have specifically hoped to eradicate. As Levin wrote in February to the SEC and other regulators drafting the Volcker rule, “banks could easily use portfolio-based hedging to mask proprietary trading” (which the rule is supposed to outlaw).
But Dimon and his fellow bankers are determined to save portfolio hedging. As Dimon specifically said in his 2010 chairman’s letter to Morgan Chase shareholders, “if there must be more rules,” they need to allow portfolio hedging.
The most important question about the trading fiasco that Gregory and Dimon danced away from involves how this affair demonstrates that risk-management models can always break down. That’s important to remember when bankers like Dimon portray such events as out-of-the-blue “mistakes” that will be guarded against in the future. The risk management expert Nassim Nicholas Taleb, author of the book “The Black Swan,” explained in 2008 that when 30 years of risk models tell you that a certain costly event is almost sure not to happen, that only means that you become so complacent that when it does happen, it destroys you utterly.
Dimon and Gregory conspired to convince Americans that this was just another “mistake.” Morgan will figure it out and move on. During the broadcast, which was taped Friday, Gregory asked Dimon: “If this happened to JPMorgan Chase, which really understands how to manage risk, what about all the other banks out there?”
Say what? The Whale affair shows that JPMorgan doesn’t understand how to manage risk. When you’re making multibillion-dollar bets using inherently volatile and unpredictable financial devices, nobody does -- JPMorgan’s own risk models showed that its exposure had suddenly doubled in a period of weeks prior to its disclosure, which means either that the risk models were hopelessly outclassed, or that risk models can’t ever be reliably accurate under all conditions. Either way, it leads to the conclusion that Dimon desperately tried to evade on “Meet the Press”: that the only way to make this sort of risk-taking safe for the financial system is to make it illegal in the first place.