Well, there’s nothing like seeing Jamie Dimon swinging for the fences. Dimon has taken his defense and turned it into an offense, in both senses of the word.
In Senate testimony, Dimon revealed his idea of “portfolio hedging” to be even more egregious than the harshest critics thought. Dimon presented the job of the CIO to be to make modest amounts of money in good times and to make a lot of money when there’s a crisis. (That does not appear to be narrowly true, since in the last couple of years, during which there was no crisis, the CIO’s staff were among the best paid in the bank and produced significant profits for the bank. That is a bald faced admission that the CIO’s mandate had nothing to do with hedging. A hedge is a position taken to mitigate losses on an underlying exposure should they occur. Instead, Dimon has admitted that the mission of the CIO is to place bets on tail risks that are unrelated to JP Morgan’s exposures. A massive, systemically destructive strategy like the Magnetar trade would fit perfectly within the CIO’s mandate.
Needless to say, this definition is an inversion of not just what the Volcker rule was meant to stand for (limiting financial firm gambles with taxpayer money), it’s NewSpeak, or in this case, DimonSpeak: “a hedge is whatever I say it is, no more and no less.” Another bit of DimonSpeak was his specious response when he was arguing against the Volcker rule. The JP Morgan chief asserted that a customer loan could be construed to be a prop trade. Um, no, Volcker applies to trading books. The fact that he’d run a line like that shows how little he thinks of the intelligence of the Senate Banking Committee and the public generally.
We argued yesterday that Dimon was running a hedge fund in the CIO, and his testimony confirms that. As we wrote:
It’s likely that a significant portion of the CIO’s activities were an accounting gimmick. Let’s remember why it was located in Treasury: it is the chief “investment” office, because it is managing the “investment” portfolio. Banks hold liquidity buffers so that they can meet a bank run. They get special accounting treatment on these positions. While they can sell them at any time, like trading inventories, they are NOT marked to market. Instead, they are kept in an “available for sale” portfolio, which is treated on a hold to maturity basis. That, in really crude terms, means you don’t need to recognize losses until they look pretty certain (usually, credit related).
So what does that mean, in practical terms? It means the CIO is the perfect prop trading/income smoothing vehicle. You can realize gains whenever you want to, by selling (provided the position is in a reasonably liquid market) or possibly even moving it over into your trading portfolio and you can defer most losses. If it makes a turkey trade, it can bury it until the bank has other trading gains or income in other businesses to offset it. And it can keep profitable positions around and realize them as needed to smooth earnings (while the unrealized losses are reported in footnotes, most investors don’t seem to pay much attention to that item). Investors really like smooth earnings, they mistake them for stability and strength of the business, as opposed to adept profit management. No wonder the people in the CIO were so well paid. They’d have to be Dimon’s favorite people.
That’s of course, assuming that they can pull off making bets on tail risk. Nassim Nicholas Taleb took issue with that idea in a recent BBC interview and said that JP Morgan is taking 10 to 15 times the risk of a regular hedge fund:
And confirming Taleb, Dimon said the new VaR model that was implemented backtested well but didn’t work so well in practice because the past does not predict the future. Duh! But we’ve suggested, there were likely other motives for using the new VaR. It was clearly intended to allow the CIO (and probably other units) to take bigger risks and yet show no increase in VaR to supervisors.
Not surprisingly, Dimon was good at giving irrelevant responses. When Jeff Merkeley tried to pin the JP Morgan CEO on the hedge fund-like nature of the CIO, Dimon talked about the low-yielding/low risk nature of the underlying assets. That may be true, but what about the derivative positions taken on top of that? Dimon only described one part of the CIO’s operations. Similarly, Jon Tester went after MF Global, trying to argue that Dimon withheld customer monies and Dimon batted that back, saying he had waited for instructions from the trustee while omitting the fact that he was fighting tooth and nail in court.
Dimon also gave an apple pie and motherhood speech along the line of: We tell people to treat their customers like friends and family. If so, his model of family relations much be the Ptolemys, in which incest and murders were normal.
Dimon had to concede that Volcker Rule might have stopped this botched CIO trade. Remarkably, he argued regulators could not have caught this. Huh? This was an outsized position in an illiquid market. It would not have been all that hard to noticed something amiss if anyone had been watching. The size of a position relative to average trading volumes should be monitored for any meaningful positions.
Finally, at the top of the hearing, a handful of protestors started chanting “Stop foreclosures now” and were promptly escorted out of the chamber. I believe it was Jon Tester (whoops, it was Herb Kohl) who quoted a constituent homeowner who was having trouble getting responses from JP Morgan; Dimon told the senator to send the information to him and he’d look into it personally. One lucky borrower hardly solves for the problems all the rest are facing (I though Michael Bennett was going to make a similar ask but he veered off in another direction). Dimon ended with a vigorous ask for austerity in the US, aka Simpson Boles.
Ironically, Dimon’s throwaway comment to Merkley, that he’s already confessed to and takes full responsibility for the ‘small’ synthetic derivative portfolio’s mistakes, was never picked up by the other senators, and I’ll be surprised if the media appreciates the significance of that wee confession. Since Dimon has admitted in Congressional testimony that he was responsible for the internal control failures in the CIO portfolio SOX should now be a slam dunk for the SEC. But of course, that will never happen.
It was instructive to see how effective confident misrepresentation can be. Most of the Republican senators fawned over Dimon after the ritual scolding at the top of the hearings, and I suspect most of the media will simply replay his lines uncritically. There were a few that will work against him, like his reluctant admission that the Volcker rule might have prevented the failed London trade. But in general, reducing complex situations to soundbites allows for obfuscation and misdirection, which is exactly what Dimon and his ilk are keen to have happen.