Jamie Dimon, John Stumpf, and to a lesser extent, Vikram Pandit and Bryan Moynihan, are running massive hedge funds. They’re placing enormous, incredibly risky bets. “Hot money” investors are giving them the cash to gamble because they all understand that you and me will make good on any losses, since we’ve started guarantying the banks-turned-hedge-funds as “Too big to fail.”

The money flowing to these gamblers-in-chief is growing by double digit percentages, and includes so much borrowed money the “leverage” may be six times what Lehman Brothers was doing when it flamed out. As long as this situation continues, a new financial crisis is inevitable, and the risks of it grow faster every day. There’s only one solution: cut these gamblers off from public support. The market will do the rest.

We cut them off by reinstating Glass-Steagall, a depression era law that kept the bankers in check for decades, until their Clinton-era lobbying prowess repealed it. Senate Candidate Elizabeth Warren has a petition going to do just that. Please sign it.

“Deposits”, the Word that’s Hiding the Hedge Funds

The information on the bailed out bankers’ hedge funds I just summarized comes from this incredibly important Bloomberg interview of Amar Bhide. (H/T to Yves Smith at Naked Capitalism.) Bhide is a professor at Tufts University who knows a lot about the financial services industry, as the excerpts I discuss below make clear. In a little more than four minutes, Bhide detailed how and why JPM “is a systemically important, structurally defective bank. As are all the other megabanks.”

Crucially, Bhide debunks the bailed-out-banker PR spin that his Bloomberg TV interviewers parrot, and he schools them in other ways too. If enough people are clued in to what is really going on, we will break up the banks and restore Glass-Steagall. But there’s no chance of that so long as major media embraces the bankers’ key word for their hedge fund money: “deposits”.

Hedge Fund Money is the “Surplus Deposits”

The media keep talking about the money JPMorgan lost as “surplus deposits” or “excess deposits“. You know what deposits are, right? It’s your money at the bank, and mine. And the business’s down the street; even big businesses. It’s the cash we all give the banks for safe keeping.

But that’s not what Ina Drew was “investing.” She playing hedge fund, speculating with hot international money.

Here’s Bhide’s first attempt to get Media Guy and Media Gal (his Bloomberg interviewers) to understand:

There’s this amazing narrative I keep hearing. The investment office exists to quote unquote “invest surplus deposits.” It isn’t the case that the surplus deposits walk in through the door. JP Morgan goes out and solicits these deposits in hot markets in order to invest them, in order to speculate with them.

Later in the interview, Bhide twice has to revisit the point because the interviewers have bought into the imagery of the bankers’ word “deposits.”

Media Guy:

But let’s explore a little bit what the bank does. We’re taking in deposits, we’re in a deleveraging economy, loan growth is anemic, what do you do with these deposits?…

See his subconscious bias in action? “Taking in deposits.” That’s “what the bank does” all right, the retail bank branch. The Chase that you and I might use. But the hedge fund branch, the “Chief Investment Office”, doesn’t “take in deposits.”

Bhide responds:

I think you have the chain possibly a little bit off. The deposits aren’t deposits put into the bank by individuals or even commercial deposits. These aren’t IBM’s deposits. These are deposits that JPM proactively goes out and solicits from hot money markets. If it didn’t solicit these deposits it would not have them to invest with.

But Media Guy isn’t ready to listen yet. Watch how he recites some data and then pronounces bank talking points, including the taking in deposits line.

Media Guy:

Well, I don’t know, the data suggest a couple of things. On the first hand, on a one-year basis JPM’s deposits on hand has grown by 13%. Wells Fargo’s have increased 11%. Citigroup 5%, Bank of America 2%. All of these banks are fighting for the same deposits. Either JPMorgan is doing something uniquely well, or, people think it’s a safer bank and Wells Fargo is a safer bank to put their money with. That’s a choice.

See how his words still evoke you and me? Notice too the “fortress balance sheet” meme in “safer bank”. Media Gal piles on that one: “Or they think Jamie Dimon’s is the risk manager.”

Bhide tries again:

Again, the word deposits is so misleading. This is hot international money. Hot international money going wherever it sees too big to fail institutions, so they’re ‘depositing’ this money, more or less, with the US Government.

To recap: Jamie Dimon and his bailed out counterparts are soliciting money, money that is looking for a hedge fund to gamble with. Dimon’s sales pitch has two parts: 1) I won’t lose your money, because I’m the greatest risk manager ever was (very Barnum of him) and 2) I can’t lose your money, because I can stick my hand into Uncle Sam’s pocket if I really need to, as deep into his pocket as I want.

The Bankers Are Going All In With Our Money

The hundreds of billions in play right now are real money. But the numbers are system threatening when you consider the “leverage.” Just like we shouldn’t call the solicited hot international money “deposits”, we should say “cash advance to gamble with” instead of “leverage.” Because that’s what “leverage” is in the hot money, hedge fund context.

Bhide:

Leverage upon leverage. The ‘deposits’ are leveraged 10 to 1. And the investor gets quote unquote “invested” by the investment office for possibly another 10 to 1. Possibly 20 to 1. So the activities of the investment office are a levered fund, probably levered 200 to 1. Levered on the backs of guarantees by you and me. And this is an enormous threat to the public good.

Let’s be clear why: enormous bets can lose and that’s bad enough when we taxpayers stand behind them. But hugely levered bets not can not only lose, they increase the losses by an order of magnitude or two, and can bring a daisy chain of other institutions into play–the money was borrowed from somebody, right? And don’t kid yourself about how big the risks are that these funds are taking. As Bhide says:

What scares me is not the $2 billion that JPMorgan lost. It’s the record $19 billion profits that JP Morgan made. How on earth do they make a $19 billion profit quote unquote “putting customers first” in an economy that’s supposedly slowing down and their customers are flat on their backs?

By placing really big, highly leveraged, very risky bets. That’s how.

The Mythology of Risk Management

Bhide makes one other extremely important point: the idea that these bailed out bankers are managing their hedge funds’ risks is complete b.s.; it’s fundamentally an impossibility.

Here’s his first try to get Media Guy and Gal to understand:

[Dimon’s] managing an organization of over 200,000 people scattered all over the world. In dozens and dozens of businesses. This is not a …Berkshire Hathaway who is on top of the specific trades that he’s doing. How could he possibly know?

Media Gal: “It’s his job to know.”

Bhide: “Well it’s a job that no human being can do.”

But the obviousness of what Bhide’s saying doesn’t sink in, so later on he tries again.

Media Gal: “Do you think the risk managers understand the type of products these traders are trafficking in?”

Bhide:

Well it’s one thing to understand the type of product generically, it’s another to know every single trade. The people running these very large organizations who are taking these very large audacious risks ought to be on top of every single trade. I know successful hedge fund managers, they make a fortune, it’s a well made fortune.

Media Guy:

So you’re saying if the CEO…cannot have enough visibility into these individual positions and understand the risks they present there’s no way that his or her institution should even be dabbling in this stuff.

Bhide: “Absolutely. I mean I have nothing against these individual instruments per se…”

Media Gal: “So you’re saying the derivatives products, it’s not them. It’s the way they’re being managed?”

Bhide: “I’m saying they don’t belong in JPMorgan, they do not belong in a large commercial bank, period.”

Media Gal: “Then where do they belong?”

Bhide: “In a specialized hedge fund!”

So there it is. Jamie Dimon and his peers are running massive hedge funds that are getting more massive (remember, Dimon’s grew by 13% last year alone), taking enormous, highly leveraged risks they cannot manage, secure in the knowledge that the American taxpayer is guaranteeing their bets.

We are accelerating toward our next, and larger, financial crisis. Time to bring back Glass-Steagall. Sign the petition, please. And watch the Bloomberg interview of Amar Bhide. And pass them both on.

We’ve criticized the Schneiderman sell out, yet the PR push to position him as the True Hero of What Passes for the left continues apace, including some ham-handed efforts like the American Prospect’s “The Man the Banks Fear Most“.

Schneiderman today proved the skeptics to be correct (hat tip reader Peter). From a writeup in the New York Law Journal of a presentation Schneiderman made on white collar crime. It seems Schneiderman is in favor of it:

Noting his role as co-chair of President Barack Obama’s mortgage-fraud task force, he said that he was “very pro-Wall Street” and had represented some financial services firms in private practice.

He said that the majority of people working in the financial industry are honest, but added that the “ability to tell people that and not have people scoff has been damaged” by ongoing scandals.

This telling admission of the truth comes as polls in swing states show that ordinary citizens aren’t fooled about Obama’s sell out on the mortgage front and to big banks. From CFS:

….majorites of independent likely voters in three swing states (Nevada, Arizona, and North Carolina) and near-majorities in two others (Pennsylvania and Florida) say they disapproved of Barack Obama’s handling of the housing crisis, and majorities in each state say the Administration is not doing enough to police Wall Street banksi in the housing market.

Strong majorities of likely voters in each state polled – Nevada, Florida, Arizona, North Carolina, and Pennsylvania – also say the economic crisis was caused partly by criminal actions of Wall Street executives.

It is going to be instructive to see whether token gestures by the Administration on the financial front between now and the election will be enough to fool voters who have suffered serious economic setbacks.

Mysterious illness strikes hundreds of flight attendants, causes rashes and hair loss – are ‘toxic uniforms’ really to blame or is it Fukushima? Natural News (furzy mouse). The piece is a bit histrionic, but that does not mean this is not a possibility.

Ahead of I.P.O., G.M. to Quit Advertising on Facebook New York Times. What do you want to bet GM used the IPO (as well as the extant doubts about the ad model) to negotiate for better ad rates and Facebook refused to budge?

“France’s Hollande’s plane struck by lightning en route to Germany” Climateer Investing (Scott)

‘It’s a witch hunt’: Rebekah Brooks comes out fighting Telegraph (Anon)

Merkel and Hollande spell out Greek fear Financial Times. “We want to you to stay in the euro, and we still want to break you on the rack.” How inviting is that?

Weisbrot and Krugman are Wrong: Greece cannot pull off an Argentina Yanis Varoufakis

Italy’s banks shaken as economic slump deepens Ambrose Evans-Pritchard, Telegraph

Europe’s growth gulf MacroBusiness

ECB’s dilemma on the euro rescue Gene Frieda, Financial Times. This is important. The reason the Fed still maintains it could not have rescued Lehman was that Lehman didn’t have good enough collateral to pledge.

Greek President Told Banks Anxious as Deposits Pulled Bloomberg

Wenzou’s debt deflation MacroBusiness

Turkey’s Attack on Civilians Tied to U.S. Military Drone Wall Street Journal

Corn on MSNBC: Romney Takes a Lead in the Polls Mother Jones. Is this why the Feds are going after JPM with such uncharacteristic speed?

Republican Party suckles at the breast of Big Business Los Angeles Times

The Main Point Peter Dorman, Econospeak (Aquifer)

Standing up to Jamie Dimon: Is it SAFE? Jerry Epstein (Triple Crisis)

The dogma of ‘credibility’ endangers stability John Kay, Financial Times

Credit event of the year…(drumroll) FT Alphaville

U.S. Said to Start Probe of $2 Billion JPMorgan Loss Bloomberg. Why is the word “criminal” not in this headline?

F.B.I. Inquiry Adds to JPMorgan’s Woes New York Times

Flawed Dimon Eliot Spitzer, Slate (Jesse)

Obama has assets in JPMorgan accounts: White House Reuters (Joe Costello)

Hedging and Proprietary Trading Adam Levitin, Credit Slips

US bank CDS hit fresh 2012 highs Financial Times. So much for the US not being exposed to a Euromeltdown.

Needy States Use Housing Aid Cash to Plug Budgets New York Times. Dave Dayen wrote about this IIRC over two months ago.

Wells Fargo Has Blood on Its Hands: Desperate Man Commits Suicide After Shocking Foreclosure Mistreatment Alternet (furzy mouse)

Accidentally Released – and Incredibly Embarrassing – Documents Show How Goldman et al Engaged in ‘Naked Short Selling’ Matt Taibbi (Matt S). You have to read this. Pretty much proves the worst of what the public believes about Goldman.

* * *
D – 115 and counting. *

It would be irresponsible not to speculate. –Peggy Noonan

NATO Summit. Guides: from OccupyChicago (PDF) and Occupy Peace. Coverage and media: Mainstream wrap-up. TimCast (independent video streamer). Guardian live blog. Inflammatory headline watch: Chicago braces for violence at NATO summit

Participants: The NATO guest list is rawther long and includes every shade of left opinion — including OccupyChicago. And the ClownBloq (avec entartistes?). For unaffiliated out-of-towners, organizing bus travel fraught (true for Occupy DC also).

Legalities: NATO could be the first public test of H.R. 347 “restrictive zones” (a la Zucotti Park “frozen zone”).

Authorities: DHS leads NATO security through Secret Service and Federal Protective Services divisions, working with the CPD (12,500 strong). (What was “shocking” six months ago is normal now.) Northern Command Gen. Jacoby reminds the troops (3000) they may not “solicit prostitutes.” Philly PD sends 67 officers to assist. (Oh great. But shows independent streamers are important.) interestingly, Charlotte, too. (Historically, forces from multiple jurisdictions face chain-of-command and communications issues, risking violence.)

Police tactics: A field guide for NATO. Kettling is costly! CPD chief McCarthy will control deployments of tear gas, bean bags, etc. “We’re going to take people who are committing crimes out of those crowds.”

Gear: For NATO, $1 million. Including LRAD sound cannons. “This is simply a risk management tool.”

Venues: NATO Summit itself is in McCormick Place (map). Protest stage, sound system permitted near venue (map). “NATO summit visitors promise to continue Chicago’s record tourism numbers.”

Occupy. Polling data on Occupy. Note NY vs. Oakland. Citizen journalist arrested during OWS march fights city and wins.

Green Party. Stein, with 50% of delegates won, claims mantle of presumptive nominee, crowd sources VP. After appeal, PA Democrats allowed to seize $56,928 from Nader campaign after Nader’s 2004 candidate petition ruled invalid and court costs were levied against the campaign.

WI (swing state). DNC offers support in every form but money. Barret blasts Walker’s criminal defense fund, connected to a secret probe of his associates. Yeah, “known unknowns”, campaign fodder, poor choice of companions, yadda yadda yadda, but “felony child enticement”?! Also, “massive [human] waste violation”. Also, too, jobs. Not.

CO (Swing State). 47,000 active oil and gas wells in CO and 17 inspectors (hat tip MR).

IA (Swing State). Gov. Branstad insists he’s ‘way ahead’ of job creation goal; state data suggests otherwise (hat tip TTH).

Inside Baseball. Everybody’s building models: Ezra Klein; WaPo; Nate Silver. Americans Elect “failed to generate interest in possible campaigns from Sens. Joe Lieberman and Lamar Alexander.” Nobody could have predicted. Schadenfreude from Krugman, and a whole gallery of very serious people who were wrong. And why not nominate The One True Wanker of The Decade?

Ron Paul. Paul’s campaign chair: “premature” to discuss Romney endorsement. “The most passive-aggressive political maneuver in modern political history.” Paul backers fail to win OK convention. Paulistas en regalia.

Romney. Romney pivots to ZOMG! Teh Debt!!! in IA barnburner: “A prairie fire of debt is sweeping across Iowa and our nation, and every day we fail to act, that fire gets closer to the homes and children we love.” In unrelated incident, Romney Veeps audition on same theme at Pete Petersen’s Catfood Conference.

Obama. The First Family has between $500,001 and $1,000,000 in a “JP Morgan Chase Private Client Asset Management Checking Account.” Have they never heard of “Move Your Money”? Why not avoid the FBI taint? Obama campaign releases “blistering” anti-Romney Bain Capital ad while raising $2 million at fundraiser held by Tony James, President of Blackstone Group. On the very same day. Pierce comments: “The problem is that the president goes around the country undermining the strategy by cozying up to the people who are in the same business as Romney is.” Obama will win in November, Americans predict.

* 115 days ’til the Democratic National Convention ends with funeral baked meats on the floor of Bank of America Stadium, Charlotte, NC. Because 115 has an odd number of 1s in its binary representation, it is sometimes called an “odious number.”

READERS: Again, here are the swing states: AZ, CO, FL, IA, MI, NV, NH, NM, NC, OH, PA, VA and WI. I’m very interested in any local or state links you can send me from those states; original reporting, not wire services stuff. Now I have help with CO thanks to MR, and Iowa thanks to TTH but there are more!

* * *

Antidote du jour:

Krugman’s post didn’t merely contain some cringe-making fawning over Obama; it was egregiously incorrect on the development that prompted the post, that of the death of Americans Elect, a shadowy group that had was out to sponsor a Presidential candidate. It’s hard to believe that Krugman does not know the orientation and aims of this failed effort.

Tom Ferguson, a political scientist who is widely considered the top expert on money in American politics, called out Americans Elect in March as a group out promote a right-wing, anti-entitlement message as “centrist” (for the record, polls regularly show majority votes in favor of preserving Social Security and Medicare). He also deemed their effort to be dead on arrival:

Last year a group, Americans Elect, surfaced with a plan that strikingly resembled one of the schemes of 2008. The idea was for an independent presidential campaign with some characteristically twenty-first century features, notably a primary to be conducted over the internet probably late in the spring, 2012…

Americans Elect’s very expensive efforts to get on the ballot in all 50 states, though, sported some very traditional features. Though it staked out a rhetorical claim to the political center, it declined to reveal who was financing it. The few moneybags it acknowledged were hardly from the political center. Peter Ackerman, for example, who acknowledges helping to finance the start up, was formerly Director of Capital Markets at Drexel Burnham Lambert, the firm Michael Milken made famous. Together with a long record of involvement in various Republican foreign policy ventures, he has championed Social Security “reform” with organizations such as the Cato Institute. Though Americans Elect has somewhat broadened its board, Ackerman’s son Elliot is the outfit’s Chief Operating Officer. And in public the organization has focused overwhelmingly on one issue: the deficit, and the need to cut government spending.

That Bloomberg would be by far the group’s strongest candidate is no secret…With Bloomberg continuing to discourage speculation about an independent bid, talk recently turned to other candidates who might mount a campaign championing deficit reduction. David Walker, the former U.S. Comptroller General and past CEO of the Peter G. Peterson Foundation, the high aerie of deficit Superhawks, has been prominently mentioned. A recent press account had Walker holding a meeting to discuss Americans Elect with various tycoons and media moguls, including a News Corporation executive and Tina Brown.

A presidential campaign by Walker or anyone besides Bloomberg is basically a Mission Impossible.

Krugman instead, loudly, treats the centrist claims of the now-defunct Americans Elect as accurate:

And the center not only did not hold, it couldn’t seem to get any attention whatsoever. Americans Elect, a lavishly funded “centrist” group that was supposed to provide an alternative to traditional political parties, has been a ridiculous flop. Basically, about seven people were actually excited about the venture — all of them political pundits. Actual voters couldn’t care less…

So why Americans Elect? Because there exists in America a small class of professional centrists, whose stock in trade is denouncing the extremists in both parties and calling for a middle ground….

Americans Elect was created to appeal to this class of professional centrists — which meant that it was doomed to go nowhere.

And why does Krugman want us to believe this “centrist” organization was doomed? Not because it was a vehicle for deficit hawkery that would get traction only if Bloomberg took up its mission, but because all sensible real centrists will of course vote for Obama:

What went wrong? Well, there actually is a large constituency in America for a political leader who is willing to take responsible positions — to call for more investment in the nation’s education and infrastructure, to propose bringing down the long-run deficit through a combination of spending cuts and tax increases. And there is in fact a political leader ready and willing (maybe too willing) to play that role; his name is Barack Obama.

There is another sneaky bit in this. Notice Krugman’s endorsement of deficit reduction (at least in part) by spending cuts, rather than via increasing growth? And also keep in mind that when the private sector delevers, unless the country runs a trade surplus, the government sector has to run a deficit to accommodate the desire of households and businesses to save. Krugman hopefully knows better than this. So why is he now starting to talk what sounds like austerity lite?

The Dems are tying to put together a Grand Bargain once again. There is apparently a push to get a deal done before the election but the folks I consider credible don’t see that happening. There is a possibility that we hit the deficit ceiling pre-election, which each party is likely to use to scapegoat the other, but odds favor the Administration coming out the loser. So in addition to the usual Obama hagiography, Krugman is also seeding the idea that a deficit cutting deal would be a good move. It will be interesting to see what contortions Krugman goes through to rationalize unwarranted cuts in Social Security and the beginning of the dismantling of Medicare. Remember, had Obamacare addressed our real Medicare problem, that of escalating health care costs, we would not need to be talking about “reforming” it.

Krugman has taken some brave stands in the past, but this sort of shameless distortion of facts to make a case for Obama diminishes him, and won’t resonate with anyone other than Democrat loyalists. The sooner Krugman recognizes this fact and starts taking up more worthy causes, the better.

By Mark Ames, the author of Going Postal: Rage, Murder and Rebellion from Reagan’s Workplaces to Clinton’s Columbine. Cross posted from eXiled.

This article was first published in The Daily Banter

Last month, shareholders finally rebelled against Citigroup, the worst of the Too Big To Fail bailout disasters, by filing a lawsuit against outgoing chairman Dick Parsons and handful of executives for stuffing their pockets while running the bank into the ground.

Anyone familiar with Dick Parsons’ past could have told you his term as Citigroup’s chairman would end like this: Shareholder lawsuits, executive pay scandals, and corporate failure on a colossal scale. It’s the Dick Parsons Management Style. In each of the three companies Parsons was appointed to lead, they all failed spectacularly, and somehow Parsons and a handful of top executives always walked away from the yellow-tape crime scenes unscathed.

This past April, for his final act as Citigroup’s chairman, Dick Parsons made sure that Citi’s top executives were handsomely rewarded for their failures. He arranged a pay package for CEO Vikram Pandit amounting to $53 million despite the fact that Citi’s stock plummeted 44% last year, and has woefully underperformed other bank stocks even by their low standards. Citigroup, as you might recall, got the largest bailout of any banking institution, larger than BofA’s– $50 billion in direct funds, and over $300 billion more in “stopgap” federal guarantees on the worthless garbage in Citi’s “assets” portfolio. Those are just the most obvious bailouts Citi received—this doesn’t take into account the flood of free cash, the murky mortgage-backed securities buyback programs, the accounting rules changes that allowed banks like Citi to decide how much their assets “should be worth” as opposed to what they’re really worth on their beloved free-market, and so on…

So just as Dick Parsons stepped down as Citigroup chairman last month, shareholders finally rebelled, suing Parsons, CEO Pandit and a handful of executives for corporate plunder.

Again, with Parsons, it’s the same story every time: Three executive jobs, three disasters, each worse than the previous one.

Before Citigroup, Parsons headed AOL Time Warner, where he helped pull off what is widely considered the single worst business deal in corporate American history: a fraud-rife merger that wiped out $200 billion in shareholder value, ruined employees, retirees and investors, sparked numerous criminal investigations and dozens of lawsuits, and yet somehow managed to enrich a tiny handful of executives—including Dick Parsons—to the tune of hundreds of millions of dollars.

Why would the government agree to name the AOL Time Warner failure Dick Parsons, Chairman of Citigroup in January 2009, just as the world’s largest banking institution was taking the biggest bailout packages, and just as its legal ownership was taken over by the American public?

It’s a basic question that goes to the heart of Dick Parsons’ rise to the top. It’s a question that should have been put to AOL Time Warner when he was thrust to the top of that firm, considering the giant S&L failure Parsons oversaw before moving over to AOL Time Warner.

From the late 1980s through the mid-1990s, Parsons served as a top executive and then chairman of Dime Savings, the Northeast’s poster child for savings & loan criminal fraud. Dime was Parsons’ first executive job—and Dime turned out to be the New England region’s closest equivalent to Charles Keating’s Lincoln Savings, a giant criminal fraud mill with victims ranging from gullible low-income home buyers to entire regional economies laid waste to fraud-pumped housing bubble.

At least in the S&L crisis of the late 80s and early 90s, some people went to jail—and Dime’s affiliates in the New England states sent scores of fraudsters to prison. Those investigations led to Dime’s New York headquarters where Dick Parsons was, but for some strange reason, even with a federal judge openly demanding criminal charges for Dime’s senior executives, in the end, Parsons and the others got away with it.

Here, for example, is a 1994 article from the New York Times about what went on at Dime Savings under Parsons’ leadership. Notice the remarkable similarities in the mortgage scam described in the article to the mortgage scams pulled off in our time:

U.S. Fraud Inquiry Into Dime’s Mortgages

Federal officials are investigating the Dime Savings Bank for possible fraud in its home-mortgage business.

The inquiry, which is being directed by the United States Attorney’s office in Concord, N.H., is apparently seeking to determine whether Dime’s executives knew during the late 1980′s that documents were falsified to allow unqualified borrowers to get loans.

The investigators also apparently want to know whether those executives knowingly allowed such mortgages to be included in packages of loans that were sold to investors.

The loans in question are known as low-documentation loans. Unlike traditional mortgages, they were often approved on the spot, with little or no background check on an applicant’s qualifications, which were often questionable.

Sounds familiar, doesn’t it? What happened at Dime in the late 1980s—the predatory subprime loans hard-sold to the least sophisticated borrowers, loans with hidden adjustable rates which they called “low-verification” mortgage loans… the fraud in the documentation, preying on the least credit-worthy, least qualified borrowers in order to pump out as many bad subprime loans as fast as possible, dumping the losses on the government—what happened under Parsons’ watch in the late 1980s, only to be revealed in the early-mid 1990s, was repeated on a grand scale a decade later at banks like Citibank, resulting in massive payouts to a small group of executives, and devastation for everyone else.

Now that Parsons is finally stepping down as chairman, I want to briefly re-trace Dick Parsons’ career. His rise from a middle-class, frat-boy slacker, to suddenly find himself at the very pinnacle of American power and finance– offers us some insight into the culture and ideology of the ruling One Percent. To quote Starship Troopers: “To defeat The Bug, we must know The Bug.”

Why Dick Parsons? Why is failure so valuable? Why was Parsons so handsomely rewarded in perfect inverse proportion to the spectacular damage he caused to so many others? That is the big question.

Dick Parsons’ biography can be summed up in two phases of his life: before meeting Nelson Rockefeller, and after meeting Nelson Rockefeller.

Before meeting Nelson Rockefeller, Dick Parsons was a self confessed clown from a middle-class African-American family in Brooklyn. “Left to my own devices, I don’t feel any compulsion to strive,” he told to the New York Times. Race was never an issue with Parsons either: ”I don’t have any experience in my life where someone rejected me for race or any other reason.’

So Parsons dropped out of high school with a “C” average, earning a GED certificate. He enrolled in the University of Hawaii for reasons he could never really explain, joined a frat, and became their social chairman. As one of Parsons’ frat brohs recalled to journalist Nina Munk, “Here’s this guy who’s at the bar sixty-seven days in a row and, as you can imagine, he did very poorly in school.”

Parsons did worse than poorly: He flunked out of U. Hawaii. Without earning a degree.

And then slacker Dick Parsons met oligarch Nelson Rockefeller, and from here on out, Parsons lived out a Cinderella fairytale for the One Percenters. As luck would have it, Dick Parsons’ grandfather was once a favorite groundskeeper at the famous Rockefeller Compound in Pocantico Hills and lived in a hut on in the shadow of the oligarchs’ mansion. Soon, Dick Parsons and his wife would move into one of those same groundskeepers huts under Nelson Rockefeller’s patronage.

As Parsons later admitted, “The old-boy network lives…I didn’t grow up with any of the old boys. I didn’t go to school with any of the old boys. But by becoming a part of that Rockefeller entourage, that created for me a group of people who’ve looked out for me ever since.”

And so, magically, despite failing out of Hawaii without a degree, Dick Parsons was accepted into the Albany University Law School program. Nelson Rockefeller happened to be in Albany too at the time, serving as governor of the state of New York. Dick Parsons was chosen to be an intern for Rockefeller.

Whereas before, when Parsons didn’t study he failed out, now, after meeting Nelson Rockefeller, by some magical twist of fate, he was the law school’s valedictorian. Sandy Stevenson, a fellow law school classmate of Parsons’ who became a professor at Albany Law,recalled: “He didn’t study hard. He played a lot of bridge. He was so smart he didn’t have to study, and he was in the cafeteria playing bridge a lot.”

Parsons took the New York state bar exam, and scored the highest in the state, beating out all the high-achieving Ivy Leaguers that year. It may have been a complete coincidence, but Nelson Rockefeller’s right-hand man, Harry Albright, was in charge of both the law school internship program with the governor, and in charge of scoring the New York state bar exams.

By another coincidence in the 1980s, the same Harry Albright headed the Dime Savings thrift, and this same Harry Albright appointed Dick Parsons to replace him.

Parsons did something right at Dime Savings. Something wrong for everyone else, but something right for those who mattered. A handful of executives pulled off what looks remarkably like the sort of “control fraud” scheme described by Bill Black: Quickly saddle the thrift with enormous amounts of bad mortgage loans, inflate the assets, loot, cash out, and dump the problem on the public.

Parsons proved himself useful in that scam. He played wingman for Harry Albright as they loaded Dime up with bad mortgage loans in warp-speed time, practically doubling the asset base from less than $7 billion in early 1987 to over $12 billion in late 1988. At the same time, as reported in the New York Times, “Checks from thousands of homeowners stopped coming.”

With the asset base pumped up and ready to collapse, Albright cashed out and moved his lawyer, Dick Parsons into the CEO’s seat to cover his tracks.

Often times I hear non-One-Percenter Americans ask, “How do these people sleep at night?” Harry Albright answered that question to the New York Times: “I am entirely unapologetic.”

Promotions and appointments followed in rapid succession for Parsons for a job well done, his career advancement largely to helping hand of Nelson Rockefeller’s brother, Laurance Rockefeller: board positions at Fannie Mae, Citibank, and most importantly, Time Warner. Thanks to Laurance Rockefeller’s introduction, Steve Ross brought Parsons onto Time Warner’s board, paving the way for Parsons to replicate his “success” at Dime over at the new AOL Time Warner, and later again, to replicate his AOL Time Warner “success” at Citigroup.

After Parsons took over AOL Time Warner, the New York Times summed up his career trajectory:

In 1988, Mr. Parsons was recruited to serve as president of the Dime Bank by Harry W. Albright Jr., another former Rockefeller aide. A few years later, the Rockefeller hand intervened again: on the recommendation of Laurance Rockefeller to Steven Ross, Mr. Parsons was invited to join Time Warner’s board in 1991. He became president of the company in 1995.

Parsons knew where his bread was buttered, as captured with painful, barely-concealed patronizing racism in this New York Times profile from the early 1990s:

”I owe them,” Mr. Parsons said of the Rockefellers one evening as the Dime’s chauffeur took him to Pocantico Hills. ”I didn’t go to the right school. I wasn’t from the right side of the tracks. But when I was fortunate enough to hook up with Nelson Rockefeller, that’s how I developed my own network.”

And the feeling was mutual, in a vague, cold, One Percenter sort of way:

“My brother liked and admired and relied on him very much,” David Rockefeller said. “I’ve always had very warm feelings about him myself.”

In fact, all the One Percenters loved their Dick Parsons:

”He’s one of the few people in this industry that I would just as soon have a shake-hand deal with as a legal contract,” said Rupert Murdoch, chairman of News Corporation, who needed the Time Warner system to carry the Fox News Channel.

Michael Eisner of Disney, which battled with Time Warner for access, also praised Mr. Parsons: ”He handled himself in such a gentlemanly and reasonable way that he got the job done.”

Everyone else would disagree of course—as revealed in the dozens of lawsuits against Dick Parsons and his fellow execs at AOL Time Warner. But they don’t count—and besides, all those settlements and legal fees were covered by AOL Time Warner, meaning Parsons and the executives were able to plunder the company to pay for their previous plunder of the company. No skin off Parsons’ back, and no skin off of the backs of those whom he “owes.”

AOL TimeWarner stock during Parsons’ tenure: Oops, missed the entire bull market run!

It all reads like some half-baked hippie’s paranoid Bilderberg-obsession—and yet, Parsons’ failure up to the top, guided all the way by his “network” of oligarchs, is just the flat, unvarnished reality.

In 2007, as Citigroup director in charge of the compensation committee, it was Parsons who approved the obscene pay for outgoing CEO Chuck Prince. Parsons also played a key role in hiring current CEO Vikram Pandit, and in Citi’s awful decision to buy Pandit’s failing hedge fund, Old Lane, for $800 million in 2007—netting Pandit a cool $80 million. Shortly afterwards, Citi shut down Old Lane, collapsed, and turned to taxpayers for a $50 billion bailout and hundreds of billions more in guarantees and the like.

In November 2008, lifelong Republican Dick Parsons was brought into President-elect Obama’s transition team, thanks to then-Citigroup chairman Robert Rubin. There was talk that Parsons might be Obama’s Treasury Secretary; instead, in January 2009, he replaced Rubin as Citi’s chairman.

Almost immediately, Parsons went to work fighting executive compensation limits, and obstructing banking reforms and making sure that FDIC chief Sheila Bair was unable to do her job effectively. Using taxpayer dollars, Parsons hired one of the darkest operators in DC, lobbyist Richard Hohlt, to fight against the interests of the same taxpayers who had bailed Citi out and who now effectively owned the bank. Hohlt’s impressive resume includes his role in drafting the 1982 savings & loan deregulation bill that most agree made possible the S&L collapse possible—a bill that helped make Dick Parsons and his Dime Savings pals rich. Hohlt lobbied for the scandal-ridden Fannie Mae (where Parsons served as a board director), for Washington Mutual (which took over Dime Savings), for Time Warner… Hohlt even played a central role in the Valerie Plame scandal, serving as go-between in the leak between Karl Rove and Robert Novak.

When news first hit that Parsons had hired Hohlt, former banking regulator Bill Black commented: “It is singularly obscene that any recipient of taxpayer assistance through the TARP program during the current financial crisis would hire one of the most infamous lobbyists in the world to represent them.”

Naturally, Dick Parsons hired him to protect Citigroup—and it worked. Talk of breaking up “Too Big To Fail” Citigroup is pretty much over now. The perpetrators are safe. The shareholders are angry, as are Citi’s victims of fraud in the years since Parsons joined, as are the rest of us who didn’t profit from the plunder of Citigroup, and the plunder of the treasury to keep Citi going.

Today, Parsons is gone from Citigroup, but he’s not gone from our lives: He’s just been appointed as Gov. Andrew Cuomo’s “education czar” for education reform in the state of New York. Sorry kids.

All of this begs the question: What makes whacky conspiracy theorists any worse or any more deluded than the “Meritocracy Theorists” who’ve been promoting a fairy-tale version of America since Reagan’s Revolution, a fairy-tale version in which talent, hard work and innovation are supposedly rewarded, and failure is punished? It’s time to admit it once and for all: Failure is the whole point. Failure makes looting easier and quicker. In that sense, Dick Parsons has been rewarded for a job well done.

The game is rigged, and Dick Parsons’ rancid story gives some insight into how the rigging operates, and why failure is so valuable. What looks like failure to us, like losing our jobs and our future and our democracy—is success and riches to the One Percent who profit from this dystopian setup.

From the Real News Network (hat tip Aquifer):

Bhide takes issue with Dimon’s description of the funds that the Chief Investment Office (part of the bank’s treasury function) as “deposits” but rather as market funds. He also contends that no one can be running a major risk-taking trading operation along with a huge, sprawling international bank. A major trading operation requires that senior management be on top of position risks, and the organizational and operational demands of running a super big bank make that impossible. Finally, he argues that the risks JPM and other banks are taking are much greater than is commonly recognized, and JP Morgan’s profit level in the face of unfavorable conditions for financial firm is proof of unduly high risk levels.

Spider guitar dazzles with style and sound (w/ Video) PhysOrg (Chuck L)

Restoring sight with wireless implants Nature

Horrific Injuries Linked to BP Dispersant Corexit RSN (martha r)

Power to the professors: A bold, new way to fund research begins at U-Michigan PhysOrg (Chuck L)

The “other reportables” oil mystery FT Alphaville (Pilkington)

Greek deadlock heightens fears of full European economic crisis Washington Post

Will the Greek exit be voluntary or involuntary? Edward Harrison

On ABC Radio National, PM program: ‘Stupendously idiotic’ policies for Greece can’t work. Yanis Varoufakis

Contagion Fears Hit Markets Wall Street Journal

Faith fades in eurozone firewall Financial Times

Is China entering a debt deflation? MacroBusiness

World edges closer to deflationary slump as money contracts in China Ambrose Evans-Pritchard, Telegraph

China ‘raises Australia-US ties’ BBC

Obama’s Switch on Same-Sex Marriage Stirs Skepticism New York Times. I am sure Lambert will pick this up but this is a needed reality check on all the effusive praise.

FAILING UP WITH CITIGROUP’S DICK PARSONS Mark Ames, eXiled

LightSquared Files Bankruptcy After Network Blocked Bloomberg (scraping_by)

Police-Occupy Stand Off at the Gill Tract Farmland in SF Bay Area AlterNet (martha r)

Red Flags Said to Go Unheeded by Chase Bosses New York Times

In Washington, Mixed Messages Over Tighter Rules for Wall St. New York Times

JPMorgan Said to Weigh Bonus Clawbacks After Loss Bloomberg. While this move certainly appears warranted, it simultaneously is clearly an effort to shift blame away from Dimon. But the CEO, both managerially and legally (via Sarbanes Oxley certifications) is responsible for the adequacy of controls.

KC Man Sues Bank Over Foreclosure Error KMBC (Lisa Epstein)

* * *
D – 116 and counting. *
Document the atrocities! –Eschaton

Dimon London Whale Fiacso. Obama on ABC’s The View: “We don’t know all the details. It’s going to be investigated but this is why we passed Wall street Reform”. Ben Smith, Politico, last graf: “[I]t would help Obama’s reelection campaign if Schneiderman gets around to the more glamorous work of putting people in handcuffs sometime in the next six months”. From The Department of Fat Chance, or trial balloon?

Robama vs. Obomney. Robama campaign’s new ad paints Obomney as “a job-killing economic ‘vampire’”. Obomney counters: “Nyah, nyah, Steel Dynamics!” American Future Fund runs ad: “Obama voted for the Wall Street bailout”. Well, Obomney is a vampire, and Robama did vote for the bailout. They’re both right! Meanwhile, Rattner sides with Bain, calls Robama ad “unfair”. “This is part of capitalism, this is part of life”. Bottom line: “A day in which the news media cover Bain instead of the unemployment rate is a good day for Obama, no matter what exactly Romney did while he was there”.

Robama. Speech at Barnard graduation: “What young generations have done before should give you hope. Young folks who marched and mobilized and stood up and sat in… I want you to know that I will be right there with you”. Gag. New and heavily redacted DHS documents: “Did the White House Direct the Police Crackdown on Occupy?”

Obomney. “Romney’s life characterized by little-told stories of generosity”. Squee! First story I read on a news operation (not just an app) built for the iPad (“The Daily”) and it’s a puff piece.

R Inside Baseball. CrossRoads SuperPAC: “[L]everaging the roughly 250,000 student-members of the College Republicans who span more than 1,800 campuses across the country” (College Republicans).

D Inside Baseball. Four frustrated Senators file suit against the Senate to abolish the filibuster (the logic, via Ezra Klein). Huh? Article 1, Section 5: “Each House may determine the rules of its proceedings”. Also, too, the administration could have used the nuclear option in 2009. Obama had a mandate, remember? Toobin on Roberts Court and Citizens United; how money became speech. Weird that Obama operatives never bring CItizens United up in the “ZOMG! The Supreme Court!” talking point. Maybe because Obama uses just as much of all that lovely money as anyone else?

Ron Paul. “Our campaign will continue to work in the state convention process”. But not, like, campaign. Fundraising dried up. Charles Pierce: “He’s not the Jerry Rubin of 2012. He’s going to sell them out. The only question now is for how high a price”.

Elizabeth Warren. London Whale is oxygen for Warren. She calls for Dimon to step down from the NY Fed, restoration of Glass-Steagall (which Ron Paul opposed abolishing). Na ga happen: “If Warren and Paul did a joint ‘break up the banks’ press conference, it sure would generate a tidal wave of support and just might change the world of banking”. Why not break the banks up? Why not put the executives in jail for fraud? Off the table!

WI (swing state). National Ds won’t give WI Ds a paltry $500K for vital GOTV (“boutonniere money”). “Considering that Scott Walker has already spent $30 million and we’re even in the polls, this is a winnable race. We can get outspent two to one or five to one. We can’t get spent 20 to one”. D Barrett: “Let us once again be a state where we can talk to our relatives, where we can talk to our co-workers, where we can talk to our neighbors about politics without it being a bitter fight. That’s our Wisconsin”. Not sure that message will resonate with the Capitol Occupiers. But they’ve got no place to go.

MI (Swing State). Travails of reporters: “[P]eople will be interviewed with the light and camera and be thinking ‘I’m on TV’ — they change totally. But I come up to the same person with my little [radio] mic, and it’s a totally different thing. I get really honest, interesting opinions on, for example, if a foreclosure policy will really be helpful to them.” Interesting foreclosure is the first story that springs to mind.

NV (Swing State). D Oceguera running for (NV-3) won’t say whether he supports ObamaCare or not. On TV! “I’m trying to look forward”. “Forward” being the one-word Obama campaign slogan…

CO (Swing State). Loveland, Fort Collins consider fracking ban due to blowout concern.

NC. David Parker, “besieged” state D Party chair, said Saturday that he would remain in his post after the party’s ruling committee voted not to accept his resignation. “The move came despite an effort by party leaders including Gov. Bev Perdue, Democratic gubernatorial nominee Walter Dalton, key state elected leaders, the national party, and the White House to ease Parker out.” On to the Convention!

Green Party. National: Barr and Stein debate in SF (video): “Obama and Romney describe the bank bailouts as a painful necessity; Stein and Barr describe it as an unparalleled heist by the 1% and say it’s time to nationalize the Federal Reserve and to cancel student loan debt”. CT: Melissa Schlag, State Senate District 33, petitions to get on the ballot. Schlag is credited with playing a vital role in opposing the Haddam Land Swap. NY: Izvestia actually covers a Green candidate, Colin “No Impact” Beavan, NY-10: “What’s going to sort us out is all of us deciding that we’re responsible for the culture that we live in”.

Libertarian Party. Lawsuit challenges VA ballot access law.

Occupy. The Occupy National Gathering will take place in Philadelphia from June 30th to July 4th 2012. While activities will take place around the city our main hub will be on Independence Mall. Awesome.

* 116 days ’til the Democratic National Convention ends with deep-fried turkey dinner and all the trimmings on the floor of Bank of America Stadium, Charlotte, NC. Cross-posted to Corrente. Let me not to the marriage of true minds Admit impediments.

READERS: Again, here are the swing states: AZ, CO, FL, IA, MI, NV, NH, NM, NC, OH, PA, VA and WI. I’m very interested in any local or state links you can send me from those states; original reporting, not wire services stuff. Now I have help with CO thanks to MR, but there are more!

* * *

Antidote du jour:

You can find it via a wayback machine (hat tip Ed Harrison for tracking it down) but not at TPM or via Google. We are reposting it to make it more accessible. It is rather curious that TPM decided to remove the article now, while a presidential campaign is on, when Ferguson’s piece demonstrates that predictive social science is possible after all.

This is the header of the piece:

And the text, which you’ll see was a good call:

Kevin Phillips once gain does us all a service with his sharp and wonderfully lucid discussion of finance and politics. Since we can take it for granted now that neither the Democrats nor the Republicans are going to attempt any reforms of the US financial system this year, the task is going to fall to the next President to propose something. I wish I could find real grounds for optimism, but that’s not easy.

Here is a table that I’ve prepared for a short presentation at an academic conference. It is an analysis of “early money” (defined as that contributed before any voting took place) in the current presidential election. It covers the usual universe of large firms and investors that I typically investigate every four years.[If you are interested in details, just see my Golden Rule (Chicago, University of Chicago Press, 1995).]

I think it pretty much speaks for itself. Both Obama and Clinton are heavily supported by financiers; I include Chris Dodd, whose candidacy was not on the same level, since he remains head of the Senate Finance Committee. Note that the candidate most heavily supported by finance in the Republican race, John McCain, also won that one.

I would caution against over-interpreting these results. Broadcasting, defense, pharmaceuticals, and other sectors all weighed in. But the particular importance of finance to the Democrats is hard to miss and I am sure will also show up when subsequent contributions get inventoried. Kevin Phillips’ analysis, I think, is likely to remain timely.

Having benefitted from risk management failures of others such as investment bank Bear Stearns and hedge fund Amaranth, JP Morgan (“JPM”) appears to have made an “egregious” and “self inflicted” hedging error. The bank would have done well to reflect on John Donne’s meditation: “send not to know for whom the bell tolls it tolls for thee”.

A US$2 billion Banana Skin …

The losses indicated are US$2 billion and may be higher. JPM’s share price fell around 9% (a loss of US$14 billion in market value) when the new was announced via a hastily arranged news conference. The bank also lost considerably more in reputation and franchise value.

The episode has all the usual trappings of a salacious trading disaster. Competitors had christened Bruno Iksil, one of the traders responsible – Lord Voldemort (after the Harry Potter villain). The position, which has been common knowledge in the market since early 2012 at least, was dubbed “the London whale”. After the losses were announced, the usual journalistic liberties have been taken – the whale has “beached” or “been harpooned”. A sub-editor gleefully coined the headline “Dimon is a Whale of a Hedge Fund Manager”.

But the losses raise serious issues. As they do not relate to the usual “rogue trading” incident which is typically dismissed as impossible to detect or control, the episode provides insights into the problems of modern high finance, bank strategies and regulation of markets.

Details are sketchy. The losses relate to a position taken to “hedge” a US$300+ billion investment portfolio managed by JPM’s Central Investment Office (“CIO”) overseen by staff including experienced hedge fund investment managers. The portfolio has increased in size from $76 billion in 2007 to $356 billion in 2011.

The objective of the CIO is hedging JPM’s loan portfolio and investing excess funds. During a 13 April 2012, conference call, Jamie Dimon, the CEO of JPM referred to the unit as a “sophisticated” guardian of the bank’s funds.

In its statement, the bank advised investors that: “Since March 31, 2012, CIO has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed.”

The large investment portfolio is the result of banks needing to maintain high levels of liquidity, dictated by both volatile market conditions and also regulatory pressures to maintain larger cash buffers against contingencies. Broader monetary policies, such as quantitative easing, has also increased cash held by banks, which must be deployed profitably. Regulatory moves to prevent banks from trading on their own account –the “Volcker” rule- has encouraged the migration of trading to other areas of the bank, such as liquidity management and portfolio risk management hedging.

Faced with weak revenues in its core operations and low interest rates on cash or secure short term investment, JPM may have been under pressure to increase returns on this portfolio. The bank appears to have invested in a variety of securities including mortgage backed securities and corporate debt to generate returns above the firm’s cost of capital.

In 2011, the CIO portfolio contributed $411 million to JPM’s earnings, below its contributions of $1.5 billion in 2008 and $3.7 billion in 2009. JPM’s disclosures show that the unit took significant risk. Based on a common measure known as VaR (Value at Risk), the potential statistical loss for a single day was $57 million in 2011, similar to the $58 million of average risk in the bank’s larger investment bank and trading business.

The Art of Topiary…

The losses relate to an attempt to hedge the exposure on this portfolio.

As hedging would reduce returns, the strategy adopted appears to have been to buy insurance against default in the short term (to end 2012) and finance the hedge by selling insurance against default in the medium term (to end 2017). The structure took advantage of the difference in pricing of insurance between the two maturities of around 0.60-0.70% per annum. The strategic view was that risk would increase in the near term but abate in the longer term.

The choice of hedge instrument was an older “off-the-run” credit index -the CDX NA.IG (“North American Investment Grade”) Series 9. In all probability, the choice was driven by economic considerations. The constitution of the index may have provided a better match to the exact risk in JPM’s books. The pricing of the index may have been more favourable than more recent “on-the-run” index. The relative liquidity of alternative hedging instruments would have been a factor.

The choice may also have been motivated by the desire to mask the bank’s trading activities from other market participants to allow the position to be established without moving market prices. The particular contract, originally issued in 2007, was extensively used in a variety of structured products. This meant that trades could be disguised as hedging existing products or client positions rather than on JPM’s own account.

It is possible that the hedge could have been “juiced up”, that is, leveraged, by trading in different instruments such as the tranched version of the index to increase sensitivity to changes in market credit spreads.

With the benefit of hindsight, the trades seem to be no more than what Lord Voldemort might view as “school-boy spells you have up your sleeve!”

Imperfect Hedges…

In the conference call announcing the loss, Mr. Dimon explained that the CIO portfolio was a hedge for the bank’s balance-sheet risk. He stated: “It actually did quite well. It was there to deliver a positive result in a credit-stressed environment. And we feel we can do that and make some net income”.

It is questionable whether the CIO portfolio or the problematic positions could be regarded as a true hedge. It is complex and relies on the correlation between the bank’s underlying positions and trades. The effectiveness of the hedge also relies on the changes in credit pricing for different maturities. The simplest way to reduce risk would have been to sell off existing positions or offset the positions exactly.

The bank’s assertion that the entire set of transactions was both a hedge and a source of earnings is confusing. The bank should have heeded the warning of the seventeenth-century French author François de La Rochefoucauld: “We are so accustomed to disguise ourselves to others that in the end we become disguised to ourselves.”

Given JPM vaunted risk management credentials and boasts of a “fortress like” balance sheet, it is surprising that the problems of the hedge were not identified earlier. In general, most banks stress test hedges to ensure their efficacy prior to implementation and monitor them closely.

While the US$2 billion loss is grievous, the bank’s restatement of its VaR risk from $67 million to $129 million (an increase of 93%) and reinstatement of an older risk model is also significant, suggesting a failure of risk modeling.

During the conference call, Mr. Dimon conceded that the trades were “flawed, complex, volatile, poorly reviewed and poorly monitored … there are many errors, sloppiness and bad judgment”.

The episode also points to failures on the part of parties other than JPM.

Banks are now obliged to report positions and trades, especially certain credit derivatives. This information is available to regulators in considerable detail. Given that the hedge appears to have been large in size (estimates range from ten to hundreds of billions), regulators should have been aware of the positions. It is not clear whether they knew and what discussions if any ensued with the bank.

External auditors and equity analysts who cover the bank also did not pick up the potential problems. Like regulators, they perhaps relied on assurances from the bank’s management, without performing the required independent analysis.

Encouraging Pundits…

The losses are complicated by Mr. Dimon’s vocal opposition to some aspects of the re-regulation of financial institutions, especially Volcker Rule which seeking to restrict proprietary trading of banks. Given the fact that JPM survived the financial crisis relatively well and his personal high standing within President Obama’s administration (he was considered a potential Treasury secretary), Mr. Dimon has held the moral high ground in arguing for less stringent regulations.

In the bank’s annual report, Mr. Dimon wrote: “If the intent of the Volcker Rule was to eliminate pure proprietary trading and to ensure that market making is done in a way that won’t jeopardize a financial institution, we agree….We, however, do disagree with some of the proposed specifics because we think they could have huge negative unintended consequences for American competitiveness and economic growth”.

Banks have sought a weaker version of the Volcker Rule with broad remit to undertake “portfolio hedging”. This would allow banks to view an investment portfolio in its entirety and enter transaction to offset the risks of the entire portfolio, without the necessity of hedging securities or positions on an individual basis as would be required by a narrow definition of hedging. Banks argued that this exemption is essential to allow flexibility in managing risk within a large financial institution.

The JPM episode has helped re-open the debate. During his conference call, Mr. Dimon ruefully observed the bank’s US$2 billion loss “plays right into the hands of a bunch of pundits out there”.

Legislators and regulators now argue that the rules for portfolio hedging are too wide and effectively impossible to police effectively. In addition, the statutory basis may not support the rule. The legislative intent was intended only to exempt risk-mitigating hedging activity, specifically hedging positions that reduce a bank’s risk. Interestingly, drafters of the portfolio hedging exemption recognized the potential problems, seeking comment on whether portfolio hedging created “the potential for abuse of the hedging exemption” or made it difficult to distinguish between hedging or prohibited trading.

In a recent Congressional hearing, Former Fed Chairman Paul Volcker, who helped shape the eponymous provision, questioned whether the volume of derivatives traded was “all directed toward some explicit protection against some explicit risk”.

The pundits have been quick to suggest that the losses point to the need for more stringent regulations. But it is not clear that a prohibition on proprietary trading would have prevented the losses.

In practice, without deep and intimate knowledge of the institution and it activities it is difficult to differentiate between legitimate investment and trading of a firm’s surplus cash resources or investment capital.

It is also difficult sometimes to distinguish between hedging and speculation. The JPM positions which caused the problems were predicated on certain market movements – a flattening of the credit margin term structure- which did not occur.

Hedging individual positions is impractical and would be expensive. It would push up the cost of credit to borrowers significantly. All hedging also entail risks. At a minimum, it assumes that the counterparty performs on its hedge. But inability to legitimately hedge also escalates risk of financial institutions. Ultimately no hedging is perfect or as author Frank Partnoy told Bloomberg: “The only perfect hedge is in a Japanese garden”.

Additional regulation assumes that the appropriate rules can be drafted and policed. Experience suggests that it will not prevent future problems.

Bankers and regulators have always been seduced by an elegant vision of a scientific and mathematically precise vision of risk. As the English author G.K. Chesterton wrote: “The real trouble with this world [is that]…. It looks just a little more mathematical and regular than it is; its exactitude is obvious but its inexactitude is hidden; its wildness lies in wait.”

Human Sacrifices…

JPM indicated that it is trying to unwind its positions. Given the size, the level of losses may increase as markets may move against the bank as it tries to liquidate its position.

But JPM should survive this loss. The bank was quick to point out that the US$2 billion loss was offset by profits in other parts of the portfolio. According to the bank: “As of March 31, 2012, the value of CIO’s total [available for sale] securities portfolio exceeded its cost by approximately $8 billion.

The fate of specific actors is more difficult to predict. Mr. Dimon’s language in describing the losses was expressive:

“… Errors, sloppiness, and bad judgment… Badly executed, badly monitored. I’m not going to repeat it 800 times…“I know it was done with the intention to hedge tail risk… it was unbelievably ineffective…”

He seemed to be trying to distance himself and the bank’s Board of Directors from the failures praising the expertise of the individuals involved: “We added different types of people, talented people and stuff like that”. He was at pains to point out that the CIO until had been very successful to date.

But human sacrifices will be needed. The question is whether it reaches the executive suite or can be limited to foot soldiers. Mr. Dimon has admitted his credibility is at stake, though not necessarily his job.

What complicates Mr. Dimon’s position is that as recently as 13 April 2012, he indicated that the CIO positions were not problematic, dismissing the issue as “a complete tempest in a teapot”. After the losses were announced, Mr. Dimon admitted on US television that he was “dead wrong” to have dismissed questions about the issue.

Just Watch This Space…

The episode raises deeper concerns, beyond the issues at JPM.

How many other such problems in other firms remain undiscovered? JPM is a major player in credit derivatives and by no means the worst managed or the most aggressive in risk taking. If it curtails its activities then the loss of liquidity may affect other players and result in unrelated losses.

How has earnings pressure in banks affected their risk taking? Clearly, the large cash holdings of banks and the need to generate adequate returns for shareholders is encouraging risk taking.

How does regulatory initiatives and monetary policy action affect bank risk taking? Central bank policies are adding to the problem of banks in terms of large cash balances which must be then invested at a profit. The implementation of the Volcker rule may have had unintended consequences. It encouraged moving risk taking activities from trading desks where the apparatus of risk management may be marginally better established to other parts of banks where there is less scrutiny.

The most important question remains whether any specific action short of banning specific instruments and activities can prevent such episodes in the future. It seems as Lord Voldemort observed in Harry Potter and the Deathly Hallows Part 2: “They never learn. Such a pity”.