I’m sure some readers will protest that comparing Jamie Dimon to Lance Armstrong is unfair. After all, Dimon is better looking than Armstrong. But this post will demonstrate that the big reason that Armstong’s reputation has crashed while Dimon’s remains largely intact is first, that bank CEOs have a powerful and largely compliant messaging apparatus in the financial media and second, that we hold sports stars to much higher standards than titans of finance and commerce.
Denial of Performance Enhancement and Exaggeration
Let’s look at the main claims Dimon and his fans make for Dimon’s performance:
Myth 1: JP Morgan Didn’t Need a Bailout. This clip is from the horse’s mouth:
You can see here how Dimon’s response does not address Merkley’s points, of the benefit that JP Morgan received from the Fed dropping rates to the floor and from the AIG rescue. Dimon gives a misleading reply by redefining bailout and assistance to mean TARP only and to claim that the value that JP Morgan derived from the rescue of AIG was limited to its direct exposure.
The real picture is actually much worse that Merkley presents. Most people, and that includes most financial writers and reporter, are ignorant of the risks that JP Morgan runs being one of the two clearing banks for US repo transactions (the other is Bank of New York Mellon). Repo is the major way that securities dealers (which included the trading operations of commercial banks like Citigroup) fund themselves. Net repo borrowing accounted for 30% to 40% of broker/dealer funding in the years before the crisis, and even with banks and dealers being urged to rely more on more stable sources of funding (and super-low interest rates allowing them to sell bonds cheaply), net repo continues to be a significant source of their financing. JP Morgan also acts as a clearing bank for derivatives transactions.
This 2010 paper by Bruce Tuckman of NYU’s Center for Financial Stability describes the critical role of the repo system and the risks that clearing banks like JP Morgan incur (emphasis original):
• While broker-dealers want to hold securities, both to facilitate their market-making activities and as investments, they do not want to commit scarce capital by purchasing these securities outright. The repo market allows them to use borrowed money to pay for the purchases by posting the securities they buy as collateral. (When the repo expires, the borrower of cash must either sell the security to pay back the loan or, quite commonly, “roll” or renew the repo for another day or term.) Repo trades for this purpose are also called “funding trades.”
• Leveraged investors, like many hedge funds, buy securities and finance the purchases through the repo market as well.
• Non-leveraged investors, including state and local governments, money market funds, other mutual funds, and foreign sovereign entities, prefer the relative safety of lending money on a secured basis to bearing the direct credit risk inherent in other money market investments….
In every morning’s “unwind,” without any cash coming from the borrowers, the clearing banks make cash available to the lenders and return securities to the borrowers’ clearing bank accounts…this process implies that during the day the clearing banks are effectively the secured lenders of the repo transactions. Hence, a very significant, unintended consequence of an operational solution to settlement problems is that an enormous amount of intra-day risk is shifted from secured lenders to the clearing banks.
The clearing banks are at great risk. The daily unwind leaves the clearing banks holding all the intra-day risk arising from the secured financing of broker-dealers. This seems reckless given that these two banks are themselves large and systemically important financial institutions. Furthermore, these substantial intra-day risks are not included in the calculation of risk- adjusted assets and, therefore, are not even on the radar of the regulatory structure governing bank capital requirements or risk charges.
Now let’s understand what that means. The emergency facilities that the Fed put in place during the Bear Stearns rescue, as well as the heavily subsidized purchase of JP Morgan of Bear, was actually a bailout of the two major clearing banks, and thus JP Morgan itself:
While most commentary throughout 2008 focused on the “run” of secured funders and prime brokerage balances away from Bear Stearns and on the extensive and leveraged holdings of impaired assets at Lehman Brothers, there are indications that actual or potential exposures faced by the clearing banks were relevant to the course of events. Chairman Bernanke explained the initiation of the Term Securities Lending Facility (TSLF)6 and the Primary Dealer Credit Facility (PDCF)7 during the week Bear Stearns collapsed by stressing the systemic danger of secured lenders abandoning the repo markets. But, amidst those remarks, he added the following:
For some time we have been working with market participants to develop a contingency plan should there ever occur a loss of confidence in either of the two clearing banks that facilitate the settlement of tri-party repos… [A] stronger financial system may require changes … in the settlement infrastructure operated by the clearing banks./blockquote>
And, in describing the Fed’s decision the day before the Lehman bankruptcy to expand the collateral accepted against PDCF loans, a Federal Reserve Bank of New York paper reported that
Although the potential failure of a major repo market participant was the immediate impetus for the Fed’s decision to expand the collateral eligible for pledge in the PDCF, the Fed was also responding to more general concerns about the structure of the triparty repo system—specifically, the exposure incurred by the clearing banks to a possible default by borrowers in the market.
Remember, the Primary Dealer Credit Facility was established in March 2008 and expanded in September 2008 to help stabilize the two major clearing banks, JP Morgan and Bank of New York. So one of the very earliest bailouts was for JP Morgan’s benefit.
Similarly, in the wake of the Lehman collapse, a money market fund that held a significant amount of Lehman commercial paper, suffered a run as it “broke the buck” as in traded below a net asset value of $1 per share. One of the major investors in repo is money market funds, so a run on money market funds was effectively a run on the repo funding system. Indeed, there were point during the crisis when it was impossible even to repo Treasuries, which one bank staffer described as tantamount to breaking the sixth seal during the Apocalypse.
So when the Fed established a program to guarantee money market fund accounts up to $250,000 to halt the run, that too was a bailout to JP Morgan. And while Dimon tried to pretend that JP Morgan didn’t need the AIG rescue because it only got $1 billion out of it, that’s hogwash. It’s almost certain that Morgan Stanley would have failed, and as Lloyd Blankfein is reported as having said at the time, if Morgan Stanley collapsed, Goldman would be next. As derivatives expert and venture capitalist Roger Ehrenberg pointed out in 2009:
Whether anyone will admit it or not, without the AIG (read: Wall Street and European bank) bail-out and the FDIC issuance guarantees, neither Goldman nor any other bulge bracket firm lacking stable base of core deposits would be alive and breathing today.
JP Morgan and Bank of New York Mellon would have been engulfed as well through their tri-party repo exposures, although operationally, they would have been easier to rescue that the former investment banks were.
So while Dimon is likely correct in his narrow claim that he didn’t need the TARP, it’s because he’d gotten more stealth bailouts than anyone else prior to that point.
“Fortress Balance Sheet” Malarkey. Dimon’s frequent repetition of his claim that JP Morgan has a “fortress balance sheet” is a pure and simple Big Lie. The best he might be able to argue is that he’s won what the Japanese call a height competition among peanuts, that he’s better than his peers, but they are all at such a low level that these distinctions aren’t as meaningful as he’d like the great unwashed public to believe. But as the discussion above indicates, Dimon’s PR leaves out the tri-party repo risks, which none of his main competitors have. As banking industry expert Chris Whalen noted, “JP Morgan is running a $2.4 trillion bank attached to a $75 trillion derivatives clearing operation.” And the bank can get away with that precisely because regulators haven’t demanded that JP Morgan hold additional capital in order to cover the risk it runs in its clearing operations. Again from the Tuckman paper:
The previous sections argue both from first principles and from the events of 2008 that the daily unwind conducted by the clearing banks is an unacceptable source of systemic risk…One important contributor has to have been that the capital requirements and risk charges governing the clearing banks do not incorporate the intra-day risk of the daily unwind.
JP Morgan Suffered Fewer Mortgage-Related Losses Because It Was Smart and Avoided the Subprime Market. Um, no. Just like Bank of America before its wildly misguided Countrywide acquisition, JP Morgan was only a mid-tier mortgage lender, mainly in prime (Fannie and Freddie quality) mortgages. But the fact that they hadn’t bulked up and gone heavily into subprime was not for want of trying. Market participants have repeatedly told me JP Morgan’s big reason for not having become a large player that it did want to expand but was unwilling to pay up to hire the staff they needed. As a senior executive on the mortgage buy side wrote:
Chase Home Mortgage was a prime and jumbo lender thru the 90s and early 2000s. Generally speaking, prime lenders were seen as less sophisticated players and it was a low margin business. So they didn’t pay well, compared to the ABS side of the business. In 2001, Chase bought the mortgage business of Advanta, a subprime lender that was considered better than average. I believe that Chase had problems integrating Advanta into the Chase world (my firm had several dealings with Chase because we had done several Advanta deals – it was a mess ).
I think the Advanta experience made Chase gun-shy on subprime before the party really started. At the time, my sense was the failure to integrate was on Chase’s part – they were trying to use prime mortgage guys – cheaper and less sophisticated – for subprime deals. Later (2002-03?) they hired a fairly young guy from Fitch to head their subprime MBS banking business. He was fairly inexpensive and not as really as seasoned as other guys at his level at other banks. His group managed to issue a few deals, but it sounded like they were always messy fire drills, compared to the much better organized banks like Lehman, Bear, Credit Suisse and even Countrywide.
I think Chase was reluctant to pay up for their bankers, at a time when the market was increasingly competitive, and didn’t have a deep staff. Lots of lenders Countrywide started it, WaMu, Ameriquest, RFC/GMAC etc followed) were building securitization “banks” at the time so they could act as their own deal runners, rather than paying third party banks and build their own direct relationship with investors.
Similarly, from an e-mail thread among people deep in the mortgage securitization world:
Person 1: Someone in the know told me JPM was really upset that they hadn’t jumped into the residential CDO market; that they’d avoided it. It wasn’t that they thought the CDO’s would hold — they didn’t; they knew they were junk — but, rather, that they thought they’d burn down much faster than they did. After they realized they were more resilient — never mind the bailouts when the predictable losses finally arrived — they weren’t happy with the amount of money they’d left on the table. The person who relayed that to me definitely would have known, and they also told me that after the carnage.
Person 2: Very consistent with my experience. I had JPM CDO salesmen banging down my door in 2006 and early 2007. They wanted to do more, but didn’t have the staff, assets etc.
They didn’t miss out on CDO carnage because of good risk management. They just weren’t that good at it.
In other words, JP Morgan wasn’t better at steering clear of risk. It was simply worse at looting.
Myth 2: JP Morgan is Better Run Than Other Banks
The only way you can believe that JP Morgan is well run, let alone better run than other banks (admittedly a low bar) is to do the equivalent of a memory-wipe of your brain on a regular basis.
The London Whale Incident Revealed Massive Risk Control and Oversight Failures. We’ve written about the astonishingly weak controls at some length, such as this section from a Michael Crimmins, who has served in senior compliance roles at several major banks, in Why Hasn’t Jamie Dimon Been Fired by His Board Yet?:
The first stunner, that JP Morgan was restating the first quarter financials, should have caused a deafening ringing of alarm bells. For a company of JP Morgan’s stature to be compelled to restate prior period financials is a very clear signal of bigger problems with their overall financial reporting. In isolation we would normally expect to see a massive selloff with an event of that seriousness. Analysts and reporters may have missed the significance since it was dropped into a footnote and overshadowed by the other disclosures. …
But the real cause for alarm is the reason for the restatement. JPM was forced to disclose that it relied on its traders to provide honest and accurate valuations for its financial statement disclosures. That’s like putting the foxes in charge of not just the henhouse, but the entire farm. Much to its chagrin that was a costly choice. Note that was not a mistake, but a conscious choice….
It appears that JPM is attempting to make the case that rogue traders, with criminal intent, mismarked the books. That may be so and relevant criminal charges against those traders should be pursued. But that strategy does not protect management. If there was mismarking, especially to the extent that occurred here, it is the responsibility of management to know or have procedures in place to alert them to the potential for fraud. Step one in that control process: Don’t let your traders mark their own books. If you do you have no excuse. Your controls are worthless and as CEO, you are responsible for ignoring that fundamental control gap. Full stop.
Which leads to the second underreported stunner.
It is a very big deal when a firm is compelled to disclose a material weakness in internal controls. That’s the worst level of internal control failure a going conern can report. In JP Morgan’s case its more damning since Dimon, as recently as May 10, 2012, certified that all was well with internal controls as of the end of 1Q2012.
That assessment means that it is impossible for the firm’s external auditor to sign off on the financial statements until and unless the control breakdowns are remediated sufficiently for the auditor to provide assurance. The description of the control weaknesses at JP Morgan appear to be design flaws, so it’s likely the weaknesses existed in periods earlier than the first quarter of 2012, when it was ‘discovered’. The fact that the unit with the weaknesses by all accounts was under the direct control of the CEO throws doubt on the validity of his prior certifications about the quality of the internal controls.
And as we wrote in March, the Senate Whale hearing revealed that the lapses were even worse than what we had surmised by reading media accounts closely. One of the new ugly bits was the degree to which JP Morgan was lying to its regulators.
Some of the more alert reporters have wised up. For instance, from a September report, How JP Morgan Failed at Every Turn in the Globe and Mail:
Whale aficionados also now have more information on just how ineffective JPMorgan’s compliance staff were at monitoring their traders. JPMorgan’s senior management did not inform the relevant back-office department in London that it was reviewing the valuation of the Whale portfolio for over two weeks. Given recent rogue trading incidents at Société Générale and UBS, the low regard in which the control function at the bank was held is extraordinary.
One of the real shockers in the recent Whale revelations (and it’s hard to be shocked given what came before) is that the bank had all of one not-very-experienced-or-powerful person on the Chief Investment Office valuation review team. Recall that one of the things that the team on the Whale team did was systematically goose the valuations (recall that one trader kept a spreadsheet showing what the value would have been given their normal accounting practice, what numbers they were actually using, and the dollar size of the gap between the two). And remember the CIO was the single biggest risk book in the entire bank.
JP Morgan has effectively admitted the gross inadequacy of its financial and operational oversight via its plans to spend over $4 billion and add 5,000 people for better compliance and risk control.
London Whale is Merely One in a Long List of Serious Risk Lapses. JP Morgan has control problems all over the bank that were costing shareholders serious money even before the famed mortgage settlement was under discussion. As Dave Dayen wrote:
I urge you to read an astonishing new report, which I’ve embedded below, from analyst Josh Rosner of Graham-Fisher and Co. The best way to describe the report, “JPM – Out of Control,” is that it reads like a rap sheet. Notably, Rosner takes mortgage abuses almost entirely out of the equation, and yet still manages to fill a 45-page report with documented case after documented case of serious fraud and abuse, most of which JPM has already admitted to (at least in the sense of reaching a settlement; given out captured regulatory structure the end result is invariably a settlement with the “neither admit nor deny wrongdoing” boilerplate appended). Rosner writes, “we could not find another ‘systemically important’ domestic bank that has recently been subject to as many public, non-mortgage related, regulatory actions or consent orders.”…
It’s hard to summarize all of the documented instances in this report of JPM has been breaking the law, but here’s my best shot. I try to keep up on these matters, and yet some of these I’m learning about for the first time:
Bank Secrecy Act violations;
Money laundering for drug cartels;
Violations of sanction orders against Cuba, Iran, Sudan, and former Liberian strongman Charles Taylor;
Violations related to the Vatican Bank scandal (get on this, Pope Francis!);
Violations of the Commodities Exchange Act;
Failure to segregate customer funds (including one CFTC case where the bank failed to segregate $725 million of its own money from a $9.6 billion account) in the US and UK;
Knowingly executing fictitious trades where the customer, with full knowledge of the bank, was on both sides of the deal;
Various SEC enforcement actions for misrepresentations of CDOs and mortgage-backed securities;
The AG settlement on foreclosure fraud;
The OCC settlement on foreclosure fraud;
Violations of the Servicemembers Civil Relief Act;
Illegal flood insurance commissions;
Fraudulent sale of unregistered securities;
Illegal increases of overdraft penalties;
Violations of federal ERISA laws as well as those of the state of New York;
Municipal bond market manipulations and acts of bid-rigging, including violations of the Sherman Anti-Trust Act;
Filing of unverified affidavits for credit card debt collections (“as a result of internal control failures that sound eerily similar to the industry’s mortgage servicing failures and foreclosure abuses”);
Energy market manipulation that triggered FERC lawsuits;
“Artificial market making” at Japanese affiliates;
Shifting trading losses on a currency trade to a customer account;
Fraudulent sales of derivatives to the city of Milan, Italy;
Obstruction of justice (including refusing the release of documents in the Bernie Madoff case as well as the case of Peregrine Financial).
The sheer litany of illegal activities just overwhelms you. And these are only the ones where the company has entered into settlements or been sanctioned; it doesn’t even include ongoing investigations into things like Libor, illegally concealing inclusions of mortgage-backed securities in employer funds (another ERISA violation), the Fail Whale trades, and especially putback suits for mortgages, where a recent ruling by Judge Jed Rakoff has seriously increased exposure. While the risks are still very much alive and will continue to weigh on the firm, ultimately shareholders will pay, certainly not executives as long as the no-prosecutions standard holds.
Rosner determined that since 2009, JP Morgan has paid out $8.5 billion in settlements, or nearly 12% of net income over that timeframe
It’s simply routine for JP Morgan to completely ignore regulations. Here’s another example. Remember the brouhaha about how Goldman was manipulating the aluminum market via its ability to control inventory levels by virtue of owning a large number of warehouses used for clearing and storage? Financial holding companies aren’t supposed to be involved in the physical aspects of commodities dealing, but Goldman had its broader freedoms from its days as an investment bank grandfathered for five years, and had the nerve to thumb its nose at the Fed by buying the warehouses during that period. But that was better than JP Morgan’s conduct. The Fed has never permitted financial holding companies to own commodity infrastructure. But JP Morgan went ahead and bought warehouses from Henry Bath warehouses, without permission. I’m told that Fed officials have said off the record that nobody at the Fed has been able to explain under what authority JPM owns warehouses.
Myth 3: JP Morgan’s Lawlessness is No Big Deal
Other Bank CEOs Have Been Shown the Door for Far Smaller Abuses. Salomon Brothers the dominant bond firm in the 1980s and in some years earned more than all other investment banks combined. Its head Treasury trader started gaming Treasury bond auctions (the Fed runs the auctions on behalf of Treasury). The Fed told him to cut it out, then changed an informal rule into a rule. The trader went nuts and got a reprimand. He ceased trying to game auctions for only a short while, then found a way to do so again that involved falsifying records. It came to the attention of management, which failed to report the abuse to the Fed. When the Fed found out five weeks later, via the Wall Street Journal, the former “King of Wall Street” John Gutfreund and three other top executive resigned and the bank lost its independence. Similarly, Bankers Trust ceased to be a freestanding firm as a result of a derivatives sales scandal followed by escheating abuses. The Chairman of the Board, CEO and president of Barclays were all forced to resign over the more recent Libor scandal.
Dimon May Be Guilty of Criminal Violations of Sarbanes Oxley. As we’ve explained earlier, Sarbanes Oxley was designed to stop the “I’m the CEO and I know nothing” defense. And it also allows a relatively low-risk way to launch criminal cases (as in the language for criminal violations tracks the civil violations statutes, so a civil case could easily be the foundation for a related criminal case if discovery unearthed enough damning evidence). We’ve written at some length about how the London Whale trade as well as the JP Morgan role in the MF Global collapse are slam-dunk Sarbanes Oxley cases. Occupy the SEC has questioned the SEC’s failure to launch a Sarbanes Oxley investigation against JP Morgan. And that letter was written before the Feds launched an investigation into JP Morgan’s likely acting as an enabler of Bernie Madoff’s Ponzi scheme. Finally, recall that the JP Morgan settlement negotiations appear to be the direct result of the Department of Justice readying a possible criminal filing against the bank for mortgage abuses for conduct that took place on Dimon’s watch. Holder initially insisted he had to keep the possible criminal charges outside the case; I may have missed it, but I haven’t seen any updates on that issue.
With all of the foregoing, it’s simply appalling to see the media depict Dimon as some sort of victim. The bank appears to be pulling in all its media chips precisely because it is in so much hot water. But Lance Armstrong demonstrates how long the media will defend or ignore the conduct of a useful high profile figure. Dimon clearly assumes he’s even more deeply in the too big to fail category for anything other than a criminal case to put his reign at risk, and if he wins the public relations war, the Administration won’t dare to go after him. Sadly, that is likely to prove to be correct.