JP Morgan's Gambling Problem- Time to Pay-up
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Charlie Munger, of Berkshire Hathaway recently gave an interview on CNBC, and when asked about Michael Lewis, an author who chronicled the financial meltdown of 2008, who said more needed to be done to help heal the ills of Wall Street, and that the Volker rule was insufficient, Munger replied, "The majority of what was wrong has not been fixed. The Volker rule is not enough. If I was making the rules, I would make Lewis look like a "piker. " (An overly cautious person.)
Munger then went on to say that his weapon of choice would likely be a Tobin Tax, named after a Yale economist, who wanted taxes which discouraged short term thinking and investing. He stated, "If taxes on short term trades were 99%, nobody would ever do it."
This was before JPMorgan Chase (NYSE: JPM), and CEO Jamie Dimon, announced that they had lost two billion dollars on a trade.
The trade in question- selling insurance derivatives against America's biggest corporations going out of business, including McDonalds, General Mills, and Alcoa. If the company's continued to do well, JPMorgan would pocket the premiums, if they went bankrupt, there would be trouble.
It seems like a no brainer, why would anybody buy the flip side of this derivative, except for what are likely overwhelming odds. In an effort to boost profits, JPMorgan’s London trading desk continued to sell more and more of these derivatives, believing that the U.S. economy was recovering, but in March, fears regarding the economy began to swirl, and the value of the derivatives that JPMorgan was selling went against the company.
This has since ballooned to a two billion dollar loss, and could get bigger. While the company could sustain a loss this size, who knows what "bigger" actually means.
These losses exemplify the same greed, hubris, and arrogance that got us into the financial crisis of 2008. Rather than acting as a hedge (protecting against an investment going down in value, by also owning the flip side of the coin,) or a being a market maker (generating a commission by matching buyer and seller at an agreed upon price), JPMorgan became the market. They bet, and they bet big; really not so different than Jamie Dimon walking up to the sports book cashier, and saying I'll bet 2 billion on the Lakers.
While Mr. Dimon managed to steer JPMorgan away from the massive losses during the financial crisis that plagued other banks/investment banks such as Citigroup (NYSE: C), Bank of America (NYSE: BAC), Morgan Stanley (NYSE: MS), and to a lesser degree, Wells Fargo (NYSE: WFC), he has been a vocal critic of new regulations that aim to rein in risk, saying they restrict banks’ room to maneuver. The question is, with all the traders who have some degree of autonomy, are JPMorgan and the banks mentioned, because of their size, too big to manage?
You can try to manage risk all you want, but if you allow 100 people a certain amount of freedom to bet money that isn't theirs in a high stakes/ high reward game, someone is going to go off the reservation, and place a huge, risky bet. Even if 99% stay pure, it takes only one bad apple.
And if thee bad apple wins, well, that just increases appetite for risk in future bets. It's simple human psychology. Conservative, conservative, conservative, you're doing well, why not raise the stakes a little, I won again, bam- let's bet the whole kit and caboodle. If there's any possibility of causing systemic financial failure, then it is up to us as a society, to manage our risk. If it's the taxpayer who has the bill collector calling when something "magically" goes awry, then it is our duty to enact regulations which prevent this possibility. Heads we win, tails you lose, is simply unacceptable.
The study of "game theory" is predicting human beings behavior under the presupposition that they will always act in their own selfish interests, and governments around the world pay high priced consultancy fees to experts in the field to predict behavioral responses of other parties, based on various potential actions and consequences that might be enacted.
Is that our money you're playing?
When a factory is dumping its waste into a river, downstream the pollutants may cause cancer, kill fish, destroy tourism, (in economics these are called "externalities"), and of course the corporation will lobby lawmakers for the right to pollute, claiming that clean-up will be onerous to profits, and they’ll be forced to lay-off employees, even as the visible (not to mention invisible) costs to the poor, often defenseless people living downstream are far greater than the costs of cleaning up. The company will not bear these costs unless our society, and our lawmakers make them. Just look at what happens when oil companies go drill for oil in foreign lands. (Texaco vs. Ecuador for example)
Similarly, if someone can bet huge sums, with tremendous upside, and little downside risk to themselves, all but the most principled person will eventually take this risk.
We need guardrails to keep the train from derailing. Yes, the regulations do slow the locomotive down, but the benefits for society as a whole, far outweigh the short term profits for the individual person or company.
And back to the investment banks, how does derivative trading benefit society? We have all these really smart people, trying to outfox one another for a buck, well more like a bill (billion.) If they want to play super high stakes poker, that's fine, but in no way should it affect you or me. The idea that my bank could potentially go bankrupt, because a couple people got greedy, or the level of risk was misanalysed, even if they are playing with "their" money, doesn't sit well.
The idea, of having just gone through the financial crisis of 2008, and people trying to water down the regulations of the Volcker rule, which are geared to prevent such an event from occurring again, is simply unconscionable. Investment banks should be separated from commercial banks, and at minimum the Volcker Rule should be enacted. (sure, call me a piker)
If then, the investment bank wants to risk all their money, then so be it, but in no way should the public be at risk.
Then again, as bets turned against MF Global, they put their customers money up as collateral. The company is now bankrupt, and it's doubtful all those funds will be returned. Can someone explain to me why all this risk is needed? I'm sure Charlie Munger would also love to hear your answers. He likes to have jokes for dinner parties.
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