Jamie Dimon Knew, What a Surprise!
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Breaking news: JP Morgan (NYSE: JPM) knew about the “Londonwhale” trades two years ago. It wasn’t just a small rogue-trading desk within the major bank that was able to execute these highly risky derivatives trades without the knowledge of the CEO or anyone reporting to the CEO. The truly breaking news is the CEO of a major multinational bank, one of the big four banks in the U.S., actually knew that the Chief Investment Office was engaging in risky trades in search of profit and approved of it. When the story emerged, we all had an inkling that he knew; and though there is a saying about assumptions, in this case the assumption was correct.
The fact that Jamie Dimon was known as a “risk adverse” CEO is what is more startling in this story. If a potential $2 billion loss using bank deposits is risk adverse, I guess we already know what happens to those CEO’s that are pro risk. One would have to assume they ran banks like Lehman Brothers and Merrill lynch. Dimon passed in front of a Senate panel to discuss, what up to this point is a $2 billion loss JP Morgan suffered due to risky trades. Dimon maintained that they were hedges, and while pressed further claimed that they were designed for a benign environment. These hedges were supposed to make money if the bottom fell out of the credit market. I am no derivatives expert, but it sounds as if these were massive shorts on the credit market, not hedges.
Luckily for Dimon, it seemed the senate panel had even less knowledge of the financial markets and refused to press Dimon further on any of these trades. It doesn’t bode well for the future of the economy when the senate banking committee is either scared or clueless. I always thought a hedge was used to protect one from losses at a smaller cost relative to what the original loss could be. When you play blackjack and the dealer is showing an ace, they will offer you insurance. You can pay a small fee before you see the next card to protect you from losing your entire bet. The JP Morgan hedges sound more like a blackjack player doubling down when the dealer is showing a ten, a risky way to try to double your money rather than a hedge against future losses. Dimon knew about the type of trades that were going on in the CIO and had reportedly made changes to company wide policy that were to be used only in that office. It would be refreshing to hear him say, “Yes we pursued risky trades for profit and the trades failed.”
Even before this escapade, Moody’s in February was warning that banks in the U.S. could have their credit rating downgraded. The banks even now seem very unconcerned with the potential of being downgraded. Goldman Sachs (NYSE: GS) CFO David A. Viniar stated that a downgrade would have a muted impact on the sector. Goldman has been accused of everything from owning the U.S. government to running the entire world but that statement is pretty chilling from a financial point of view. If Goldman, which is one of the most profitable investment banks on the planet, is unconcerned with a downgrade they will obviously be pursuing business as usual. Since all of these banks compete with each other in the same sector, if one or two of them are using bank deposits to chase risky profits, one would have to assume the other would have to as well, or be left in the dust during earnings reports. Even Goldman’s CEO has come out and stated that risk judgment shouldn’t be penalized too much. You should ask that question to investors in JP Morgan who saw over $25 billion of market capitalization vanish after these trades became public.
After the financial crisis of 2008, there was further consolidation in the banking sector. Bank of America (NYSE: BAC) entered the investment banking arena with their purchase of Merrill Lynch. This left all of the major banks in the U.S. operating in the highly lucrative yet risky business of investment banking. BOA has had a very difficult time integrating all the major pieces it picked up in the crisis but has seen its underlying fundamentals improve. You can think as it rights the ship the lucrative call of risky derivatives trades will be hard to resist. It goes back to this culture of banks being profit-seeking entities and if one bank is making a large profit doing something, the other banks will be lambasted if they don’t do the same.
What banks should be is a safe haven for depositors, a loan provider for individuals and businesses, and a place to invest your money. If banks are going to invest money to chase risky trades they should invest their own profits and spin off the risky investment offices into separate entities so if trades fail the bank, the bank's investors and its depositors are not torched. JP Morgan should put the government on notice that unless there are major changes in the way banks can operate there will continually be this issue of banks making big bets on risky trades. If they haven’t learned from bringing the entire financial sector to its knees, a $2 billion hiccup will be easily swept under the rug.
mooseelz has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America and JPMorgan Chase & Co. Motley Fool newsletter services recommend Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.