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Are JPMorgan's Losses a Canary in a Coal Mine?
That sound of shattered glass you’ve been hearing is the iconic portrait of Jamie Dimon splintering as it hits the floor of JPMorgan Chase. As the Good Book says, “Pride goeth before a fall,” and the sleek silver-haired, too-smart-for-his-own-good CEO of America’s largest bank has been turning every television show within reach into a confessional booth. Barack Obama’s favorite banker faces losses of $2 billion and possibly more – all because of the complex, now-you-see-it-now-you-don’t trading in exotic financial instruments that he has so ardently lobbied Congress not to regulate.
Once again, doing God’s work — that is, betting huge sums of money with depositor funds knowing that you are too big to fail and can count on taxpayers riding to your rescue if your avarice threatens to take the country down — has lost some of its luster. The jewels in Dimon’s crown sparkle with a little less grandiosity than a few days ago, when he ridiculed Paul Volcker’s ideas for keeping Wall Street honest as “infantile.”
To find out more about what this all means, I turned to Simon Johnson, once chief economist of the International Monetary Fund and now a professor at MIT’s Sloan School of Management and senior fellow at the Peterson Institute for International Economics. He and his colleague James Kwak founded the now-indispensable website baselinescenario.com. They co-authored the bestselling book 13 Bankers and the most recent book, White House Burning, an account every citizen should read to understand how the national deficit affects our future.
Bill Moyers: If Chase began to collapse because of risky betting, would the government be forced to step in again?
Simon Johnson: Absolutely, Bill. JPMorgan Chase is too big to fail. Hopefully in the future we can move away from this system, but right now it is too big. It’s about a $2.5 trillion dollar bank in terms of total assets. That’s roughly 20 percent of the U.S. economy, comparing their assets to our GDP. That’s huge. If that bank were to collapse — I’m not saying it will — but if it were to collapse, it would be a shock to the economy bigger than that of the collapse of Lehman Brothers, and as a result, they would be protected by the Federal Reserve. They are exactly what’s known as too big to fail.
Moyers: I was just looking at an interview I did with you in February of 2009, soon after the collapse of 2008 and you said, and I’m quoting, “The signs that I see, the body language, the words, the op-eds, the testimony, the way these bankers are treated by certain congressional committees, it makes me feel very worried. I have a feeling in my stomach that is what I had in other countries, much poorer countries, countries that were headed into really difficult economic situations. When there’s a small group of people who got you into a disaster and who are still powerful, you know you need to come in and break that power and you can’t. You’re stuck.” How do you feel about that insight now?
Johnson: I’m still nervous, and I think that the losses that JPMorgan reported — the CEO Jamie Dimon reported — and the way in which they’re presented, the fact that they’re surprised by it and the fact that they didn’t know they were taking these kinds of risks, the fact that they lost so much money in a relatively benign moment compared to what we’ve seen in the past and what we’re likely to see in the future — all of this suggests that we are absolutely on the path towards another financial crisis of the same order of magnitude as the last one.
Moyers: Should Jamie Dimon resign? I ask that because as you know and as we’ve discussed, Chase and other huge banks have been using their enormous wealth for years to in effect buy off our politicians and regulators. Chase just had to pay up almost three quarters of a billion dollars in settlements and surrendered fees to settle one case alone, that of bribery and corruption in Jefferson County, Alabama. It’s also paid out billions of dollars to settle other cases of perjury, forgery, fraud and sale of unregistered securities. And these charges were for actions that took place while Mr. Dimon was the CEO. Should he resign?
Johnson: I think, Bill, there should be an independent investigation into how JPMorgan operates both with regard to these losses and with regard to all of the problems that you just identified. This investigation should be conducted separate from the board of directors. Remember that the shareholders and the board of directors absolutely have an incentive to keep JPMorgan Chase as a too-big-to-fail bank. But because it is that kind of bank, its downside risk is taken by the Federal Reserve, by the taxpayer, by the broader economy and all citizens. We need to have an independent, detailed, specific investigation to establish who knew what when and what kind of wrongdoing management was engaged in. On the basis of that, we’ll see what we’ll see and who should have to resign.
Moyers: Dimon is also on the board of the Federal Reserve Bank of New York, which, as everyone knows is supposed to regulate JPMorgan. What in the world are bankers doing on the Fed board, regulating themselves?
Johnson: This is a terrible situation, Bill. It goes back to the origins, the political compromise at the very beginning of the Federal Reserve system about a hundred years ago. The bankers were very powerful back then, also, and they got a Federal Reserve system in which they had a lot of representation. Some of that has eroded over time because of previous abuses, but you’re absolutely right, the prominent bankers, including most notably, Jamie Dimon, are members of the board of the New York Federal Reserve, a key element in the Federal Reserve system. And he should, under these circumstances, absolutely step down from that role. It’s completely inappropriate to have such a big bank represented in this fashion. The New York Fed claims there’s no impropriety, there’s no wrong doing and he doesn’t involve himself in supervision and so on and so forth. Perhaps, but why does Mr. Dimon, a very busy man, take time out of his day to be on the board of the New York fed? He is getting something from this. It’s a trade, just like everything else on Wall Street.
Moyers: He dismissed criticism of his dual role yesterday by downplaying the role of the Fed board. He said it’s more like an “advisory group than anything else.” I had to check my hearing aid to see if I’d heard that correctly.
Johnson: Well, I think he is advising them on lots of things. He also of course meets with some regularity with top Treasury officials, and some reports say that he meets with President Obama with some regularity. The political access and connections of Mr. Dimon are second to none. One of his senior executives was until recently chief of staff in the White House, if you can believe that. I really think this has gone far enough. Under these kinds of circumstances with this amount of loss of control over risk management, what we need to have is Mr. Dimon step down from the New York Federal Reserve Board.
Moyers: He told shareholders at their annual meeting Tuesday — they were meeting in Tampa, Florida — that these were “self-inflicted mistakes” that “should never have happened.” Does that seem reasonable to you?
Johnson: Well, it’s all very odd, Bill, and I’ve talked to as many experts as I can find who are at all informed about what JPMorgan was doing and how they were doing it and nobody really understands the true picture. That’s why we need an independent investigation to establish — was this an isolated incident or, more likely, the breakdown of a system of controlling and managing risks. Keep in mind that JPMorgan is widely regarded to be the best in the business at risk management, as it is called on Wall Street. And if they can’t do this in a relatively benign moment when things are not so very bad around the world, what is going to happen to them and to other banks when something really dramatic happens, for example, in Europe in the eurozone?
Moyers: Some of his supporters are claiming that only the bank has lost on this and that there’s absolutely no chance that the loss could have threatened the stability of the banking system as happened in 2008. What do you say again to that?
Johnson: I say this is the canary in the coal mine. This tells you that something is fundamentally wrong with the way banks measure, manage and control their risks. They don’t have enough equity funding in their business. They like to have a little bit of equity and a lot of debt. They get paid based on return on equity, unadjusted for risk. If things go well, they get the upside. If things go badly, the downside is someone else’s problem. And that someone else is you and me, Bill. It goes to the Federal Reserve, but not only, it goes to the Treasury, it goes to the debt.
The Congressional Budget Office estimates that the increase in debt relative to GDP due to the last crisis will end up being 50 percent of GDP, call that $7 trillion dollars, $7.5 trillion dollars in today’s money. That extraordinary. It’s an enormous shock to our fiscal accounts and to our ability to pay pensions and keep the healthcare system running in the future. For what? What did we get from that? Absolutely nothing. The bankers got some billions in extra pay, we get trillions in extra debt. It’s unfair, it’s inefficient, it’s unconscionable, and it needs to stop.
Moyers: Wasn’t part of the risk that Dimon took with taxpayer guaranteed deposits? I mean, if I had money at JPMorgan Chase, wouldn’t some of my money have been used to take this risk?
Johnson: Again, we don’t know the exact details, but news reports do suggest that yes, they were gambling with federally insured deposits, which just really puts the icing on the cake here.
Moyers: Do we know yet what is Dimon’s culpability? Is it conceivable to you that a risk this big would have been incurred without his approval?
Johnson: It seems very strange and quite a stretch. And he did tell investors, when he reported on first quarter earnings in April, that he was aware of the situation, aware of the trade — he called it a “tempest in a teacup,” and therefore, not something to worry about.
Moyers: He’s been Wall Street’s point man in their campaign against tighter regulation of derivatives and proprietary trading. Were derivatives at the heart of this gamble?
Johnson: Yes, according to reliable reports, this was a so-called “hedging” strategy that turned out to be no more than a gamble, but the people involved perhaps didn’t understand that or maybe they understood it and covered it up. It was absolutely about a bet on extremely complex derivatives and the interesting question is who failed to understand exactly what they were getting into. And how did Jamie Dimon, who has a reputation that he burnishes more than anybody else for being the number one expert risk manager in the world — how did he miss this one?
Moyers: I’ve been reading a lot of stories today about members of the house, Republicans in particular, saying this doesn’t change their opinion at all that we’ve got to still kill Dodd-Frank and diminish regulation. What do you think about that?
Johnson: I think that it is a recipe for disaster. Look, deregulating or not regulating during the boom is exactly how you get into bailouts in the bust. The goal should be to make all the banks small enough and simple enough to fail. End the government subsidies here. And when I talk to people on the intellectual right, Bill, they get this, as do people on the intellectual left. The problem is, the political right largely doesn’t want to go there because of the donations. I’m afraid some people, not all, but some people on the political left don’t want to go there either.
Moyers: The Washington Post reported that the Justice Department has launched a criminal investigation into JPMorgan’s trading loss. Have you spotted — and I know this is sensitive — but have you spotted anything in the story so far that suggests the possibility of criminality? Dodd-Frank is not in existence yet, so where would any possibility of criminality come from?
Johnson: Well Dodd-Frank is in existence but the rules have not been written and therefore not implemented. So yes, it is hard to violate those rules in their current state. And many of those rules, by the way, violation would be a civil penalty, not a criminal penalty. If you violate a securities law — if you’ve mislead investors, if there was material adverse information that was not disclosed in an appropriate and timely manner — that’s a very serious offence traditionally.
I have to say that the Department of Justice and the Securities and Exchange Commission have not been very good at enforcing securities law in recent years including and specifically since the financial crisis. I am skeptical that this will change. But if they have an investigation that reveals all of the details of what happened and how it happened, that would be extremely informative and show us, I believe, that the risk management approach and attitudes on Wall Street are deeply flawed and leading us towards a big crisis.
Moyers: So what are people to do, Simon? What can people do now in response to this?
Johnson: Well, I think you have to look for politicians who are proposing solutions, and look on the right and on the left. I see Elizabeth Warren, running for the Senate in Massachusetts, who is saying we should bring back Glass-Steagall to separate commercial banking from investment banking. I see Tom Hoenig, who is not a politician, he’s a regulator, he’s the former president of the Kansas City Fed, and he’s now one of the top two people at the Federal Deposit Insurance Corporation, the FDIC. He is saying that big banks should no longer have trading desks. That’s the same sort of idea that Elizabeth Warren is expressing. We need a lot more people to focus on this and to make this an issue for the elections.
And I would say in this context, Bill, it’s very important not to be distracted. I understand for example, Speaker Boehner, the Republican Speaker of the House of Representatives, is proposing to have another conflict over the debt ceiling in the near future. This is the politics of distraction. This is refusing to recognize that a huge part of our fiscal problems today and in the future are due to these risks within the financial system that are allowed because the people running the biggest banks hand out massive campaign contributions across the political spectrum.
Moyers: Are you saying that this financial crisis, so-called, is at heart a political crisis?
Johnson: Yes, exactly. I think that a few people, particularly in and around the financial system, have become too powerful. They were allowed to take a lot of risk, and they did massive damage to the economy — more than eight million jobs lost. We’re still struggling to get back anywhere close to employment levels where we were before 2008. And they’ve done massive damage to the budget. This damage to the budget is long lasting; it undermines the budget when we need it to be stronger because the society is aging. We need to support Social Security and support Medicare on a fair basis. We need to restore and rebuild revenue, revenue that was absolutely devastated by the financial crisis. People need to understand the link between what the banks did and the budget. And too many people fail to do that. “Oh, it’s too complicated. I don’t want to understand the details, I don’t want to spend time with it.” That’s a mistake, a very big mistake. You’re playing into the hands of a few powerful people in the society who want private benefit and social loss.