In an August 2010 commentary about JPMorgan's losses in coal trades I wrote: "The commodities division isn't the only area in which JPMorgan is vulnerable. Credit derivatives, interest rate derivatives, and currency trading are vulnerable to leveraged hidden bets. Ambitious managers strive to pump speculative earnings from zero to hero."
At issue is corporate governance at JPMorgan and the ability of its CEO, Jamie Dimon, to manage its risk. It's reasonable to ask whether any CEO can manage the risks of a bank this size, but the questions surrounding Jamie Dimon's management are more targeted than that. The problem Jamie Dimon has is that JPMorgan lost control in multiple areas. Each time a new problem becomes public, it is revealed that management controls weren't adequate in the first place.
JPMorgan's Derivatives Blow Up Again
Jamie Dimon's problem as Chairman and CEO--his dual role raises further questions about JPMorgan's corporate governance---is that just two years ago derivatives trades were out of control in his commodities division. JPMorgan's short coal position was over sized relative to the global coal market. JPMorgan put this position on while the U.S. is at war. It was not a customer trade; the purpose was to make money for JPMorgan. Although coal isn't a strategic commodity, one should question why the bank was so reckless.
After trading hours on Thursday of this week, Jamie Dimon held a conference call about $2 billion in mark-to-market losses in credit derivatives (so far) generated by the Chief Investment Office, the bank's "investment" book. He admitted:
"In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed, and poorly monitored."
But lets get back to commodities. For several years, legendary investor Jim Rogers has expressed his concern to me about JPMorgan's balance sheet, credit card division, and his belief that Blythe Masters, the head of JPMorgan's commodities area, knows so little about commodities. Jim Rogers is an expert in commodities and is the creator or the Rogers International Commodities Index. He also sells out-of-the-money calls on JPMorgan stock. So far, that strategy has worked out well for him. (Rogers gave me permission to publicly reflect his views and his trades.) Moreover, JPMorgan is still grappling with potential legal liabilities related to the mortgage crisis.
Is Jim Rogers justified in his harsh view of JPMorgan's commodities division? After he expressed his concerns, JPMorgan's coal trade made the news, and it appeared to me that Jim Rogers is on to something. For those of you who missed it the first time, my August 9, 2010 commentary is reproduced below in its entirety. Dawn Kopecki at Bloomberg/BusinessWeek broke the story wherein Blythe Masters' quotes first appeared:
JPMorgan's Losses from Indecent Overexposure - August 9, 2010
JPMorgan Chase's fixed-income revenue fell almost 28% to $3.6 billion in the second quarter, down from $5.5 billion in the first quarter, and down from $4.9 billion for the same period last year. JPMorgan blamed an interest rate squeeze and bad results in the credit markets and the commodities markets.
There were no details of its significant loss from unwise, gigantic, wrong-way wartime coal bets. The bank took a short position so enormous that it was oversized relative to the global coal market, and second quarter losses reportedly were in the hundreds of millions of dollars.
Financial Reform Failure
Blythe Masters, managing director in charge of JPMorgan's global commodities group, spent time lobbying in Washington to dilute financial reform. By her own admission, JPMorgan's recent speculation in coal wasn't client driven; the risk was taken on JPMorgan's behalf. The Dodd-Frank Financial Reform Bill does nothing to prevent a repeat -- or even a potentially worse -- debacle.
The commodities division isn't the only area in which JPMorgan is vulnerable. Credit derivatives, interest rate derivatives, and currency trading are vulnerable to leveraged hidden bets. Ambitious managers strive to pump speculative earnings from zero to hero.
Instead of transparent and regulated markets, we have dark markets, hidden leverage, proprietary speculative trading, lax regulation and oversized risks.
"Scared Sh*tless" 1
Blythe Masters told her remaining employees that competitors are "scared sh*tless" of JPMorgan's commodities division. She claimed the layoffs of 10% of front office staff are not a sign of JPMorgan "panicking" and called the risk taking in coal trading that left JPMorgan wide-open to a massive short squeeze a "rookie error."
For individual traders, JPMorgan doesn't follow the Wall Street maxim: He who sells what isn't his'n, must buy it back or go to pris'n. The U.S. can count on JPMorgan to continue both long and short market manipulation and take its winnings and losses from blind gambles. Shareholders, taxpayers, and consumers will foot the bill for any unpleasant global consequences.
Physical oil traders from JPMorgan's brand new RBS Sempra Commodities LLP acquisition (JPMorgan paid $1.7 billion) left of their own accord to join smaller firms with less capital. Masters said these were "very interesting career decisions."
The defections were all the more interesting, because Masters began her career as a JPMorgan commodities trader. RBS Sempra's oil traders gave Masters a vote of no confidence. Their flight was a loss of "key people," whom she said she needs to replace.
Masters is poised for more debacles:
"All it's going to take is a little pop to the upside. We could be producing a 30 to 35 percent ROE and looking like gods."
"We've got too many banks chasing too little volume and margins have compressed."
"I don't want us talking to the outside world, neither about successes nor about failures."
1 All words in this article in quotation marks are from Business Week's (Bloomberg News) major scoop after the leak of a tape of an internal JPMorgan July 22 conference call: "Blythe Masters Says 'Don't Panic' as Commodities Slip," by Dawn Kopecki, August 3, 2010.
2 Based on my reading of an advance copy of Arianna Huffington's new book: Third World America: How Our Politicians Are Abandoning the Middle Class and Betraying the American Dream, Crown Books, September 2010.
Endnote: Jane Wollman Rusoff interviewed me for Research Magazine's May cover story, "Finding the Culprits of the Crisis," about the deep monetary connections of Wall Street and Washington and the corrosive effect it has had on the economy and the Republic.
1. Doesn't the following imply 'criminal' insider manipulation of coal prices, and therefore energy costs globally? "The bank took a short position so enormous that it was oversized relative to the global coal market..."
2. If "He who sells what isn't his'n, must buy it back or go to pris'n" is the Wall Street maxim, why are they allowed to bet on the price of stocks/commodities/derivatives that they don't actually own? The entire modern stock market appears to driven by non-ownership, like they are gambling in Vegas without having to use their own money.
Reinstate The Uptick Rule.
Impose a Financial Tax on each stock trade to address High Frequency Trading Abuses.
Financial Enforcement of Fraud is at a 20 year low when it should be at a 20 year High.
Regulate and Void Derivatives. No one should be able to profit when your house burns down without an actual insurable risk.
End FAS 157 Mark To Fantasy.
http://www.zerohedge.com/news/five-banks-account-96-250-trillion-outstanding-derivative-exposure-morgan-stanley-sitting-fx-de
The top 4 banks: JPM with $78.1 TRILLION in exposure,
Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively.
And that's your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return.
It doesn't take a lot of brains to be stable enough to attract retail and small commercial depositors to make deposits, to hold reasonable capital in reserve, to pay attractive (but realistic) interest on your depositors' deposits, and then loan that money out to individuals and small businesses at an appreciated interest rate of return.
Just make sure that the spread between what you pay out, and what you take in is more than enough to cover potential losses from potential defaults. Small, but steady profits result.
Remind me again why it is a bad idea to require retail and investment financial 'banking' to be in separate companies?
The american people aren't even being given a chance to vote for someone who supports majority positions because both parties have been bought off. If we ad a real president, this episode would have him at the bully pulpit speaking to america about the need for a tough volker rule. Yet he's silent. People protesting BofA are attacked by Romney and this company has a history of illegal activity that should have the senior management in jail and the company shut down.
Adding insult to injury the police in Charlotte have been given new powers to in effect arrest anyone, who protests BofA's illegal activity. This isn't the USA I was born and raised in, It's a kleptocracy and I think the end game will be violent because the system doesn't seem to be able to reform.
Continued voting for the corporate-controlled two-party duopoly will accomplish no meaningful reforms.
There are two options:
o MASSIVE and peaceful movement, like civil rights
o Second revolution
That JPM et al cannot manage risk after all the warnings they have gotten these past few years is staggering. What do they intend to due if/when all the arcane derivatives that entangle US banking with Europe explode and turn it's slow motion collapse into cardiac arrest? I just cannot believe these are the people running important if not critical institutions in our country. I don't know who are the real villains. The bankers and other financial wolves or the regulators and politicians who have stood idly by just waiting for their turn to double dip and work the private sector they just got done supposedly regulating for US.
I find it scary, incredibly scary but only a fraction of the fear I feel from the utter lack of response in the past 3 plus years from Obama, Geithner, Summers, et.al. That is what is scary to me especially in light of the fact that Obama is still more likely to do something proactive than is Romney.
From where i sit, we are doomed when our choice is between Obama and Romney. It feels like 1898 all over again. But at least then the government was determined to protect its citizens from the tyranny of the 1%.
One year ago HuffPost’s JPMorgan headline was: “JPMorgan's First Quarter Profit Rises 67 Percent” April 13, 2011
www.huffingtonpost.com/2011/04/13/jpmorgan-profit-first-quarter_n_848478.html