Jamie Dimon appeared before Congress yesterday to testify about both recent multibillion dollar trading losses at the company's Chief Investment Office and proposed regulatory changes resulting from the Dodd-Frank Act. Mr. Dimon acquitted himself well. He apologized for the series of errors that led to the massive trading losses, and he asked for quality regulation instead of quantity regulation. JPMorgan shares posted moderate gains during his testimony. So far this afternoon, those gains are sticking. The industry couldn't have a better spokesman.
JPMorgan's loss is a concern but not a crime. It is a concern for shareholders who assumed the risk of buying stock, and they have appropriately suffered a significant decline in market price. Depositors did not suffer and neither did taxpayers. The banking system was not jeopardized beyond adding to the emotional mistrust of Wall Street. The loss incurred will be an earnings issue and not a balance sheet issue. This means that in spite of the multi-billion dollar amount, it is quite manageable by a company that earns $2-$3 billion per month before taxes.
Investors lack conviction amid the banking drama on Capitol Hill and the denial that is all the rage across Europe. No matter what anyone tells you, it stands to reason that this European crisis is significant and will be around for quite a while longer. What will markets do? Follow the money. As long as there is dry powder, we see no reason to believe that this cycle of crisis/response will end any time soon.
The Jesuits in high school asked us theology questions like "if God is omnipotent, can He create a rock that is too big for even God to lift?" Central bankers are not gods, and there are certainly problems too large for them to cure. With 10-year yields at 1.65% and 30-year fixed-rate mortgages less than 4%, how much additional economic activity can we expect if rates fall another half-a-point? This is another way to say that central bankers, especially in the US, may be "pushing on a string." Their actions certainly cause asset prices (including stocks) to go up, but are they really helping the economy to heal?
Credit concerns leading to higher funding costs, leading to graver credit concerns, is a debt trap. This is happening in Spain and Italy. Spain's GDP is twice the size of Ireland, Portugal and Greece combined, and Italy is much larger than Spain. This problem is not getting cured, and it will not be solved by increasing the debt load of any of these countries.
This week the European Central Bank said,
While these five areas provide the necessary critical foundations upon which a sustainable monetary union must be based, there is now a need to go beyond these areas and conceive a banking union as an integral counterpart of Monetary Union. Such an endeavor would clearly take time to implement and could require legal changes. But once in place, three critical objectives could be achieved:
First, strengthening the euro area-wide supervision of the banking sector in order to reinforce financial integration, mitigate macroeconomic imbalances and, therefore, improve the smooth conduct of the single monetary policy.
Second, breaking the link between banks and sovereigns -- which significantly exacerbates the impact of any financial disturbance -- also by establishing a European deposit guarantee scheme and resolution arrangements.
Third, minimizing the risks for taxpayers through adequate contributions by the financial industry.
We've written before that the European banking system is very different from ours. They are much more closely tied to their respective governments, and their outstanding debt is enormous relative to the GDP of their home countries. Keeping European banks liquid and operating has been challenging and will continue to be challenging. Without the help of an FDIC-type guarantee for depositors, funding and stabilizing individual European banks is may be daunting.
Amidst this ongoing volatility, investors need to be very careful with their money. There is great temptation to jump on the short-term momentum trade. This typically pulls them away from established discipline and closer to peril. Stay diligent, disciplined, and dispassionate. Invest for the long-term. Believe in America. And remember, this too shall pass.