What JPMorgan wont tell you

JPMorgan has been in all the business headlines owing to its shocking $2bn trading loss. This has lead to a revival of debates questioning whether these ‘megabanks’ are actually beneficial to the society. The banks believe that they bring economies of scale, therefore higher efficiency. The critics have argued against the high levels of leverage maintained by these financial institutions and the risks associated with it.

The current crisis has also revealed that very little has changed following the 2008 global financial crisis. Lessons that should have been learned have been completely ignored. The recent loss is associated with trading credit derivatives, almost similar investments were made four years ago which started the global recession.

Anat Admati, Professor of Finance and Economics at Stanford Graduate School of Business, asked some tough questions about one and a half year ago, whose relevance has all the more improved in the wake of the recent developments.

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The questions, with the relevant link to the main article are posted below.

(i) Is "too big" the same as "too big to fail?"

(ii) Do capital requirements force banks to "set capital aside for a rainy day" and not use it to help the economy grow?

(iii) Are banks different than non-banks in that high leverage is essential to banks' ability to function?

(iv) Would terrible things happen if capital requirements were to increase dramatically?

The first order of business is to clear the fog and focus on the right things. I will try to explain. With the basics in place, answers will begin to emerge, or at least the right questions to ask.

By the way, I answer an emphatic NO to each of the above questions.

Admati, A. (2010). What Jamie Dimon Won’t Tell You: His Big Bank Would Be Dangerously Leveraged. The Baseline Scenario. [Onine]

Link: Click Here. (Opens in New Window)

Your comments and feedback are always appreciated.

Sarfaraz A.K.

sarfaraz@when.com

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JPMorgan reports $2bn trading loss

JP-Morgan Delivers a Shocker and Voldemort was responsible 

The biggest US bank, JPMorgan has reported a trading loss of at least $2bn on Thursday. The CEO Mr. Jamie Dimon said in the press conference arranged after the markets closure, “errors, sloppiness and bad judgment” were committed by the bank that caused the monumental loss, which “could get worse”. The bank had adopted a risky hedging strategy which could take the total loss to $3bn. The strategies adopted have been "riskier, more volatile and less effective" than originally thought.

Net losses, after accounting for all other inflows and outflows, are expected to cross $800 million by the end of the second quarter. 

The news of the loss caused JPMorgan’s shares to slide by 9%. Effects were also felt by other banks in US and Europe with Bank of America’s shares falling by 2.4%, Barclays 3.5% and Deutsche Bank 1.6%.

JPMorgan’s business unit called Chief Investment Office (CIO) is responsible for hedging the bank’s portfolios of individual holdings. Fluctuations in prices can decrease the value of an asset which can be very costly to a business or individual. To reduce this risk, banks and other financial institutions practice “hedging” whereby the cost of an asset is mutually agreed and maintained by two or more parties to eliminate the risk of any future price fluctuations.

JPMorgan’s CIO unit was responsible for hedging the risks. Mr. Bruno Michel Iksil, a JPMorgan trader based in London who was responsible for making bets as part of his hedging strategy, which is often practiced by the bank, but this time it failed. Mr. Iksil is a well known within the trading circles and is often referred to as the “London Whale” and “Voldemort”.

The Bank is not expected to report any profit, or breakeven, in the first quarter of 2012.  It is not only embarrassing for JPMorgan but the entire banking industry. It was one of the few banks that had enjoyed consumer confidence and was able to rise up from the 2008 global recession more quickly than its rivals. Potential investors and regulatory authorities might think that if JPMorgan could do this, then what about other financial institutions? The news is bound to invite even tighter financial rules.

According to the New York Times, the Federal Reserve and Financial Services Authority, UK’s banking regulator, came to knew about the trading losses a month ago and were having discussions with the concerned bank.

Impact on Volcker Rule

The Volcker rule is one of the primary provisions of the 2010 Wall Street Reform law originally proposed and named after the former Federal Reserve chairman Paul Volcker. The provision aims to put restrictions on banks on making speculative and risky investments that might not benefit the customers or the shareholders. There have been news about banks and other financial institutions lobbying to soften the clauses of Volcker rule but the current events will put an end to such activities. The law is currently being finalized and will be implemented from the third week of July, 2012.

JPMorgan has earlier claimed that tougher financial regulations come with a hefty price tag for the banks and increase their costs up to $600 million. The bank has often publicly criticized the Volcker rule.

Rep. Barney Frank, one of the authors of the rule has said, “The argument that financial institutions do not need the new rules to help them avoid the irresponsible actions that led to the crisis of 2008 is at least $2 billion harder to make today”.

All eyes on JPMorgan

The shocking news of the trading loss has attracted attention not only of the global media but regulators, analysts, economic pundits, and above all the Securities and Exchange Commission. Its chief Mary Schapiro has said, “I think it's safe to say that all the regulators are focused on this."

Ratings Downgrade

Fitch, one of the leading credit rating agencies, have downgraded JPMorgan's long term and short term debt.  The ratings agency believes that although the loss is "manageable" but the bank will face some short term liquidity problems. 

Standard and Poor have revised the bank's ratings to "negative", indicating a possible decline in ratings in future.

Your comments and feedback are always appreciated.

Sarfaraz A.K.

sarfaraz@when.com

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