11 May 2012

JP Morgan Failure Shows the Incompetency of the Fed As Regulator And a Corrupted Government

...And They Repeatedly Fail to Protect the Public From It.
"How can we expect righteousness to prevail when there is hardly anyone willing to stand up for a righteous cause?

Such a fine, sunny day, and I have to go..."

Sophie Scholl, last words

The spin machine is revving up, and the spokesmodels are gesticulating wildly, in an effort to direct and deflect this failure of governance at JPM.
See how manfully Jamie Dimon has come clean on this. And look how well the Fed's capital standards are protecting us from a failure at JPM because of this unfortunate but 'manageable' trading mistake.  

Jamie and the regulators could not possibly have known (CEO defense) what was going on in their firm because the world is now so complex.  They will try and work harder so don't disturb them or bad things will happen to us and it will be your fault.  But this will be a buying opportunity!
A craven Congress, dominated by a hard core of one-percenter bully boys, an Obama Administration intimately tied to Wall St. cronies, and the Federal Reserve, which is a private institution of financial establishment insiders making a weak attempt at self-regulation cloaked in secrecy, have failed the public once again.

Simon Johnson points out what many may miss in all this. The side effects of the continuing campaign by the banks' lobbyists to weaken reform have given us a hint of the next financial crisis to come which will be caused by a collapse in the derivatives market. And who could have seen it coming.

And I would like to make the point, and nail it to the door of the spineless media, that JPM had to admit, while the position was still open, that their 'hedge' had blown up in their faces, and that it was no hedge at all, but a thinly disguised attempt to circumvent the curbs on proprietary trading.  More simply, they were preparing to flout the law and were brazenly lying about it, and their use of leverage and very risky bets in search of enormous bonuses.  And they are doing the same thing on a much larger scale in other markets.

And it is no coincidence that financial fraud prosecutions under the Obama Administration are at a twenty year low, and the media and even his political opposition say almost nothing about it.
"All governments suffer a recurring problem: Power attracts pathological personalities. It is not that power corrupts but that it is magnetic to the corruptible."

Frank Herbert
The credibility trap has captured our leadership. They cannot change course without admitting their failures, and to admit their failures is to weaken or even lose their grip on power. And so it's steady as she goes, onto the rocks. Better a general than a personal failure, risking other people's lives to protect your gains, because there is opportunity in a crisis as long as you still have a seat in the game.

The cheating, stealing, and lying will continue until the system finally collapses, or until the people finally wake up, take responsibility for their government, and demand meaningful reform.

JP Morgan Debacle Reveals Fatal Flaw In Federal Reserve Thinking
By Simon Johnson
May 11, 2012

Experienced Wall Street executives and traders concede, in private, that Bank of America is not well run and that Citigroup has long been a recipe for disaster. But they always insist that attempts to re-regulate Wall Street are misguided because risk-management has become more sophisticated – everyone, in this view, has become more like Jamie Dimon, head of JP Morgan Chase, with his legendary attention to detail and concern about quantifying the downside.

In the light of JP Morgan’s stunning losses on derivatives, announced yesterday but with the full scope of total potential losses still not yet clear (and not yet determined), Jamie Dimon and his company do not look like any kind of appealing role model. But the real losers in this turn of events are the Board of Governors of the Federal Reserve System and the New York Fed, whose approach to bank capital is now demonstrated to be deeply flawed.

JP Morgan claimed to have great risk management systems – and these are widely regarded as the best on Wall Street. But what does the “best on Wall Street” mean when bank executives and key employees have an incentive to make and misrepresent big bets – they are compensated based on return on equity, unadjusted for risk? Bank executives get the upside and the downside falls on everyone else – this is what it means to be “too big to fail” in modern America.

The Federal Reserve knows this, of course – it is stuffed full of smart people. Its leadership, including Chairman Ben Bernanke, Dan Tarullo (lead governor for overseeing bank capital rules), and Bill Dudley (president of the New York Fed) are all well aware that bankers want to reduce equity levels and run a more highly leveraged business (i.e., more debt relative to equity). To prevent this from occurring in an egregious manner, the Fed now runs regular “stress tests” to assess how much banks could lose – and therefore how much of a buffer they need in the form of shareholder equity.

In the spring, JP Morgan passed the latest Fed stress tests with flying colors. The Fed agreed to let JP Morgan increase its dividend and buy back shares (both of which reduce the value of shareholder equity on the books of the bank). Jamie Dimon received an official seal of approval. (Amazingly, Mr. Dimon indicated in his conference call on Thursday that the buybacks will continue; surely the Fed will step in to prevent this until the relevant losses have been capped.)

There was no hint in the stress tests that JP Morgan could be facing these kinds of potential losses. We still do not know the exact source of this disaster, but it appears to involve credit derivatives – and some reports point directly to credit default swaps (i.e., a form of insurance policy sold against losses in various kinds of debt.) Presumably there are problems with illiquid securities for which prices have fallen due to recent pressures in some markets and the general “risk-off” attitude – meaning that many investors prefer to reduce leverage and avoid high-yield/high-risk assets.

But global stress levels are not particularly high at present – certainly not compared to what they will be if the euro situation continues to spiral out of control. We are not at the end of a big global credit boom – we are still trying to recover from the last calamity. For JP Morgan to have incurred such losses at such a relatively mild part of the credit cycle is simply stunning.

The lessons from JP Morgan’s losses are simple. Such banks have become too large and complex for management to control what is going on. The breakdown in internal governance is profound. The breakdown in external corporate governance is also complete — in any other industry, when faced with large losses incurred in such a haphazard way and under his direct personal supervision, the CEO would resign. No doubt Jamie Dimon will remain in place.

And the regulators also have no idea about what is going on. Attempts to oversee these banks in a sophisticated and nuanced way are not working.

The SAFE Banking Act, re-introduced by Senator Sherrod Brown on Wednesday, exactly hits the nail on the head. The discussion he instigated at the Senate Banking Committee hearing on Wednesday can only be described as prescient. Thought leaders such as Sheila Bair, Richard Fisher, and Tom Hoenig have been right all along about “too big to fail” banks (see my piece from the NYT.com on Thursday on SAFE and the growing consensus behind it).

The Financial Services Roundtable, in contrast, is spouting nonsense – they can only feel deeply embarrassed today. Continued opposition to the Volcker Rule invites ridicule. It is immaterial whether or not this particular set of trades by JP Morgan is classified as “proprietary”; all megabanks should be presumed incapable of managing their risks appropriately.

Read the rest here.