Corzine Syndrome: JPM's Stealth Prop Trading Unit Was Crafted for Risky Profit and Reported Directly To Jamie Dimon

I want to put a spike in all this spin around the CEO defense, that poor Jamie could not have possibly known what was going on in London because the company was so large, and he is such a busy man. Sarbanes-Oxley was designed to put a stop to that lame excuse touted out by defense lawyers and apologists in the media every time something like this happens.

The CIO operation was transformed under Jamie's direction as a dodge to the impending Volcker Rule, set to take effect in July, that prohibited this kind of risky prop trading by institutions backed with deposit insured money and both explicit and de facto government guarantees.

He wanted it up to be what it was, an opaque profit center.   It probably sounded like a good idea, taking a risk hedging and reduction function and turning it in to a profit center.   Because of the accounting differential between the CIO and the portfolios it was alleged to hedge,  one could take profits and not realize losses in a quarter, which provided a nice billion dollar cushion for earnings.   Every industry has their accounting dodges like this that allow a company to 'manage earnings.'  In tech it is in acquisition accounting and inventory writedowns.

But in their clumsy piggishness, the JPM CIO traders took their usual overly large and manipulative positions, as they have done in other markets, masquerading as hedges. But this particular credit market was too narrow and specialized, and they stepped on the toes of savvy market insiders.  And it blew up in their faces.

When the media called Jamie on it a few months ago, after traders complained that 'the London Whale' was rigging market prices, he called it a legitimate hedging operation and dismissed it as 'not a problem.'

The same thing is going on in other markets as well, even now, and on a much larger scale with larger positions and more leverage. The difference is that it is smaller traders and the public that are being hurt, while much of the risk is being misrepresented and unrealized, for now.

And so the regulators are sitting on their hands and doing nothing about it because they are being discouraged from taking action by powerful interests in the Administration and the Congress.   JPM has long been known as the government's 'go to guy' when something needs to be done to unofficially intervene in markets.

Remember, it was pressure from the Geithner Treasury and the Fed at the behest of JPM that created the loophole that would have permitted the CIO unit to continue to function as a prop trading unit even after the Volcker Rule supposedly shut such risky ventures down.

And they are afraid of what will happen to JPM if these market positions, particularly in the derivatives and metals markets, are exposed for what they really are, and their own involvement in allowing it to happen for so long.  That is the credibility trap, and the reason for the remarkable lack of investigation and prosecution of financial fraud.

International Financing Review
JP Morgan investment unit played by different high-risk rules
16 May 2012

The JP Morgan Chase unit that lost more than US$2 billion through a failed hedging strategy had looser risk controls than the rest of the bank, according to people familiar with the situation.

The risk of losses is tallied by the bank using a so-called value at risk (VaR) calculation. However, the Chief Investment Office, the unit responsible for the high-profile loss that JP Morgan disclosed last Thursday, had a separate VaR system.

It used a less stringent calculation that gave a lower risk assessment of its trades, according to people who previously worked at the bank.

The unit also reported directly to CEO Jamie Dimon, a factor which allowed it to maintain a separate risk monitoring set-up to other parts of the investment bank, these people said.

“It was very large, but was never very transparent, and it wasn’t clear that they had an appropriate funding cost,” said the source with direct knowledge of the CIO. “They were running more risk than the investment bank – and with no peer review process (from those in the investment bank).”

Despite repeated warnings from executives inside the firm as long ago as 2005, the CIO unit remained notably free from oversight.

A source with knowledge of the situation said that these warnings included the size of the CIO, the fact that its risk reporting was not transparent and the scope for the unit to get “bigger and bigger” because it had a lower cost of funding than the rest of the investment bank.

Until April, the CIO unit’s unusual autonomy allowed it to build up risky positions without triggering alarms.

Indeed, the unit was encouraged to be a profit center, as well as hedging against risk, a source with direct knowledge of the unit said. Ina Drew, who headed the unit, earned more than US$15 million in each of the past two years, making her among the highest-paid executives at the bank and one of the most compensated women on Wall Street.

Drew could not be reached for comment... (Did you check under the bus? That is where masters-of-the-universe like Corzine and Dimon throw the ladies when they are done using them to establish plausible deniability. - Jesse)

Read the rest here.

Gold Daily and Silver Weekly Charts - Facebook, Greece, and the Hollow Men

I am leaving a bit early this evening.

Facebook and Greece are dominating the market, and both in their own ways are contributing to the selling.

The wiseguys see Facebook coming out at around 36-38 and intend to run it up I think to the 60+ are and then dump it for a quick return. So they are raising cash and, gasp, selling even AAPL to do it.

Greece has the markets edgy for all the usual reasons. The status quo does not like it when people stand up to them.

The Open Interest in the precious metals on the Comex is doing some odd things, staying steady or even rising on sell offs. That is not long liquidation yet. It is more of a transfer or ownership and the expansion of 'the big short.'

More on this tomorrow.

SP 500 and NDX Futures Daily Charts - Facebook Cometh Tomorrow Night

Leaving a bit early today. Will catch up tomorrow.

Facebook will price after the bell tomorrow. Expectations are for about $36 per share or so.

There was some interesting hypocrisy on Capitol Hill this morning by the Republicans who are red-faced over the JPM antics, since they have been adamant about turning back regulations.

A friend sent this in to my email.  I did not see it, so I do not know if it is literally true, but if so I thought my friend's observation was brilliant.

I watched part of a press conference today where the NYPD commissioner said, with a straight face, that a $50,000 SUV, stolen in NYC, could be sold in Africa for $150,000. Not surprisingly, not a single person there asked him why, if that was true, someone didn’t simply buy the vehicles and ship them there legally.

Hot Money Bets Backed By Taxpayers: Extreme Moral Hazard of 'Too Big To Fail' - Credibility Trap

The professor makes some excellent points about the real world of finance that bear some serious thought. He certainly left the Bloomberg spokesmodels yammering in search of a sound byte.

He misses a key point however. It is not that Jamie Dimon does not know, or even that he cannot know, about the risky speculation in his firm. It is that the system is so designed now that in the long run he is heavily incented not to care, as long as he can maintain a plausible deniability.  There are management controls, policy, and objectives that flow down from the top in any large corporation.  Dimon had a personal hand in recrafting the CIO to do what it was doing in order to sidestep the Volcker Rule.  This was no rogue operation.

As long as the profits are rolling in, the band plays on and the players keep dancing.

It is the same problem that led to the financial crisis, and the collapse of so many of the brokerage and investment houses, followed by a policy that made a show of reform, but concentrated their recklessness selfishness into a few enormously larger vessels, making them all the more effective at gaming and corrupting the system.

That is the problem one faces when the public is apathetic, and the political leadership is composed of cynically pragmatic dealmakers and shallow but ardent ideologues driven by narrow personal expediency, not firmly rooted in history, moral principles, and stewardship for the broader public trust.

It touches on an age old scheme in the mix of banking and speculation that most modern day economists seem to have forgotten, perhaps conveniently. Better to keep one's nose buried in intricate obfuscation than speak to the heart of things, the things that really matter, and risk professional isolation.

It is a sweet deal when one is permitted to play with enormous sums of money and leverage, keeping the wins for yourself, and laying off the losses on the public, enabled by the Fed and a system thoroughly rotten with corruption.

And when they go along the road with you long enough, you can obtain permission to do almost anything, and have them turn a blind eye to it, rather than be exposed along with you. That is the credibility trap.

"Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country.

When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin!

Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, (bringing his fist down on the table) I will rout you out."

Andrew Jackson, original minutes of the Philadelphia bankers sent to meet with President Jackson February 1834,  Andrew Jackson and the Bank of the United States (1928) by Stan V. Henkels

(h/t Yves)