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The MSM article of the day is a NYT takedown of JP Morgan’s raping and pillaging of various cities and pension funds. The accusation: Shared profits, client’s losses. When hedge funds do this, the private placement memorandum covers the terms. It is less clear that a brokerage firm can do this legally.

This follows Matt Taibbi’s March 2010 takedown of similar JPM misdeeds, Looting Main Street.

NYT Excerpt:

Here is the deal: Funds lend some of their stocks and bonds to Wall Street, in return for cash that banks like JPMorgan then invest. If the trades do well, the bank takes a cut of the profits. If the trades do poorly, the funds absorb all of the losses.

The strategy is called securities lending, a practice that is thriving even though some investments linked to it were virtually wiped out during the financial panic of 2008. These trades were supposed to be safe enough to make a little extra money at little risk.

JPMorgan customers, including public or corporate pension funds of I.B.M., New York State and the American Federation of Television and Radio Artists, ended up owing JPMorgan more than $500 million to cover the losses. But JPMorgan protected itself on some of these investments and kept millions of dollars in profit, before the trades went awry.

How JPMorgan won while its customers lost provides a glimpse into the ways Wall Street banks can, and often do, gain advantages over their customers. Today’s giant banks not only create and sell investment products, but also bet on those products, and sometimes against them, putting the banks’ interests at odds with those of their customers. The banks and their lobbyists also help fashion financial rules and regulations. And banks’ traders know what their customers are buying and selling, giving them a valuable edge.

Some of JPMorgan’s customers say they are disappointed with the bank. “They took 40 percent of our profits, and even that was O.K.,” said Jerry D. Davis, the chairman of the municipal employee pension fund in New Orleans, which lost about $340,000, enough to wipe out years of profits that it had earned through securities lending. “But then we started losing money, and they didn’t lose along with us.”

How did an industry that began by servicing their clients end up as an industry that only robs them? When I was coming up, financial services were a noble way to help people save for retirement; it appears to have morphed into something entirely different . . .

See related video here.

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Source:
Banks Shared Clients’ Profits, but Not Losses
LOUISE STORY
NYT, October 17, 2010
http://www.nytimes.com/2010/10/18/business/18advantage.html

Category: Derivatives, Investing, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

38 Responses to “Shared Profits, Not Losses”

  1. b_thunder says:

    So, Steven Rattner in comparison with JPM was a “choirboy” ?

    Question #1: WTF are the pension fund managers are getting paid for? For giving the fund’s money to JPM to gamble? If JPM has no downside, naturally JPM will gamble to maximize potential profits! Why those fund fund managers are not sharing cell with Madoff?

  2. Yes, it’s all true, banks can’t really provide enough opportunities to get retired in a wealthy positions, because really such powerful banking institutions as JP Mprgan serves it own purpose – gaining profit!
    But it also means that people have to be aware of his fact and try their best to make their financial future their own way.

  3. perra says:

    And here I thought my tax dollar was a bad investment….

  4. BrianMcC says:

    So this is basically the same as backing someone in a poker tournament. The funds put up the entry fee and JPM is their “horse” in the tournament. Ask anyone in the poker world how often that works out for the backer. More often than not the guy you are backing has had some big wins and has been on TV a few times, and he’s capable of brilliance, but he’s got some serious leaks, possibly a lifetime loser if you were ever able to get a full accounting, which is why he’s always broke looking for a rich guy to put him in action.

  5. dead hobo says:

    How does this differ substantially from the commission system known as 2/20? My understanding of 2/20 is the asset manager gets 2% for managing the account and receives 20% of the profits. The 2% is always due. The 20% is from an agreed upon point in time. For example, if the account loses money, then the 20% resumes at an agreed upon date when the account begins to rise again. Thus, the account owner may pay 2/20 over the same assets over and over again if frequent losses occur. The asset manager shares none of the risk and only suffers lowered gains if losses occur.

    Please correct me if this understanding is wrong.

  6. s1gins says:

    Amazingly when I mentioned Sec lending on some of our plan’s DC investment funds with an investment manager, they were offended tha tI would raise the question!

    b_thunder, you are using the wrong word – gamble- in all of these cases the sec lending invests in very staid securities that are short in nature and of “high” quality. While recent, rapid bankruptcy of previously sound companies has caused pain, the real problem is the mismatch in a declining rate environment between the the investments and the repos…

  7. Mannwich says:

    Somewhere along the way, this country ran out of legitimate ways to make money, or it was simply easier to do it this way. Think Occam’s razor, especially when there’s no penalty for breaking the law anymore.

    Without such predatory “businesses”, our economy would be in serious trouble.

  8. wally says:

    “But then we started losing money, and they didn’t lose along with us.”

    Well, OK… but the time to address this is when you sign a deal with them, not later when you whine about the results.

  9. Mannwich says:

    Exactly wally. That is pretty pathetic. How much do these so called money “managers” make to supposedly manage OP’sM?

  10. PDS says:

    the stock loan departments on Wall St are huge profit centers for the bulge firms…they are a racket…imagine…an individual or institution signs a margin agreement that allows the broker to lend out their securities to, say a hedge fund as “as service” provided via their prime broker dept, and they, the broker, collect a fee or as it is c0mmonly called “a rebate”…of course this rebate is not shared with the owner of securities….something for nothing…which is the norm on Wall St

  11. george matkov says:

    Yes, the banks steal everyone blind at every opportunity but not in this case:
    - these pension funds are managed by ‘professionals’ earning six-figure salaries plus ‘performance bonuses’. They are 100 % responsible for these losses.
    - this is another consequence of ZIRP leading to a desperate ‘chase for yield.’
    - Dimon refused to be interviewed probably because he wouldn’t be able to keep from laughing at the stupidy – and cupidity- of these idiot money managers.

    just my 2-cents worth.

  12. dead hobo says:

    wally Says:
    October 18th, 2010 at 10:22 am

    “But then we started losing money, and they didn’t lose along with us.”

    Well, OK… but the time to address this is when you sign a deal with them, not later when you whine about the results.

    reply:
    ————
    The pension managers were probably handled by a very friendly sell sider who would burst with anger if anyone suggested that the pensions would not fare well throughout the sales cycle. They were probably told they didn’t need to read the contract because it was, of course, a standard contract. The pension managers also probably got a really good meal at a really nice restaurant while being wooed. They were probably treated as if they wouldn’t be liked or respected if they didn’t just go along and be as smart as everyone else appears to be.

    The easiest people to rip off are the ones who think they’re too smart to be taken advantage of and, as my departed father firmly believed “When you go with the big names, you can’t do any better. Besides, people will respect you if you say you are a part of something big that everyone respects.” He managed to make it through life in simpler times. These pension dumbfucks are another story. Anyway, it wasn’t their own money they were investing, after all. They’re all still employed, I’m quite sure.

  13. Petey Wheatstraw says:

    OT, from The Onion:

    Microlender Forecloses On Goat
    OCTOBER 18, 2010 | ISSUE 46•42

    SAN FRANCISCO—Representatives from One World Finance, a U.S.-based microcredit provider, confirmed Monday that they had initiated foreclosure proceedings on a goat in southern India following a borrower’s repeated failure to make her $2.20 monthly loan payments. “I tried to work with Ms. [Subha] Thangam on this, but once she fell a full $6.10 behind, I had to repossess the goat,” said loan officer Michael Conrad, who stated that he was just doing his job and that it was “not [his] fault” if certain subsistence farmers were living beyond their means. “I’d love to recoup the entire $22 loan at auction, but given the glut of foreclosed and abandoned goats in the area, I’d be lucky to get even half that.” Conrad also acknowledged that the owner had left the goat in “pretty bad shape” and had even stripped it of its hair for potential resale on the paintbrush market.

    http://www.theonion.com/articles/microlender-forecloses-on-goat,18278/

  14. - these pension funds are managed by ‘professionals’ earning six-figure salaries plus ‘performance bonuses’. They are 100 % responsible for these losses.
    - Dimon refused to be interviewed probably because he wouldn’t be able to keep from laughing at the stupidy – and cupidity- of these idiot money managers.
    ~~

    these flippin’ “Fund Managers” are the ones that need to be ‘outed’..

    Who? are/were They? What? did They receive in return for their ‘Investment Decisions’?

    and, really, Why? are ‘Taxpayors” going to be given (a/another) Bill to ‘top up’ the, now, further, depleted “Funds” They were hired to Manage?

  15. ACS says:

    How did this become acceptable fiduciary practice?

  16. rktbrkr says:

    The TBTF run the same game with US, heads they win, tails, do-over

  17. dead hobo says:

    Or, then again, maybe the pension managers were stupid enough to agree to a 2/20 scheme for their idle cash? Oh well, to them it’s OPM. No biggie.

  18. Petey Wheatstraw says:

    ACS Says:

    How did this become acceptable fiduciary practice?
    __________

    Deregulation, in the broadest sense of the term. For example, 2 + 2 = 5.683. See? Just because it’s incorrect, doesn’t mean it’s wrong.

  19. And don’t forget that pension fund managers are basically charged with not making stupid investments, i.e., everything has to be AAA, etc. Which, of course, means nothing. But what the fuck. They manage the retirement funds of teachers and other beknighted public servants. So, throw these contracts out, too (along with the mortgages and promissory notes of the employees represented in the pension fund) . Then put JPM in the slammer. Yeah. The whole goddamn bank. Rush in early one Monday morning and put ankle bracelets on everyone in their headquarters.

    All this rear-view-mirror looking ain’t gonna get us anywhere. It’s like we arrived at a place we didn’t wish to go, and now want to crucify the driver because he got us there too fast.

  20. Arequipa01 says:

    Anyone remember Charles Millard?

    http://tpmmuckraker.talkingpointsmemo.com/2009/03/genius_federal_pension_guarantor_switched_from_bon.php

    Posterboy of the Death of Fiduciary Responsibility. Why are we surprised? Enron electricity traders were actively seeking to bankrupt ‘granma in Pasadena’. Sociopathy, it’s in the air.

  21. bmoseley says:

    you seem to have forgotten the book from the 1920s: Where are the customers Yachts.
    is anything really new with Wall St.
    they haven’t been this bad since the 20s, but they were over the history of the US: eg robber barons.

  22. AHodge says:

    pension funds and life insurance companies baby
    thats where mostof the trillion or so still unmarked and unrealized losses are…

  23. rat89 says:

    re: question posed by dead hobo:

    “How does this differ substantially from the commission system known as 2/20? ”

    It’s a great question, really. My immediate thought is that here the risk comes not from the potential loss due to management of the funds, but from potential loss derived from trades made by the third party who borrows the shares, and who has no relationship to the primary investor (the pension fund).

    By pressuring the pension fund to accept the arrangement the bank, it would seem to me, is violation any fiduciary responsibility they have to the pension fund. The third party investor is out on margin, using someone else’s asset as seed money. Who know what risk the third party investor has, but the bank as the middleman has none, and the pension fund not only has risk, but has no control over the investment.

    My next thought is that when we talk about various unfunded pension liabilities, I have to wonder whether they would be in the position they are in if they weren’t taking on this risk, either willingly or unwillingly, and going for that extra half percentage point. Is this so different than the retirees who put money into funds that invested in cdo’s and mortgage backed securities because they were chasing that extra point in yield thinking that there was no risk involved?

    The overwhelming message here is that there is no such thing as free money.

  24. notakid says:

    “It’s like we arrived at a place we didn’t wish to go, and now want to crucify the driver because he got us there too fast.”

    I think the term you were searching for would be “extraordinary rendition”

  25. DeDude says:

    Unbelievable that the pension funds agreed to such an arrangement. If anybody wanted to borrow stocks they should be paying a rental fee and the iBank should guarantee the return of the stocks (and take the full loss if they are not returned). Looks to me as another case (just like the CDO’s) of pension funds reaching for yields and getting into something they don’t quite understand. But it is the responsibility of the iBanks to fully inform the pension funds about what the products, potential yields and risks are – did they do that?

  26. JerseyCynic says:

    ACS

    How? — by putting the douche in fiduciary!

    CURMUDGEON —

    speaking of AAA,

    what do you think would happen if some of us over 50 folk…

    (who got a crappy start in the housing market late 80′s, sat tight while the shit storm took our 401′s down the toilet early 2000′s, then dumped all kinds of pretend equity money doing our part as little consumers to kick start the economy because these banks let us use our homes as ATMs throughout the 2000′s)

    were to take the penalty of early withdrawal on their retirement accounts now and use the proceeds to pay off
    their mortgages?

    I’m getting nervous that “they” really are going to come after our retirement accounts next.
    I didn’t jump on the scare wagon earlier this year when I stumbled upon this piece at pravda:

    PREPARE NOW TO AVOID (_______’s) RETIREMENT TRAP ( of course pravda/Ron Holland used obama’s name in his piece. he could have put the names of any of our past puppets):
    http://english.pravda.ru/opinion/columnists/15-01-2010/111678-retirement-0/

    but now I’m seriously thinking about becoming COMPLETELY debt free — the house is the only thing left.

    We’ve gambled and lost the whole way through this american dream thing and I’d just as soon get out now while the getting is good (?10%ish).

  27. Long term says:

    The pension fund mgrs are certainly guilty of incompetence.

    However, if you trace the pressure back to the source, it is often the folks who work at the companies. They want the higher returns and would surely have hassled pension fund mgrs for being conservative during a period of ostensible high returns. I know this firsthand because the 401k plan at my institution is limited such that only high-risk instruments are available. I have brought this up many times with co-workers and nobody cares a whit. People have to care before ownership and risk mgmt arrive.

  28. DeDude says:

    It seems like we need a ban on insured and public pension funds lending out their stocks. Maybe an exception can be made for lending out stocks provided the potential loss is 100% insured by the iBank arranging for the lending.

  29. ACS says:

    Thanks Petey, I tried that equation on my claculator but kept getting the wrong answer. Guess that’s why I’m not running a pension fund.

    DeDude, seems to me that any reasonable definition of fiduciary responsibility would exclude any scheme of heads I win, tails you lose, but hey, I guess that’s why I’m not running a pension fund. BTW, how would your ban affect short selling; does most of the borrowed stock come from those funds?

  30. [...] Securities lending from the bank’s perspective: heads I win, tails you lose.  (NYTimes, Big Picture) [...]

  31. DeDude says:

    ACS; it would make short selling more expensive. If the iBank rather than pensioners had to carry the risk of short selling (collapses) then the price would be set higher.

    What the iBanks are doing with short selling is similar to what they did with their CDO/MBS scams. Harvest the fees and pass the risk. They have zero interest in managing the risk when they don’t suffer any of it – and can harvest profits on each transaction. It gets even worse when you allow them to bet the other side of their clients trade. It’s a no brainer, you have to change the incentives in this game.

  32. ACS says:

    Maybe even shut down some of the games!

  33. DeDude says:

    Problem with fiduciary responsibility is that it is a pretty fuzzy concept in the context of the law. If there is pressure to get higher yields, we all know that increased risk is part of the game. When does the risk benefit analysis cross the line of unacceptable in the context of fiduciary responsibility? A lot easier to just set a rule in stone, so the public will not have to bail out insured pension funds after the pension fund managers and iBanks have ripped them off and are long gone with their bonuses and fees (I mean fool me once, shame on you, fool me twice, aaa-hmm-I wont be fooled again).

  34. DeDude says:

    I am not sure if completely shutting down short selling is a great idea. It may serve a certain very limited positive purpose in our financial system, by countering absurd overvaluing (and putting a brake on pump-and-dump). However, I don’t see anything wrong in changing the incentives such that a stock has to fall at least 10% before the short seller breaks even.

  35. rch says:

    I’m sure that Barney Frank and Dodd fixed all this in the finanical reform bill….right?

  36. HarleyHoward says:

    60% of the profits and 100% of the losses?? WTF!! Whoever signed those agreements should be sued for breach of fiduciary trust, fired, and have their pay and bonuses confiscated! The bankers? Prosecute them for theft, jail them, and confiscate their ill gotten gains!

  37. [...] never ending parade of stock scandals seems to continue unabated, the stock lending scam being only the most recent. As history has shown us — from Mexico to Orange County to analyst [...]