The disclosure by once future Treasury Secretary and current JP Morgan CEO Jamie Dimon of a sudden and previously undisclosed $2 billion dollar derivative loss should be a wake up call. It unwittingly reveals much about the present state of finance:

• The inherent tension between traders using leveraged risk with Other People’s Money in the pursuit of enormous bonuses is still weighed heavily towards excess risk taking;

• There is no bank in the United States that has demonstrated the ability to manage proprietary trading risks — if they use derivatives and/or leverage;

• It took less than 3 years after the financial crisis peaked for traders to engage in the same sorts of highly leveraged reckless speculative bets that helped crash the economy last time. Imagine the sorts of risks these mis-incentivized desks will be doing when the memories of the crisis fade 10 years after.

• Trades that are so enormous as to be “credit index distorting” are not hedges, but pure speculation. Within banks, apparently the word “Hedging” loosely translates as “speculation.” Actual hedging of existing positions appears to be nonexistent.

• VaR remains a mostly useless concept as applied by banks today. It is a false model of reality whose deviations have devastating consequences. (Call it physics envy)

• At these size trades, the asymmetrical preference for bonuses over risk management is such that even clawbacks won’t work;

• Jamie Dimon, formerly praised as the Capo di tutti capi of bank CEOs, apparently has been more lucky than brilliant. This quarter, his luck ran out.

• Derivatives, because of their enormous built in leverage, are inherently dangerous. They are still financial weapons of mass destruction;

• Too big to fail banks remain a threat to the stability of the global economy.

While this was “only” a $2 billion loss it easily could have been much greater. That banks such as JPM are still putting on trades that distort indices is quite bluntly, astonishing.

The solution to this risk is very very simple: The USA should reinstate Glass Steagall, and repeal the Commodity Futures Modernization  Act.

Until that occurs, the risk of catastrophic failure remains present in the financial system.

>

~~~

Disclosure: Long JPM

Category: Bailouts, Regulation, Trading

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.

53 Responses to “Imperfect, OverReaching, Bonus-Driven Bankers”

  1. [...] Bank reformers say “I told you so.”  (Dealbook also Big Picture) [...]

  2. number2son says:

    And this is why Obama will not get my vote in 2012.

  3. sithlord says:

    While I agree entirely about the reinstatement of GS within the US — how do we respond to the sheepish argument that such an act would only serve to “lessen the competitiveness” of US versus foreign banks. Also, reinstating a Glass Steagall type framework wouldn’t necessarily serve to enhance stability within the global financial system unless UK, EMU, and Asian regulators follow suit, correct??

    ~~~

    BR: how did the deregulation help the competitiveness of US banks the past 30 years if the end result was they blew themselves up?

  4. Wiggs says:

    I dislike Congress as much as the next guy, but why is nobody on the Hill pushing smart and effective regulation of financial institutions (I don’t consider Dodd-Frank to be smart OR effective)?

    And where in the world are the regulatory bodies that are supposed to be policing this type of behavior?

    Very disappointing.

    Looks like bank execs know that the rest of us are still on the hook for their missteps.

  5. [...] like Barry’s rather accute assessment of what this tells us about the fincial markets as they stand [...]

  6. farmera1 says:

    I love this. JPMorgan’s problems weren’t derivatives they were they were “synthetic credit portfolio”. Talk about Bull Shit.

    First they wouldn’t call them insurance because they would have to set aside reserves on their bets, now they call them SYNTHETIC CREDIT PROTFOLIOs.

    Amazing how far humans can go to distort things including ethics , morality and language so they can make millions. This is true especially when we the people pick up the pieces and pay the final bill.

  7. Businessweek 4/19/12: http://www.businessweek.com/videos/2012-04-09/jpmorgan-traders-swap-bets

    ZeroHedge 4/13/12: http://www.zerohedge.com/news/why-jpms-chief-investment-office-worlds-largest-prop-trading-desk-fact-and-fiction

    ~~

    Disclosure: Long JPM

    BR,

    is there a difference between a ‘Trade’, and an ‘Investment’? ;)

  8. dead hobo says:

    I sat here for a few minutes trying to get worked up enough to write something clever. I couldn’t. It’s not worth the aggravation to get worked up about it. This is business as usual See MF Global for another example of recent similar events.

    Look, it’s our job (you, me, the person hiding behind the tree) to subsidize these people. This is why we have congress … to protect the upper class who subsidize those who run the government, most of which were put into congress and government by said bankers and others in a similar protected position.

    Whether I get worked up over it or not, nothing will change. And the Fed will be there to bail out the bankers without penalty if they need it. The FDIC will be invisible. The SEC will be hiding. After all, it’s none of their business. It looks like the losses will be contained so that the only the bottom line is hurt. The potential for larger loss and the incompetent risk management is ultimately OK because it didn’t spread. The magnitude is of no consequence. Nobody except a few clumsy traders will lose their jobs, and that’s where the issue ends.

    I just can’t get too excited over it because it won’t make any difference if I do, except to make me feel bad. The bank will just hire some flacks and they will happy talk their way out of it. These people are royalty. Get over it.

  9. KJ29 says:

    You are right that there are plenty of risks in modern banking and little or nothing has improved. Indeed do we even know we are being told the truth now? The economist Shaun Richards has highlighted another potential flaw in his blog.

    “Another problem: accountancy has been perverted

    Banks do have a way of improving things as if by magic. They simply transfer the trades from their marked to market book to their long-term hold to maturity book. If I was a JP Morgan shareholder I would be very worried about whether this has happened already as well as being concerned for future possibilities of this. It might be how the losses have improved.”

    So has it got better as JP Morgan claim or are we being misled yet again?

  10. machinehead says:

    ‘The USA should reinstate Glass Steagall’ … and yank investment banks such as Goldman Sachs and Morgan Stanley off of the Federal Reserve’s ZIRP sugar teat — surely the most egregious ongoing abuse in the financial firmament.

    Giving ‘free money’ to speculators and expecting beneficial results is about as intelligent as handing a case of wine coolers and the car keys to some rowdy 16-year-olds.

    This is your Kongress on crack.

  11. stonedwino says:

    I honestly think the too big to fail banks don’t know when to stop, when enough is enough and even after the financial mess we have been through, they still don’t get it…they are committing “Sepuku” rather slowly, though this drip, drip, drip of disclosures that they just cannot be trusted to do the right thing and people, one by one will move their money and business elsewhere. This latest JPM fiasco will in my view is the first step in awakening us all to – The solution to this risk is very very simple: The USA should reinstate Glass Steagall, and repeal the Commodity Futures Modernization Act.

    There is zero appetite in Washington to offer another dime to bailout any of these banking psychopaths…the only banking solution is to nationalize these mega banks or break them up into tiny little pieces – they do not add or contribute to the growth of the economy, the country or the average American. JPM with their blatant disregrad should be made an example…chop, chop, chop…

  12. rd says:

    This wasn’t a wake-up call.

    This was the snooze alarm ringing again for the umpteenth time since 2008.

    Despite repeated blatant evidence that these people will gamble our country away like drunks in Las Vegas, the rent-to-own politicans and regulators contineu to believe that people who wear well-tailored suits can’t be incompetent or fraudulent despite history showing that these are the people who do the most damage.

    Instead we continue to throw people in jail with long sentences for a third possession of a dime bag of marijuana while we bankroll and guarantee bankers’ gambling habits without any investigation of potential fraud. Please note that it is unlikely that Dimon and JPM committed fraud here unlike many of the other bankers, just incompetence which presumably justifies another large bonus.

  13. Greg0658 says:

    clever :-/ fyi info onT

    Chris Whallen 8:10am brings up an old phrase, a be careful what you wish for moment > PPT

    all BHO fault not doing anything – NOT and a corportist is gonna be on labors side – KISS not KISBarack – they are calling you out – bedrooms forget it – go for the boardrooms NOW
    ~~
    and then Michelle 8:25am why Spaniards eat ham > proof of religious allegiance :-) during/after old world wars

    gotta say CNBC is real real tv in the Twilight Zone – we control the H we control the V

  14. John Rothe says:

    In addition, wasn’t there a possible $1 billion more that may be reported next quarter. Ouch. This is going to get the whole “break up the banks to pre 2000″ argument going again. Congress will use this as an opportunity to show that they are “watching out for the little guy” since it’s an election year.

  15. rd says:

    BTW, I have been seeing arguments re-appearing recently that Shiller’s 10-yr CAPE isn’t valid because of the big “one-time” losses in 2008. Shiller’s (and originally Benjamin Graham’s) argument for the 10-yr period was so that there would be time for gussied up earnings to be exposed with write-offs, instead of just relying on the past year’s reported earnings. This JPM event is further demonstration that earnings can be dressed up for a couple of years but occasionally the septic tank in the basement bubbles over and exposes the place to be not quite so sweet-smelling. The more things change, the more they stay the same.

  16. Moe says:

    History demonstrates regularly that human beings are not capable of managing their desire to accumulate wealth no matter what the cost to the larger system.

  17. theexpertisin says:

    JPM earns $2b, folks complain about excess profits.
    JPM pukes up $2b, folks want more regulations and constraints.

    If Congress wants to re-impose Glass Steagall and have banks trade as, say, utility stocks, fine. Probably, most informed citizens would welcome it so long as there was a rational discussion and recognition of unintended consequences.

  18. ConscienceofaConservative says:

    I’m struck by a few points.
    1) CDS are nefarious instruments that defy margin-want to get out the loss is p.v.’d and monetized
    2) Bankers bonus is based on return on equity, whch encourages low levels of common stock
    3) JP Morgan is a too big to fail institution tied into the Fed system and able to borrow with FDIC insured funds
    4) With interest rates floored, there’s no yield premium for banks to earn , and are resorting to proprietary
    trading(the current blow up) and fee products(prepaid debit cards with high monthly costs) to maintain profit

    My conclusion is the Volcker rule is entirely appropriate(we really need Glass Steagall back) and the Fed needs to ease up on ZIRP as Thomas Hoenig has pointed out. By keeping rates at zero for an extended period of time Bernanke risks the same problems Greenspan brought on nearly a dozen years ago.

  19. louis says:

    This is what we had to save?, everyone crying that we had to save these assholes so we could watch this. We should of killed this bullshit from the start with Bear.

  20. Petey Wheatstraw says:

    All of the dreck we swept under the carpet is still there. The banks are still insolvent. They are still run by the same criminals who created this mess. And the looting continues, unabated. The Government — fully complicit in the scam — causes a distraction (right now, it’s got everyone in an uproar over gays marrying).

    Nothing — absolutely nothing — has been remediated.

    Add the recent political upset to the Euro horse cart — and the subsequent strengthening of the already crippled USD — and you have real trouble brewing (keeping in mind that if the USD is your best refuge, you are pretty much screwed, long term, anyhow. “Faith and Credit” of the US government? Sure, Mack, gim’me a truckload of that).

    At some point, as in Europe, there will be political push-back, here, if only because of the economic ripple effect (a tsunami also cannot be discounted).

    This is starting to get interesting, again.

  21. Expat says:

    Two-Face Dimon: We just lost $billion! We need more liquidity!

    Bernanke-Man: Quick! To the Bat-Pump!

  22. jimc1004 says:

    On CNN-Money “Guo Xiongwei” commented,

    “Too big to manage!”

    I agree that this shows that Dimon and JPM were not geniuses three years ago, merely lucky,
    and obviously they did not learn ANYTHING!

    Gotta love the timing, though.

  23. Francois says:

    “Disclosure: Long JPM”

    Did you mean “Long JPM LEAPS puts”?

  24. GeorgeBurnsWasRight says:

    “A man’s got to know his limitation.”

    I think Jamie Dimon has unfortunately believed all the people who say he’s the smartest man in the room.

  25. GeorgeBurnsWasRight says:

    Sorry, “limitations”.

  26. PeterR says:

    Right on BR!

    Still way too many Hair Triggers at the ready.

    To quote Warren Buffet once again from 2005:

    ‘There are more people [like hedge-fund managers] that go to bed at
    night with a hair trigger than ever before, it’s an electronic herd,
    they can give vent to decisions that move billions and billions of
    dollars with the click of a key. We will have some exogenous event -
    we will have that. There will be some kind of stampede by that herd ?
    ‘When you have far greater sums than ever before, in one asset class
    after another, that are held by people who operate on a hair-trigger
    mechanism, then they lend themselves to more explosive outcomes.
    People with very short time horizons, with huge sums of money – they
    can all try to head for the exits at the same time. The only way you
    can leave your seat in burning financial markets is to find someone
    else to take your seat, and that is not always easy …’

    http://money.cnn.com/2005/05/01/news/fortune500/buffett_talks/

  27. Francois says:

    For those who wonder about financial reform…abandon all hope until people get REALLY, DANGEROUSLY mad. Because it is a cesspool of corruption, capture and ideological mendacity of the lowest order imaginable.

    http://www.policyshop.net/home/2012/5/10/financial-reform-confronts-not-so-blind-justice.html

    Strongly suggest replacing pitchforks with this!
    http://www.youtube.com/watch?feature=player_detailpage&v=9h_bbMvApCg#t=130s

  28. Mike in Nola says:

    Chris Whalen is blaming the Volcker for this.
    http://video.cnbc.com/gallery/?video=3000089572&play=1

    Seems wrong headed to me. He says they do the same thing in his fund, but he has a fund, not a government backed bank.

  29. rsbelovich says:

    Another solution is to impose a sales tax on securities transactions. The tax rate could be very modest and still be effective at curbing this kind of abuse.

  30. Bridget says:

    I’ve done business with the same conservative, sound, regional bank since I was in college. (a longer time that I care to admit :) ) Can’t imagine why anyone would keep deposits with, own stock in, or buy the bonds of any of our major banks. Those who do are part of the problem.

  31. MikeB says:

    Some research shows increased incentive reduces performance.
    http://comment.rsablogs.org.uk/2010/04/08/rsa-animate-drive/

  32. DarthBeta says:

    Forget JPM- the interesting part of the story is following the hedge funds on the other side of the trade
    Purely speculation
    Is it possible he knowingly took poor positions (the reciprocal being he helped the hfunds into good positions)
    Nothing like getting fired from JPM only to end up at your buddies budding $2b hedge fund

  33. PeterR says:

    Ditto to DarthBeta, I had the same thoughts. Who MADE money on these Whale trades. Hmm.

    What a tangled web we weave!

  34. Woj says:

    As a trader, we were constantly pushing to relax the risk limits or explaining why the measures always over-represented our actual risk. This is a natural part of the speculative trading business where individual bonuses are based solely on the income earned, not on the amount of risk taken. Trying to alter the trader’s incentives is and will remain nearly impossible.

    http://bubblesandbusts.blogspot.com/2012/05/barry-ritholtz-imperfect-overreaching.html

  35. WFTA says:

    For the past 30 years I’ve managed to eke out a living selling fertilizer (not the organic variety that Jamie Dimon was peddling yesterday,) so I’ve never needed to be a financial genius, but a “hedge” by definition cannot lose money. It is a defensive measure used to protect a gain, or to insure in an outcome. It may limit upside if the event you were defending against doesn’t happen, but it never, ever loses money.

    When the financial press allows the CEO to use the word “hedge” to explain a $2 billion loss other than in a sentence like, “Our failure to hedge resulted in a $2billion loss,” our financial press does us a disservice.

  36. DarthBeta says:

    This wasnt one trader gone rogue, this was delibrate. I have no proof, other than I have seen the type of risk analysis (& risk departments) major banks have.
    Numerous individuals allowed this to happen
    Why? Doubt it was a mistake, ignorance or a trade gone bad.
    The Afghanistan test- Hours after 9/11 the leaders of Afghanistan were on the news claiming innocence
    Jamie (I am always running for prom king) Demon failed said test

  37. ToNYC says:

    With every month that passes, the unnatural act that ZIRP presents to the savers of real US Capital, creates similarly synthetic credit that needs smoke machines and mirror factories to get the dark pool views just right. Celestial mechanics got out of religion with Galileo’s tool.
    Junk food goes away when you don’t buy it.
    Try it with your refrigerator instead of your regulator.

  38. AnnaLee says:

    Since a few people are saying they blame the President, I am wondering if the same people think that if they choose the other guy, GS reinstatement will be the first item on his agenda. I guess I am wondering about the entire premise of anyone changing the status quo when it seems that we the people are so busy beating up on our neighbor to change anything substantive.

  39. momus says:

    Dunning-Kruger strikes again.

  40. Marc P says:

    I’ve read the articles and the comments, and I have a very different view.

    JP Morgan Chase has $70 trillion in derivatives bets. That’s $70,000 billion. Why is anyone surprised that it lost $2 billion? If you sat down at a poker table with $70,000 in chips, would anyone be surprised that at any given point that you had lost $2?

    Why is the press surprised at this? Why is Jamie Dimon? If the gigabanks are going to bet this much then losses of $10 billion, $20 billion, $50 billion are going to be common.

    In case you’re wondering, JP Morgan Chase had $183 billion in net worth at the end of 2011. The bank can bet right 99.7% of the time and be bankrupt.

  41. Sunny129 says:

    Market keeps on ‘PROPPED UP” every time it enters the RED zone.

    This is in spite of one of the mega Bank announcing the 2B+ loss and counting!

    The charade of manipulated market continues! Nothing new. Move on!

  42. number2son says:

    Since a few people are saying they blame the President, I am wondering if the same people think that if they choose the other guy, GS reinstatement will be the first item on his agenda.

    For me, at least, it will be “none of the above” or a 3rd party candidate.

  43. DarthBeta says:

    Not $70t in derivatives bets, $70t in derivative notional exposure that is sold to counterparties. e.g Asset manager a needs swap JMP sells it and hedges out the risk.
    This is different in that they were trading there own book/capital.
    A $2b dollar loss is not the death blow to JPM but more than one person and one department knew this was going on.
    So why did they let it?
    Didnt know any better,
    had the other side,
    mid east, asia, east europe client who walked away for the trade (my guess),
    maybe they like helping hedge fund guys get rich, ect…

  44. DarthBeta says:

    Hangovers kill my ability to write- ugh how embrsing

  45. 873450 says:

    What does it take for a degenerate gambling addict to admit they are a degenerate gambling addict?

    “The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions … Derivatives have permitted the unbundling of financial risks.”
    - Alan Greenspan, May 2005

    “There’s no question about it, … Wall Street got drunk, that’s one of the reasons I asked you to turn off the TV cameras. It got drunk and now it’s got a hangover. The question is how long will it sober up and not try to do all these fancy financial instruments.”
    - George W Bush, July 2008

    The Bush quote was revealing in that after Bear Stearns and before Lehman his administration already pinpointed precise blame for the financial industry collapsing on itself. Yet Bush signaled an intention to do nothing, choosing blind adherence to ideological dogmatic belief that U.S. style capitalism is inherently self preserving, self regulating and self correcting. It wasn’t until later that all the eventual Big Lie culprits (100-year storm, corrupt GSE’s, predatory mortgage originators, overborrowing home buyers, intimidated property appraisers, lax underwriting, sloppy rating agencies, lazy government regulators, sophisticated investors recklessly chasing yield and failing to conduct due diligence, Barney Frank, etc.) were being tossed out en masse to provide TBTF with smoke screen cover.

    TBTF is an out-of-control degenerate gambler addicted to greed that, unmonitored and unsupervised, cannot resist a compulsion to play Russian roulette nonstop until it shoots itself in the head. At the beginning, middle and end of the day government’s primary function is to protect its citizens. Notwithstanding initial, possibly well intended government motivations, the bailouts and Citizens United are enablers feeding TBTF’s addictions with the radioactive fallout posing too great a threat to society at large. The mother of all socialist safety nets assembled almost overnight and since ongoing to support TBTF is too expensive, is not succeeding and must be withdrawn. TBTF needs to be laced into a straightjacket and locked in a padded cell until it is trained to walk again without falling down. Upon release, it should be kept on a short leash. If gradually permitted to roam, it should be implanted with two-way tracking devices that will paralyze it when dangerous activity is detected.

  46. Greg0658 says:

    thanks for that 873450 …
    and I signed in to add an additional thought .. the __folks are running statements like:
    “now mind you, its the banks* money that was lost, not taxpayer money”
    * sometimes throw in “& shareholders”

    now I remind 1) those bank moneys come from consumers of cash & thats everybody
    now I remind 2) these instruments are excellent football passes to a team receiver

  47. LVAuctioneer says:

    ” The solution to this risk is very very simple: The USA should reinstate Glass Steagall, and repeal the Commodity Futures Modernization Act.” Hear! Hear!

    Even a novice investor should know the importance of position sizing. Yet our government allows a small handful of institutions to create positions that risk blowing up the global financial system. Common sense should tell us that thousands of small banks pose less systemic risk than 5-10 multinational firms. Yet the national governments historically give regulatory preference to large, entrenched constituencies, especially those who have the demonstrated ability to donate to campaign funds.

  48. DeDude says:

    @Greg0658;

    Don’t forget that these gambling banks are FDIC insured. So if they gamble and lose big time it is taxpayers that are on the hook for the loses. If they gamble and win – the spoils are theirs. What could possibly go wrong with that system. If they want to gamble with their own money and loses cannot get big enough to harm the rest of society, that is fine with me. But if they are big enough that their failure can hurt the economy or their loses are insured by the public, then they need to get the heck out of the gambling business.

  49. NMR says:

    Largely agree on substance Bazza but GS isn’t coming back (and imho) nor should it. That said the SEC has to tighten up on this backdoor proprietary trading. How the hell Dimon with a straight face can claim it was hedging when you can’t unwind the positions without taking a bath is beyond me but no doubt this is what he’ll be telling everyone tomorrow when he gets some softball interview.

  50. ToNYC says:

    LTCM was 1998 when genius failed..it required a mere four Billion of real interest-producing money for the perfect hedgers to almost blew up the US Financial system. With ZIRP money, the hedges are only algorithmic models better suited to Lewis Carroll’s Through the Looking Glass, as the debris field slowly populates.

  51. [...] and what most likely went wrong with them. Felix Salmon has a good take too, and Simon Johnson, Barry Ritholtz and Yves Smith have good discussions of what this tells us about the overall state of the financial [...]