[Vision2020] Why JPMorgan gets away with bad bets

Art Deco art.deco.studios at gmail.com
Tue May 15 09:43:37 PDT 2012


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  <http://www.cnn.com/2012/05/14/opinion/black-jpmorgan-banks/>
    *Why JPMorgan gets away with bad bets
*
By William K. Black , Special to CNN

updated 5:39 AM EDT, Tue May 15, 2012
 CNN.com

Editor's note: William K. Black is an associate professor of economics and
law at the University of Missouri-Kansas City. A former senior financial
regulator and a white-collar criminologist, he is the author of "The Best
Way to Rob a Bank is to Own One."

(CNN) -- JPMorgan Chase can be considered a systemically dangerous
institution, which means that it is "too big to fail" because the
government fears that its collapse would cause a global financial crisis.

It is simply irrational to allow such an institution to exist, especially
when it can easily incur a $2 billion trading loss.

Banks are more efficient when shrunk to the point that they can no longer
endanger the world economy. But because JPMorgan and similar banks are the
leading contributors to Democrats and Republicans, neither political party
has the courage to order them to reform.

The Volcker Rule, which aims to prevent insured banks from engaging in
speculative bets, was passed as part of the Dodd-Frank Act over the
objections of Treasury Secretary Timothy Geithner and almost the entire
Republican congressional delegation.

CNNMoney: JPMorgan investment chief out

Back in 2008 when the financial crisis hit us hard, a host of large
institutions were destroyed. AIG, Merrill Lynch, Bear Stearns, Lehman
Brothers, Fannie Mae, Freddie Mac, Washington Mutual and Wachovia all
suffered massive losses on their toxic derivatives, particularly
collateralized debt obligations (CDO) and credit default swaps (CDS),
better known as "green slime." One would think everyone has learned a
lesson. Jamie Dimon, JPMorgan's CEO, now agrees that banks should not
invest in derivatives. But government subsidies have a way of encouraging
fraud and speculation.

JPMorgan, the nation's largest bank, receives an explicit federal subsidy
(deposit insurance) and a much larger implicit federal subsidy. It's
improper for the megabank to use these subsidies to speculate in
derivatives. And yet it can do so with hardly any serious regulatory
consequences.

Followand
 Capitol Hill reacts to JPMorgan's loss
 Sen. Corker calls for JPMorgan hearing
 Sheila Bair on JPMorgan's loss

Financial institutions such as JPMorgan love to buy derivatives because
they are opaque, create fictional income that leads to real bonuses and
when (not if) they suffer losses so large that they would cause the bank to
fail, they will be bailed out.

The Dodd-Frank Act's Volcker Rule was designed to solve the problem.

However, JPMorgan led the effort to gut the Volcker Rule and the provision
that requires transparency. JPMorgan is the world's largest proprietary
purchaser of financial derivatives -- precisely what the Volcker Rule
sought to end. The bank claims that it does not engage in proprietary
trading and that it purchases derivatives solely to hedge. That claim is an
example of what Stephen Colbert meant when he invented the term:
"truthiness."

A hedge is an investment that offsets losses in another investment.
JPMorgan's supposed hedges aren't hedges under accounting rules because
they haven't been shown to perform as hedges.

JPMorgan bought tens of billions of dollars of derivatives that increased
its losses rather than reduced them. It calls these anti-hedges "hedges" --
in other words, it practiced "hedginess." The bank's approach to hedging is
that it would like to purchase a derivative if it deems that derivative to
be a hedge to something else and voila, it's a hedge.

The draft regulations of the Volcker Rule allow such faux hedges because
JPMorgan lobbied to render the rule useless. JPMorgan asserts that these
inherently unsafe and unsound anti-hedges are "hedges" as that term is
defined in the draft regulations implementing the Volcker Rule. But if
hedginess is permissible, the Volcker rule is unenforceable.

It is a travesty for JPMorgan to be able to create an additional $2 billion
in losses through investments that are supposed to be allowed only if they
reduce losses. The government must revise the regulations and reject
JPMorgan's absurd treatment of anti-hedges as hedges.

Faux hedges are a common, dangerous abuse and a lethal form of speculation.
>From 2003 to 2006, the Securities and Exchange Commission caught mortgage
giants Fannie Mae and Freddie Mac violating hedge accounting to maximize
their executives' compensation. Fannie's faux hedges, like JPMorgan's faux
hedges, increased losses. The Justice Department failed to prosecute, and
the senior executives walked away wealthy. Their successors blew up Fannie
and cost taxpayers hundreds of billions of dollars.

When a bank CEO is honest but incompetent, faux hedges simultaneously
increase risk and create a false complacency that the hedge has offset the
risk. This can cause catastrophic losses.

Dishonest bank CEOs use faux hedges to loot the bank by creating fictional
income and hiding real losses. The fake income makes the CEO wealthy by
maximizing his compensation.

The current JPMorgan speculation in derivatives weakens but will not kill
the bank. If it and other systemically dangerous institutions continue to
engage in hedginess, it is only a matter of time before we'll get a replay
of the financial crisis. And who'll lose out? Taxpayers like you and me, of
course.

The opinions expressed in this commentary are solely those of William K.
Black.

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-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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