Jamie Dimon Welcomes You to the Next Financial Crisis
President and CEO of JPMorgan Chase Jamie Dimon testifies before the Senate Banking Committee on Capitol Hill June 13, 2012 in Washington, DC.
There was a great irony in JP Morgan Chase Jamie Dimon's love-in of a hearing in front of the Senate this week.
While lawmakers were ostensibly asking Dimon how to prevent the next, distant financial crisis, he was openly telling them that JP Morgan had predicted, to the tune of $100 billion, that we're hurtling towards one this year.
In his least-challenged, least-questioned statement, Dimon explained the intent and strategy of JP Morgan's "London Whale" trade - a complicated $100 billion bet that, so far, may have led to a $2 billion loss and $39 billion in lost market value for the bank. The enormous bet, Dimon explained, was designed "to make money for JP Morgan in a global credit crisis."
Let's stop and think about that: JP Morgan started the London Whale trade in late 2011 or early 2012. That's when the bank must have seen a global credit crisis coming. Dimon said in his testimony this week that JP Morgan, with $700 billion in loans, needed to "protect itself" against "a systemic event." The bank was so positive that this systemic event would occur that it was planning to make money on it.
It's not as if JP Morgan was "hedging" here - there's no question that JP Morgan was inordinately confident that the London Whale was onto something, that a global credit crisis is coming.
When Dimon called the press coverage in April "a tempest in a teapot," it was because at JP Morgan, "almost everyone up and down the line thought it was temporary, it was a small thing, it was blown way out of proportion." To the extent that JP Morgan and Dimon have taken any blame, they have faulted their "model" that accounted for their risk, and not the strategy of the trade itself. Jamie Dimon earlier said that the bank has every intention of hanging with the bet - albeit with reduced risk. In fact, there appears to be a time limit on the bet: the corporate-bond index that JP Morgan bet on expires around December 15 of this year. JP Morgan has to collect its losses or its profits before then.
Translation: the bank's stubborn backing of this bet means it believes losses are temporary; the profits will last.
In another clue, JP Morgan made its gamble by betting on corporate bonds - which means the bank must have believed that this credit crisis would not just affect the obvious suspects - Spain, Greece, and Europe - but also large corporations. (In fact, JP Morgan's bet had a good opportunity to distort the market for corporate debt -- not just through its own actions, but also because its giant bet made the bank a giant target and spurred hedge funds to jump into the market and buy the underlying corporate bonds to bet against JP Morgan. That was an easy consequence to foresee with a big trade and, if the circumstances were right in the financial markets, could have caused a panic on its own, as I discussed with Lauren Lyster at Capital Account on Wednesday.)
JP Morgan is also stubbornly clinging to the bet. Bruno Michel Iksil, the trader who was dubbed the London Whale, is still at the bank, temporarily, but there's no indication that JP Morgan is unwinding the trade. On the contrary, Dimon has publicly said in the firm's conference call that he's willing - and expects - to keep bearing the losses.
In short, JP Morgan heard 2008 rattling its chains. And on that front, the bank may not be wrong. The drumbeat of a global financial crisis is getting louder and closer; in fact, we're probably already in it. Consider the evidence:
- Greek elections this weekend are throwing the entire Eurozone into existential and financial turmoil. If an anti-austerity party in Greece wins this weekend, the country may be a prime candidate to exit the euro. Financial panic is sure to ensue. The week has already brought two pre-emptive bailouts: $125 billion to Spain's banks - which failed because it ended up raising the country's borrowing costs and debt to record levels - and 100 billion in England (which will actually take effect June 20). Cyprus is considering a bailout soon, but it knows the EU has no money so it's also thinking of asking Russia and China for money.
- Central banks are preparing for unified action and bailouts galore. 2008's bailout architects in the U.S. - including Hank Paulson, Tim Geithner and Neel Kashkari - had an impromptu reunion to plan and/or grouse about Europe in early June. This week, Ben Bernanke told Congress he was worried not just about the fiscal cliff, but about Europe. Today, European Central Bank chief Mario Draghi said the bank - remarkably loath to commit to action over the past few months - is prepared to mobilize if there is a financial crisis. And as the eurocrisis deepens and it may become harder to borrow money in the markets, some analysts predict that the Federal Reserve will extend or create new stimulus.
- The weaknesses of money-market funds have been flagged by regulators as a renewed danger to the financial system - to the tune of "a $2.7 trillion disaster." Many financial regulators - and bankers - will never forget the run on money-market funds in 2008, which the scene for a run on the banks. In late 2011, money-market funds started pulling their money out of Eurozone banks to reduce their risks - a sure sign that those funds saw enormous bank losses coming in Europe. Still, money-market funds are huge investors in banks. Perhaps that's why Securities and Exchange Commission chair Mary Schapiro has been on a crusade this year to reign in money-market funds. She wants to make sure the funds are better capitalized so they are able to meet redemptions without pulling their investments out of banks.
- The weaknesses and ill-preparation of banks are coming to the forefront again. The Governor of the Bank of England pleaded today for a "major recapitalization" of Europe's banks. The Swiss central bank said in a report today that its two stalwarts, Credit Suisse and UBS have inadequate capital to withstand a crisis. I reported last week that one Nobel Prize winner, Robert Engle, had identified the systemic risk of major global banks and found U.S. banks roughly $500 billion short of the capital they would need to make it through a crisis. Moody's is also concerned about banks; the ratings firm promised to embark on a series of downgrades - the most devastating of which would be against Morgan Stanley, which is the smallest of the big banks and would struggle to post more collateral and meet higher funding costs.
This witches' brew of worry could persist for weeks and probably months in low- or mid-level crisis mode until a financial panic sets it off on the boil. That panic could come from the Greek elections, the U.S. "fiscal cliff" problems, or any kind of unexpected financial disaster.
No wonder JP Morgan is standing by its bet. It's hard to argue right now that the bank was totally wrong.