The Future of Finance

JP Morgan Losses

JP Morgan loss could play into regulators' hands

The $2bn trading loss on credit derivatives incurred by JP Morgan's chief investment office, which hedges the global group's loan portfolio and invests excess deposits, could toughen the resolve of regulators seeking to put the brakes on perceived high-risk activities.

 In a conference call on 10 May,Chief Executive of the bank, Jamie Dimon, warned the losses could get worse in the next few quarters. "The markets and our decisions will be a critical factor" in putting right the losses, he said, while adding "to put this in perspective, this is the reason we have a fortress balance sheet - to handle surprises". Mr Dimon said the bank's Basel III core capital ratio will be amended down from 8.4% to 8.2% of risk-weighted assets, but that the bank would continue to meet its Basel I and Basel III capital ratio targets, which are conservative.

Mr Dimon described the losses as "egregious" and "self-inflicted".

In a statement, US Senator Carl Levin, who is chairman of the Senate Permanent Sucommittee on Investigations and one of the authors of the Volcker Rule, which is designed to restrict US banks from making certain types of speculative investments, said: "The enormous loss JP Morgan announced today is just the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making. Today's announcement is a stark reminder of the need for regulators to establish tough, effective standards to implement the Merkley-Levin language to protect taxpayers from having to cover such high-risk bets."

Mr Dimon acknowledged in the conference call that the loss would "play into the hands of ... pundits out there" who have called for tighter regulation of the financial industry. He said: "This trading may not violate the Volcker rule but it violates the Dimon principle."

The Volcker rule is often characterised as a ban on proprietary trading by commercial banks, whereby deposits are used to trade on a bank's personal accounts, although a number of exceptions to this ban were included in the Dodd-Frank Act.

Gordon Kerr, founder of Cobden Partners, a UK-based firm that undertakes sovereign advisory work, told Bloomberg that tighter restrictions on proprietary trading are likely to result from the JP Morgan loss, but 'micro rules' would not solve the problem. He argued that managers and directors should be made personally responsible for losses. "The degree of complexity and the innovation skills of bankers will always beat the regulators," he said. Credit default swaps and credit derivatives that are linked to loan portfolios were the primary driver of systemic banking failure and a loss such as JP Morgan's could easily happen again, he warned.

David Marshall, a senior analyst at research firm CreditSights in Singapore, was more upbeat, saying JP Morgan is a very large bank that could easily absorb such a loss

"All banks are vulnerable to fraud and rogue traders, but this loss appears to have resulted from the size and complexity of the risks JP Morgan was trying to manage. It will lend support to critics of the big banks that rely on their own models to predict market volatility. There will be more scrutiny from regulators."

The announcement of the loss came on the same day as the release of the latest Harris Poll, which surveys Americans about Wall Street. An overwhelming majority of 82% of the 1016 adults surveyed said recent events (the poll was conducted before the JP Morgan loss) showed that Wall Street should be subject to tougher regulation. However, 62% said Wall Street was absolutely essential to the US economy

In other findings, 78% of people believed  Wall Street firms should pay bonuses only when they are doing well and making good profits and 70% believed most people on Wall Street would be willing to break the law if they believed they could make a lot of money and get away with it.

Mr Dimon said he and a senior management team at JP Morgan would work on the investment office problem: "we will learn from it, fix it and move on", he said.

 

Posted by Risk in the Market at 00:00

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