Jamie Dimon, CEO of JPMorgan, admitted in Senate testimony on Monday that his executives made serious errors that resulted in at least a $2 billion trading loss.
The errors related to the bank’s hedging activities, which are supposed to ameliorate risk, but somehow morphed into a “casino-type” wager that backfired.
The Volker Rule has been created, but not yet implemented, to prevent large financial institutions from making such over-sized proprietary investments which can endanger an institution and necessitate a bailout by the federal government with taxpayer money. Dimon has stated emphatically that the original intent of the JPMorgan investments in question was not intended to expose the bank to huge risk, but rather, they were executed to offset existing risk in the bank’s portfolio of assets.
Dimon has led the fight against what he believes to be over-regulation of the banking industry by Congress.
Congress, alternatively, is trying to protect taxpayers against bank activities that could threaten the financial system. “Too big to fail” is the term used to describe institutions that cannot be allowed to fail and would have to be saved from their own missteps. Dimon believes that Congress is overly concerned with these contingencies.
Dimon’s colleagues created a complex derivative transaction that was originally put in place to offset risks of certain bank assets. Times changed, and perceptions of the risk needed to be adjusted. The derivative transactions became too unwieldy and ultimately exposed the bank to risks not intended, or so the story goes. Many in Congress believe that certain traders at JPMorgan responsible for offsetting risks could not resist the urge to make some risky investments that caused the losses. The bank has not yet disclosed the exact elements of these activities, although some traders on the Street have a sense of what transpired.
In the end, Dimon’s reputation for managing risk and navigating through the 2008 financial crisis has been tarnished only slightly. He went to Washington to speak with members of the Senate to reclaim his leadership and the confidence of lawmakers. By most accounts, Dimon did a superb job in accomplishing his objectives.
It should be noted that JPMorgan is not in any financial risk relating to the expected losses from the transactions in question. Its running profitability can easily absorb the losses. So, there is no need to change the direction of Congress relating to financial regulation, or so Dimon says.
From Congress’ perspective, is the loss only the tip of the iceberg? Are there other risky, proprietary trades at JPMorgan and other financial institutions that could bring down the system? And, how can Congress tweak Volker to ensure that permissible hedging of risk does not become a threat to our financial system?
JPMorgan still has a lot of questions to answer about the rogue trades. Most analysts believe that Volker will not become more lax because of the JPMorgan situation, and odds are that the rule will be tightened up to bridge the gap between legitimate hedging and uncovered bets by financial institutions.
What is most interesting is Congress’ focus on punishing JPMorgan executives who were involved in the trades that caused the losses. Most senators want the bank to rein back their bonuses. This is certainly a reasonable expectation, but to reclaim a few million dollars of compensation is not what Congress should be spending time on. The multi-billion dollar risk of the trades is far more important. Once again, some members of Congress cannot live with high compensation in financial companies, an issue that does not threaten the industry.