So, this did blow up in Jamie Dimon's face. I am impressed by two things.
- The speed with which it occurred.
- The losses that have been incurred thus far: $2 billion, which is $1 billion (100%) more than what Dick Bove estimated.
This is not what the market wants or needs to hear. Given that total losses are unknown, I am seriously thinking that if one owns JPM's stock that they should get out until the dust settles. I am very much so concerned that Dick Bove was off by so much and since the man on top has no idea, I can't help but feel like we are staring into another abyss; real or not. I understand this may be viewed as an overreaction, but I don't think it is because we just had one of the largest credit and banking crisis's in modern history and within four years the largest, and arguably the most important bank, is back to gambling like a casino. Do we really need to burn the house down to the ground in order to learn our lesson? Come on guys!
What is the lesson I am referring to?
Banks exist solely to match net savers with net borrowers, to hedge against the risk of default between the two, and to accept all of the downside through those losses while only being entitled to the limited upside of the interest spread. Sure, they can charge fees on other services to enhance revenue. But no more speculation and gambling. And let me state this, I do not believe that JPM was engaging in bon-a-fide hedging, because I doubt there would have been such excessive losses, if any, i.e., hedging. So, I conclude that JPM was gambling and trying to prove to the government that they knew what they were doing and that FinReg was an overreaction that needed to be watered down or repealed. Derivative speculation is not a viable business model from which a bank earns its revenues. That is a highly risky and highly volatile business that exists to hedge against legitimate risks. I know that traditional banking is not 'sexy', but it never was meant to be. Executives hate this because there is no 'sexy' upside via bonuses and lucrative stock options (I suspect bank stock returns would theoretically be tied to GDP growth and interest rates under this scenario). Banks can make money without really having to do or innovate anything. All you really need to run a bank is a computer, and maybe an ATM machine for anyone who still uses cash (not being snarky here, but more and more transactions are occurring via plastique). Innovation is a difficult task as it is and so the real risk takers get to take that challenge on by creating new businesses and innovating - and either being rewarded with huge upside or punished into bankruptcy. In other words, banks are not supposed to be innovators (or gamblers) of anything, just risk hedgers and, like a bookie (who never bets on any one game), they take the interest rate spread (grease). Being a bank is pretty easy and very profitable if you're good at it. This is purely an academic statement and yet we allow banking executives to subject us to this crap over and over again.
Whatever argument Dimon had against the regulators, and I would argue that Dimon was leading that pack when he did this, he just lost it...for good. That is what having egg on his face means. But note, I was never taking the stance that the point was whether or not this blows up in his face, but if the government does anything about it based off FinReg. Especially in an election year cycle. This may actually boost Obama... How much? I don't know. Again, JPM is a big bank that can stomach a lot and it depends on how bad the losses really are and how much the market makes of it. But, the media saw this one coming, reported on it, and the regulators did nothing...Smooth. Obama will argue that he is not to blame because the teeth on financial regulation were removed. The Republicans will argue that current regulation is enough and that the regulators were asleep under Obama's watch with the so-called enhanced FinReg, which they will then use to argue that there is too much regulation and that it is not working. Let the circus around this begin.
Both will have valid arguments I think, but the fact is that Glass-Steagle needs to come back in its full glory; that is to say, prevent banks from gambling with both their own money and their clients money. From there, we can probably scrap most other banking regulation with the exception of fair lending standards and fair credit reporting. I am not anti-capitalistic in saying this. But, quite the opposite. A healthy economy is absolutely dependent upon a healthy banking sector; If you blow up the banks, then you blow up the economy. Note: if Glass-Steagle is re-enacted, this will force JPM to break up - the Investment bank will we stripped off the company and formed as a separate entity. This will be a political hot potato. But, the banking executives have proven that they cannot handle the two diametrically opposed businesses well...twice in the last 4 years and more so over the long run.
The irony is that this has been my one and only major fear in the market over the past few months - that we are getting out of the crisis and the big banks are going right back to the slot machine to gamble everything away again. I am not too happy with this. Though, I erroneously believed that JPM knew what it was doing. Maybe it was because I am a former employee and was impressed with the team that I worked with (they were in the custody side of the business - trillions and trillions of dollars...not just billions).
http://www.bloomberg.com/news/
P.S. It wasn't a mistake for Dimon if he had been right and won. IT was greed. This will need to sting in order for him to learn. I know this from experience. And, I hope to god that this is simply a hic-up and not a full blown tempest that, when I er-read this to check for errors, I am fearing that this may be. But, I wonder if anyone else was out swimming naked. I would rather appear to be a blow-hard who is taking too much credit, than I would in being right. Because, if I am right then we all lose.
What is the lesson I am referring to?
Banks exist solely to match net savers with net borrowers, to hedge against the risk of default between the two, and to accept all of the downside through those losses while only being entitled to the limited upside of the interest spread. Sure, they can charge fees on other services to enhance revenue. But no more speculation and gambling. And let me state this, I do not believe that JPM was engaging in bon-a-fide hedging, because I doubt there would have been such excessive losses, if any, i.e., hedging. So, I conclude that JPM was gambling and trying to prove to the government that they knew what they were doing and that FinReg was an overreaction that needed to be watered down or repealed. Derivative speculation is not a viable business model from which a bank earns its revenues. That is a highly risky and highly volatile business that exists to hedge against legitimate risks. I know that traditional banking is not 'sexy', but it never was meant to be. Executives hate this because there is no 'sexy' upside via bonuses and lucrative stock options (I suspect bank stock returns would theoretically be tied to GDP growth and interest rates under this scenario). Banks can make money without really having to do or innovate anything. All you really need to run a bank is a computer, and maybe an ATM machine for anyone who still uses cash (not being snarky here, but more and more transactions are occurring via plastique). Innovation is a difficult task as it is and so the real risk takers get to take that challenge on by creating new businesses and innovating - and either being rewarded with huge upside or punished into bankruptcy. In other words, banks are not supposed to be innovators (or gamblers) of anything, just risk hedgers and, like a bookie (who never bets on any one game), they take the interest rate spread (grease). Being a bank is pretty easy and very profitable if you're good at it. This is purely an academic statement and yet we allow banking executives to subject us to this crap over and over again.
Whatever argument Dimon had against the regulators, and I would argue that Dimon was leading that pack when he did this, he just lost it...for good. That is what having egg on his face means. But note, I was never taking the stance that the point was whether or not this blows up in his face, but if the government does anything about it based off FinReg. Especially in an election year cycle. This may actually boost Obama... How much? I don't know. Again, JPM is a big bank that can stomach a lot and it depends on how bad the losses really are and how much the market makes of it. But, the media saw this one coming, reported on it, and the regulators did nothing...Smooth. Obama will argue that he is not to blame because the teeth on financial regulation were removed. The Republicans will argue that current regulation is enough and that the regulators were asleep under Obama's watch with the so-called enhanced FinReg, which they will then use to argue that there is too much regulation and that it is not working. Let the circus around this begin.
Both will have valid arguments I think, but the fact is that Glass-Steagle needs to come back in its full glory; that is to say, prevent banks from gambling with both their own money and their clients money. From there, we can probably scrap most other banking regulation with the exception of fair lending standards and fair credit reporting. I am not anti-capitalistic in saying this. But, quite the opposite. A healthy economy is absolutely dependent upon a healthy banking sector; If you blow up the banks, then you blow up the economy. Note: if Glass-Steagle is re-enacted, this will force JPM to break up - the Investment bank will we stripped off the company and formed as a separate entity. This will be a political hot potato. But, the banking executives have proven that they cannot handle the two diametrically opposed businesses well...twice in the last 4 years and more so over the long run.
The irony is that this has been my one and only major fear in the market over the past few months - that we are getting out of the crisis and the big banks are going right back to the slot machine to gamble everything away again. I am not too happy with this. Though, I erroneously believed that JPM knew what it was doing. Maybe it was because I am a former employee and was impressed with the team that I worked with (they were in the custody side of the business - trillions and trillions of dollars...not just billions).
http://www.bloomberg.com/news/
P.S. It wasn't a mistake for Dimon if he had been right and won. IT was greed. This will need to sting in order for him to learn. I know this from experience. And, I hope to god that this is simply a hic-up and not a full blown tempest that, when I er-read this to check for errors, I am fearing that this may be. But, I wonder if anyone else was out swimming naked. I would rather appear to be a blow-hard who is taking too much credit, than I would in being right. Because, if I am right then we all lose.
Incredible analysis Jeff; I believe you have hit the nail on the head. It might very well be that the sell looks like to be a bit overdone from my view. I wouldn't think even a $5 billion loss would generate a $20 billion reduction in market cap. But you may be right, perhaps this is just the tip of the iceberg.
ReplyDelete