Friday, May 11, 2012

Volcker Rule, JPMorgan's (JPM) $2 billion bad bet

The Volcker Rule, set to go into effect in July, would prevent banks from making speculative bets that could put both themselves and taxpayers at risk. It's named for the man who proposed it -- the 84-year-old former Federal Reserve chairman, Paul Volcker

JPMorgan's $2B trading loss puts spotlight on risky practices, Volcker rule
JPMorgan Gaffe Is an Argument for Capital, Not the Volcker Rule
Bair: Fed Should Tighten Volcker Rule To Avoid Whale-Like Mischief

JPMorgan's $2B trading loss puts spotlight on risky practices, Volcker rule

(CBS News) The lessons of the Great Recession didn't last long. As of Friday night, the nation's largest bank and one of its biggest energy companies are both reeling. Reckless investments in one case, questionable management in the other.

JPMorgan Chase said Thursday it lost at least $2 billion in investments that it called "egregious." On Friday, JPMorgan lost $14 billion in stock value. CBS News correspondent Anthony Mason looks into the bank's situation.

The losses for JPMorgan Chase continued Friday. This time to its stock price, which tumbled more than 9 percent as the bank reeled from its $2 billion trading blunder. And bank analysts took aim at CEO Jamie Dimon.

"He should have done his homework better," said Mike Mayo, who closely watches the company for the investment firm CLSA, said.

Mayo, who is also the author of the book "Exile on Wall Street: One Analyst's Fight to Save the Big Banks from Themselves," said that in April Dimon dismissed concerns the bank was making big bets on credit derivatives that even then were rattling the markets.

"One month ago, Jamie Dimon gave a reassurance that this was 'tempest in a teapot' when it came to the company's investments," said Mayo. "Here we are one month later and there's a $2 billion loss on their books."

The risky bets were placed out of the bank's London office by a trader named Bruno Iksil, nicknamed the "London Whale." But Iksil was not a "rogue," and critics say that raises serious questions about risk management at America's biggest bank.

"The 'too big to fail' culture is really still there," said Michael Hewson, an analyst with London investment firm CMC Markets. "And it is a concern. And I think what it will do is make the proponents of the Volcker Rule even more emboldened."

The Volcker Rule, set to go into effect in July, would prevent banks from making speculative bets that could put both themselves and taxpayers at risk. It's named for the man who proposed it -- the 84-year-old former Federal Reserve chairman, Paul Volcker

Fitch cuts JPMorgan Chase's credit rating
JPMorgan's $2 billion loss: How is that even possible?
SEC chief: Regulators 'focused' on JPMorgan

"Do you believe the culture on Wall Street has to change?" Mason asked Volcker.

"Yes," he said.

In an interview for "CBS Sunday Morning" in March, Volcker said he thought the traditional culture of banking had been distorted by speculation.

"My concern has been the health of the banking system," he said.

But banking executives, including Dimon, have attacked both the reforms and Volcker himself.

"Some CEOs have been particularly critical of you," Mason pointed out to Volcker

"I wasn't aware of that," Volcker joked. "That amazes me. You telling me that? No."

"Jamie Dimon, the head of JPMorgan Chase, said, 'Paul Volcker by his own admission, has said he doesn't understand capital markets. He has proven that to me," said Mason.

"Well, unfortunately, I think that they proved some of that to me, too," said Volcker. "Their own misunderstanding. How did they get in so much trouble?"

JPMorgan Chase could face up to another billion dollars in losses from its bad bets. But the biggest loss may to its reputation and to trust in the banking system.

"CBS Evening News" anchor Scott Pelley asked Mason if JPMorgan is in jeopardy.

"It's not. As big a loss as that was, and that's a big number, the bank is well capitalized, it can absorb it. The company was downgraded by one ratings agency Friday -- Fitch said it is worried by the company's risk management.$2b-loss/

JPMorgan Gaffe Is an Argument for Capital, Not the Volcker Rule

For supporters of the Volcker Rule, JPMorgan’s (JPM: 36.96, -3.78, -9.28%) $2 billion bad bet is “manna from heaven,” proof that big investment banks shouldn’t be gambling their clients’ money in the big casino.
“Understandably and predictably, supporters of the Volcker rule will use this to advance their cause,” said one financial policy expert who opposes the measure that would prohibit big banks from speculating for their own benefit.
But the supporters are badly missing the point, the expert said. JPMorgan’s loss isn’t an argument for the Volcker rule, he said, it’s an argument for capital.
“The purpose of capital is to serve as a buffer for banks when banks sustain losses due to mistakes. As many people are indicating today, this is barely going to make a dent in JPMorgan’s earnings and it’s going to have no impact on their capital. From a safety and soundness standpoint, this is a non-event,” he explained.
On Thursday JPMorgan announced after the markets closed that it had bet wrong on the strength of the U.S. recovery. An investment strategy that involved complex derivatives had backfired on the investment banking giant, leaving a $2 billion hole, with more losses likely.
Almost immediately, supporters of a rule proposed by former Federal Reserve Chairman Paul Volcker intended to rein in speculative bets by big banks like JPMorgan, often described as “too big to fail,” began pointing to the bank’s losses as proof of their case.
Supporters of the Volcker rule, a key element of the Dodd-Frank financial reform legislation passed in 2010, say risky speculation by big banks in search of outsized profits played a significant role in the 2008 financial crisis.
JPMorgan’s CEO Jamie Dimon, who led the bank’s conference call Thursday, addressed the argument: “This doesn’t violate the Volcker rule, but it violates the Dimon principle,” he told analysts and reporters.
Dimon has been outspoken in his opposition to stricter regulations of the financial industry, arguing that they will curtail market competition and cut into bank profits.
Senator Carl Levin (D-Mich.), who helped write the proposed Volcker legislation, barely waited for Dimon to end his conference call Thursday before issuing a statement calling for tougher regulations limiting risk taking by banks.
In any case, some analysts pointed out Friday that the losses sustained by JPMorgan will be easily absorbed by the bank.
JPMorgan: $2.2 Trillion in Assets
JPMorgan had $99.8 billion in revenue in 2011, should have $98 billion in 2012, and is forecast to have $101 billion in revenue in 2013, according to research note issued by Nomura on Friday.
Moreover, the bank has more than $2.2 trillion in assets.
“Others can comment on what this really means but the market cap of JPMorgan is $155 billion, and the investment banking arm had revenues of $26 billion in 2011, while the overall bank’s revenues were close to $100 billion," Kit Juckes, chief of foreign exchange at Société Générale, told Canadian newspaper The Globe and Mail.
“All the numbers are huge - the losses and the earnings. There will be lots of headlines and this is fuel both for a market which is looking for reasons to be risk averse, and for advocates of limits on banks’ risk-taking. But it would be wrong to overstate the macro significance.”
In other words, the losses are JPMorgan’s problem and JPMorgan will handle it.
The financial policy expert interviewed by said JPMorgan has “enormous amounts of capital, and this is why they do.”
Indeed, in March JPMorgan was one of 15 big banks to pass a stress test administered by the Federal Reserve Board. The tests were conducted to determine if banks had enough capital to withstand a sudden crisis similar to the subprime mortgage meltdown in 2008 that nearly crippled global markets.
JPMorgan’s passing grade allowed the bank to raise its quarterly dividend to 30 cents and announce a buyback of up to $12 billion in stock this year.
While the $2 billion (and counting) in losses suffered on bets related to corporate bonds is certainly a black eye for JPMorgan and Dimon, the failed bets should be viewed for what they are, the policy expert said.
“Banks are in the risk business. Finance is about taking and managing risk,” he said. “This is an argument for capital and the good news is that JPMorgan has lots of it.”

Bair: Fed Should Tighten Volcker Rule To Avoid Whale-Like Mischief

By Kristina Peterson and Alan Zibel

Notable critics of big banks, including Sheila Bair and Thomas Hoenig could have some new ammunition due to the $2 billion trading loss announced by J.P. Morgan Chase & Co. Thursday night.

Bloomberg News
In an interview Friday, Bair said the Federal Reserve should consider whether it needs to more narrowly define what kind of hedging will be allowed under the so-called Volcker rule, which restricts banks’ trading activites.

“There is a risk that a loosely defined hedging exception can open the door to a lot of mischief,” she said. “The Fed should look at tightening the definition of hedging as a result of this situation.”

Regulators have yet to finalize the regulation spelling out exactly what is and isn’t permitted under the Volcker rule, which seeks to limit risky trading by commercial banks that enjoy government backing.

Two Democratic senators said Friday that the language of the Dodd-Frank overhaul of the financial system was intended to allow only hedges that were designed to reduce risks tied to specific assets or positions held by a company, not broader bets, as in the case of J.P. Morgan.

However, a draft regulation put out in October by the Fed, the Securities and Exchange Commission and other regulators did permit so-called portfolio hedging, though it added an extra layer of compliance above what banks must do for other types of hedging.

“That proposed regulation is full of ambiguities and loopholes,” Bair said. “There should be some tightening of making sure that any event that’s hedged is clearly correlated with an underlying economic risk.”

And Jaret Seiberg, an analyst with Guggenheim Securities said the J.P. Morgan episode could lend credence to big-bank critics like Thomas Hoenig, a new member of the FDIC’s board and a former president of the Federal Reserve Bank of Kansas City.

“The odds are still in favor of the status quo, but a break-up-the-bank outcome has now moved from the improbable to the possible,” Seiberg wrote in a note to clients.

Hoenig has advocated for banks to be barred from the securities, derivatives and hedge fund business — a step that’s far more dramatic than the Volcker rule restrictions on bank trading.

“Dealing and market making, brokerage and proprietary trading extend the safety net’s coverage and yet do not have much in common with core banking services,” Hoenig said in Senate testimony this week.

The J.P. Morgan loss illustrates the need for large banks to have separate management for their major business lines, Bair said, noting that even a well-managed bank like J.P. Morgan couldn’t stay on top of all its complex operations. Departments of mega-banks should be split into divisions with their own executives and boards, even if they share a brand under one bank-holding company, she said.

“It is just extremely difficult to manage these institutions from the top of the house,” Bair said. J.P. Morgan’s lapse “raises a serious question about whether these very large associations are too big to manage.”

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