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2012-05-15

Crony Capitalism: After Lobbying Against New Financial Regulations, JPMorgan Loses $2B in Risky Bet

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JPMorgan Chase, the nation’s largest bank, is under fire after losing at least $2 billion in derivatives trading it was warned carried high risk. The loss has renewed calls for tougher regulation of Wall Street, with critics saying JPMorgan could have avoided it under regulations the bank opposed. We’re joined by former financial regulator, white-collar criminologist, and University of Missouri-Kansas City Professor William Black, author of "The Best Way to Rob a Bank is to Own One." Black says JPMorgan’s latest woes stem from the flaws endemic to "too big too fail." "Allowing [banks] to be this big, even conservative economists call this crony capitalism," Black says. "The only way this can work is to shrink the systemically dangerous institutions — this is the 20 largest banks in the United States — down to the point that they no longer pose a systemic risk, they are no longer too big to fail, and therefore, they will no longer have this implicit federal subsidy that completely distorts competition [and] ... destroys democracy, because these giant institutions have so much political power." [includes rush transcript]

Transcript

This is a rush transcript. Copy may not be in its final form.

AMY GOODMAN: As shareholders of JPMorgan gather in Tampa today, pressure is growing on bank CEO Jamie Dimon over the bank [losing] at least $2 billion in risky derivatives trading. The New York Times reports Dimon and other bank executives repeatedly ignored warnings about the bank’s risky bets. So far, three JPMorgan executives have resigned, including Ina Drew, the head of risk management at JPMorgan and the bank’s chief investment officer.

The loss has renewed calls for tougher regulation of Wall Street, with critics saying JPMorgan would have avoided the loss under regulations that it’s opposed. Speaking to ABC’s The View, President Obama said the JPMorgan crisis illustrates why Wall Street reform is essential.

PRESIDENT BARACK OBAMA: JPMorgan is one of the best-managed banks there is. Jamie Dimon, the head of it, is one of the smartest bankers we’ve got. And they still lost $2 billion and counting, precisely because they were making bets in these derivative markets. We don’t know all the details yet; it’s going to be investigated. But this is why we passed Wall Street reform. This is the best- or one of the best-managed banks. You could have a bank that isn’t as strong, isn’t as profitable, making those same bets, and we might have had to step in. And that’s exactly why Wall Street reform is so important.

AMY GOODMAN: JPMorgan was among a number of large banks to lobby against the Volcker Rule, which would prevent banks from certain kinds of risky trading. Speaking on NBC’s Meet the Press, JPMorgan CEO Jamie Dimon says he expects increased scrutiny from regulators.

JAMIE DIMON: We’ve had audit, legal, risk, compliance, some of our best people look into at all of that. We know we were sloppy. We know we were stupid. We know there was bad judgment. We don’t know if any of that is true yet. Now, of course, regulators should look at something like this, that’s their job. So, you know, we are totally open kimono with regulators, and they will come to their own conclusions. But we intend to fix it, learn from it, and be a better company when it’s done.

AMY GOODMAN: To discuss the implications of this latest Wall Street crisis, we go to Kansas City to speak with William Black, white-collar criminologist, former senior financial regulator, author of The Best Way to Rob a Bank is to Own One. He’s also associate professor of economics and law at the University of Missouri-Kansas City.

William Black, welcome to Democracy Now! Can you please explain what happened at JPMorgan?

WILLIAM BLACK: Well, I can try. One of the things about this kind of derivatives is that it’s extremely opaque, and we only have JPMorgan’s side of the story at this point, without any real investigation, and JPMorgan’s story doesn’t make a whole lot of sense. But here’s what the story that they’re telling is. They had about $15 billion in distressed European debt. As your, you know, listeners and viewers know, Europe has been in just a ton of trouble. And so, those investments were losing all kinds of value. Now, the story, which, again, doesn’t make a whole lot of sense, is that they decided to hedge this position. A hedge is something where you invest in a second asset that is supposed to offset losses that you suffer in the first asset. In this case, the first asset was that distressed European debt, and the second asset, the supposed hedge, was a derivative of a derivative. In this case, it was an index of credit default swaps, which are a form of derivative that blew up AIG. Now then, the story gets even murkier, but it—the claim from out of JPMorgan is nobody was looking very carefully at the supposed hedge, and the hedge didn’t perform to offset losses, instead it increased the losses and increased the losses dramatically. And supposedly, no one was looking, and no one adjusted for this. And they woke up, and they had a $2 billion loss. So that’s the story from JPMorgan, as I said, that doesn’t make sense, and I can explain that, if you wish.

AMY GOODMAN: Explain.

WILLIAM BLACK: OK, so first, if you have distressed European debt, you’re supposed to have already reserved against the losses in it. So, why hedge the position at all? Just sell it. Get rid of these incredibly risky assets before they can suffer any additional losses. If you’ve already got loss reserves, you don’t even have to recognize a loss, because you’ve already reserved for it. So, you shouldn’t have had to hedge, period.

Second, if you were going to hedge, he should have hedged. And the way you would hedge something like this is to buy a credit default swap protection against the bad assets. That would hedge. In other words, if you lost on the value of the European debt, the credit default swap would go up in value, and you would be protected against loss. Instead, they have allegedly bet in the opposite direction by buying this derivative of a derivative. If the European debt lost value, the derivative of the derivative was also likely to lose value. Well, that’s not a hedge. That’s a double speculation in the same direction. You’re doubling down on the bet.

And the reason you’re calling it a hedge is because it’s illegal, under the Volcker Rule, to speculate in this fashion. So the story coming out of JPMorgan doesn’t make any sense as a financial matter. It seems reasonably clear that this is faux hedges. This is, you know, to hedging like truthiness is to truth. So this is hedginess: not really a hedge, but you call it a hedge to evade the law.

AMY GOODMAN: I want to play more of what JPMorgan Chase chair Jamie Dimon said this weekend on Meet the Press.

JAMIE DIMON: We support getting rid of "too big to fail." And it’s very important that—and this is not—this is a—not going to even remotely—we’re going to make money, we’ve got tons of capital. But we support "too big to fail." We want the government to be able to take down a big bank like JPMorgan, and it can be done. We think Dodd-Frank, which we supported parts of, gave the FDIC the authority to take down a big bank, and when it happens, I believe compensation should be clawed back, the board should be fired, the equity should be wiped out, and the bank should be dismantled, and the name should be buried in disgrace. That’s what I believe. We need to put that back in the system, and we’ll work with the regulators to try to get that back in the system.

AMY GOODMAN: That’s JPMorgan Chase chair Jamie Dimon. William Black, your response?

WILLIAM BLACK: Well, you can’t have a system work the way he is saying. So, if the institution is allowed to stay this large, it will be too big to fail, and its creditors will be bailed out. And that’s to prevent what is feared to be a cascade of failures, in which one big bank would then cause the failure of the next big bank, etc., etc., and you would have a global crisis. So, allowing them to be this big, even conservative economists call this crony capitalism, and they say that it creates such competitive advantage in it for the systemically dangerous institution—JPMorgan in this case—that it is the equivalent, when they compete with smaller banks, of — and I’m quoting — "bringing a gun to a knife fight."

So the only way this can work is to shrink the systemically dangerous institutions—this is the 20 largest banks in the United States—down to the point that they no longer pose a systemic risk, they are no longer too big to fail, and therefore, they will no longer have this implicit federal subsidy that completely distorts competition. And, of course, we’re not just talking about destroying market systems; this also destroys democracy, because these giant institutions have so much political power. And lastly, the statement is completely disingenuous because JPMorgan in fact opposes all efforts to get rid of "too big to fail."

AMY GOODMAN: Speaking of democracy, JPMorgan’s Jamie Dimon, speaking on Meet the Press, said he understands the anger of the American people with Wall Street. He’s interviewed by David Gregory.

DAVID GREGORY: A lot of Americans are galled by the fact that the American worker is still struggling, and yet banks like yours are making a lot of money. Your compensation, north of $20 million, has been published in reports. Do you understand that frustration?

JAMIE DIMON: Sure. You know, people have asked me, "What are you doing about Occupy Wall Street?" And I’ve said that, surprisingly, if the average American has the right to say that the institutions of America let me down—and that’s true. I think if the average American says that’s predominantly Washington and Wall Street, broadly defined, I think that’s true, too. You know, Washington and Wall Street are the epicenter. I blame both of them. I mean, there are a lot of policies and procedures. I think when you go beyond that and start to blame every single bank or every single politician, every single bank, no, it’s not true. A lot of banks were a port in the storm. Not all the banks needed to be bailed out. A lot of them did things, like Bear Stearns and WaMu, Wells Fargo bought Wachovia, and did everything to help, financing cities, states, hospitals. So, that should be recognized, too. So—but I understand that frustration. I understand the frustration in inequity. I think the world, we’ve become a little more inequitable. I don’t think it’s a good long-term thing for society. And therefore, I’m in favor of progressive taxation. You know, you can get into specifics, exactly—

DAVID GREGORY: The Buffett rule, for instance?

JAMIE DIMON: Well, but I don’t understand the Buffett rule exactly, but if you said—

DAVID GREGORY: Or more taxes on capital gains.

JAMIE DIMON: Believe it or not, I think most people on Wall Street would be happy to pay—you know, to have the Bush tax cut go away and pay higher capital gains, if they thought it was part of a plan to fix everything. I do believe that. And that’s why, in fact, taxing them is—attacking is not the right thing, because they’re willing to do their part. Matter of fact, I think you should appeal to people’s better nature and say, "Listen, you’re well paid. You’ve benefited from this great country. We need you to give a little bit more for now to help lift the country up." So, anyway, I do understand the anger.

AMY GOODMAN: That’s JPMorgan’s Jamie Dimon. William Black, your response?

WILLIAM BLACK: Well, first, they didn’t make the world better off by acquiring Bear Stearns and Washington Mutual; they made themselves even more powerful and made it even more impossible to have them fail, and therefore vastly increased their political and their economic power.

The proof of the pudding is what the big banks actually did. And the big banks lobbied to create the Gramm-Leach-Bliley Act, which repealed Glass-Steagall. Glass-Steagall had worked brilliantly. It separated commerce and investment. And it would have prohibited and prevented the losses that JPMorgan just suffered. They also, the big banks, pushed the Commodity Futures Modernization Act, and if that act had not been passed, we would have avoided much of the entire financial crisis that we just went through, and we might well have avoided the $2 billion loss that JPMorgan has just suffered. The big banks fought tooth and nail, and continue to fight tooth and nail, to destroy the Volcker Rule, which, again, if the Volcker Rule had been in place, with real regulations, would have prevented this loss. The big banks also fought tooth and nail the requirement that derivatives, when they did invest in them, that they do so in a transparent way through a clearing house, which also would have prevented this $2 billion loss. But that rule is not in effect because JPMorgan led the effort to delay the adoption of these rules and to weaken these rules so much that they are completely unenforceable.

AMY GOODMAN: Elizabeth Warren, who’s running for Senate in Massachusetts but was one of the shapers of the Consumer Financial Protection Bureau, has said Jamie Dimon should resign from his position as director of the New York Fed. Explain what that position is and why this is significant.

WILLIAM BLACK: Yeah, the Federal Reserve banks—there are 12 of them, regionally—have as their directors, overwhelmingly, industry. So these are overwhelmingly executives from the banks that they’re supposed to regulate. Most regulation in the Federal Reserve is done through the field, through these regional Federal Reserve banks. So, Timothy Geithner was supposed to be the top regulator in New York in his role as president. But no real regulation occurs, of course, because you can’t expect people to regulate their bosses. It doesn’t work. Congress recognized this in a completely analogous situation. In 1989, in the FIRREA legislation to deal with the savings-and-loan crisis, it looked at the Federal Home Loan Bank System, which was set up in a parallel way to the Federal Reserve banks. And it said this is an impossible conflict of interest. You cannot regulate your bosses. And so, it removed all governmental authority from the Federal Home Loan Banks. The same thing desperately needs to be done in the Federal Reserve, where it is far more damaging because these are much bigger players and much more destructive players.

I mean, what we haven’t mentioned to this point is why there is a Volcker Rule. And there is a Volcker Rule because it was these derivative positions that caused the global financial crisis. They caused hundreds of billions of dollars of losses to the largest banks. The list of systemically dangerous institutions that Jamie Dimon went through that failed, they all failed in large part because of these financial derivatives, what we call the green slime. So, that’s what brought down Fannie and Freddie and Lehman Brothers and Bear Stearns and Washington Mutual, Lehman, Merrill Lynch and Wachovia. After those catastrophic disasters that caused the Great Recession, cost six billion Americans their jobs directly, prevented another five to eight million jobs from being created, helped lead to a global crisis called the Great Recession—after that, the banks still fought to be allowed to do exactly the same kind of derivative trades. And even when the Volcker Rule was adopted, over their opposition and over the opposition of the Federal Reserve and of Treasury Secretary Timothy Geithner, who remains true to his former boss, Jamie Dimon, after that, they gutted the rule—at least the draft rule to implement the Volcker Rule. And unless it is changed, the Volcker Rule will be essentially unenforceable, because you’re allowed, under the current draft, to simply call something a hedge, even though it operates in the exact opposite of a hedge. And voilà, this hedginess is OK, and the losses just mount up and produce the next disaster.

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