Some big picture perspective from Jamie Dimon via his annual letter to shareholders.
How We View European Sovereign and Geopolitical Risk
The European Union (EU) is one of the great collective endeavors of all time – where participating countries are striving to form a permanent union of nations for the benefit of all their citizens. In the short run, i.e., in the next year or two, we believe that the Euro Zone, in fits and starts, will work through its problems. It has the will and wherewithal to do so.
The politicians of Europe seem to be completely devoted to making this work – as their predecessors were for the past 60 years. The process will be messy, but the consequence of giving up could be far worse: Sovereign defaults could lead to a bank crisis with serious economic consequences. Since it is the same money (if sovereign nations default on their debt, the EU will have to recapitalize its banks by approximately the same amount), it is better to fix the problem without causing additional complications.
Once the short-term issues are addressed, there likely will be some restructuring of the fiscal and monetary agreements between the nations and possibly the restructuring of some of the nations’ debt.
We believe there are ways to do this with minimal damage – particularly if the EU is able to achieve economic growth. When the sovereign crisis started, JPMorgan Chase’s gross exposures to Greece, Ireland, Portugal, Spain and Italy totaled approximately $40 billion – but net of collateral and hedges, our real exposures were approximately $20 billion. We did not run or panic – we stayed the course. While we reduced some of our exposures (essentially, the investment of excess cash for the company), we did not reduce the exposures associated with serving our clients, and we continued to actively conduct business in those nations.
Our position was clear and consistent: to be there for our clients, not just in good times, but in bad times as well. Going forward, this mission will not change. We know the risks, and we are prepared to take them. For example, in the unlikely occurrence of extremely bad outcomes in all these countries, JPMorgan Chase ultimately could lose approximately $3 billion, after tax.
But we are in the business of taking risks in support of our clients and believe that this is a risk worth bearing since we hope to be growing our business in these countries for decades to come.
Our broader perspective on geopolitical uncertainty is that it is a constant state of affairs, which has been and always will be there, whether immediately visible or not.
Such uncertainty is one of the main reasons we control our credit exposures and maintain extremely strong capital and liquidity at all times. Before turning to the economic impact of the crisis in the Middle East, we hope, first and foremost, that the outcome of these historic movements will be to enhance the life and rights of the people in the region.
For our company, in particular, our direct exposures are manageable. The key economic impact is if extreme turmoil leads to extraordinarily high oil prices, which then could cause a global recession. As you know, however, we always run this company to be prepared to deal with the effects of a global recession.
How We View the American Economy —Short Term and Long Term
Five years ago, very few people seemed to worry about outsized risk, black swans and fat tails. Today, people see a black swan with a fat tail behind every rock. The U.S. economy was, is and will remain for the foreseeable future the mightiest economic machine on this planet. America is home to many of the best universities and companies in the world. It still is one of the greatest innovators. The volume and variation of our inventions created in America are extraordinary – from bold new technologies, like the Internet, to thousands of small, incremental improvements in processes and products that, in aggregate, dramatically improve productivity.
America also has an exceptional legal system (notwithstanding my many reservations about the class-action and tort system) and the best and deepest capital markets. The American people have a great work ethic, from farmers and factory workers to engineers and businessmen (even bankers and CEOs). And it still has the most entrepreneurial population on earth. American ingenuity is alive and well.
I mention all this because we need to put our current problems – and they are real – into proper context. Our problems may be daunting, but they also are resolvable. As a nation, we have overcome far worse challenges, from the Civil War to the Great Depression to World War II. Even amid our current challenges, we have begun to see clear signs of stability and growth returning to the capital markets and the U.S. economy.
Almost everything is better than it was a year or two ago. It’s conceivable that we are at the beginning of a self-sustaining recovery that could power through many of the negatives we’ve been focusing on recently. Consumers are getting stronger, spending at levels similar to those two-and-a-half years ago, but, instead of spending more than their income, they now are saving 5% of their income. And consumer debt service costs, i.e., how much they spend of their income to service their debt, have returned to levels seen in the 1990s (due to debt repayment, charge-offs and debt forgiveness, lower interest rates, etc.).
Businesses, large and small, are getting stronger. Large companies have plenty of cash. Medium sized and small businesses are in better financial condition and are starting to borrow again. Global trade is growing – U.S. exports were up 16% in 2010. Job growth seems to have begun. Financial markets are wide open – and banks are lending more freely. U.S. businesses, large and small, are investing more than $2 trillion a year in capital expenditures and research and development.
They have the ability to do more, and, at the end of the day, the growth in the economy ultimately is driven by increased capital investment. The biggest negative that people point to is that home prices are continuing to decline, new home sales are at record lows and foreclosures are on the rise. Our data indicates that the rate of foreclosures will start to come down later this year. Approximately 30% of the homes in America do not have mortgages – and of those that do, approximately 90% of mortgage-holding homeowners are paying their loans on time. Housing affordability is at an all-time high. The U.S. population is growing at over 3 million a year, and those people eventually will need housing. Additionally, the fact that fewer homes are being built means that supply and demand will come into balance sooner than it otherwise would have. That said, housing prices likely will continue to go down modestly because of the continuous high levels of homes for sale. The ultimate recovery of the housing market and housing prices likely will follow job growth and a general recovery in the economy.
Yes, America still is facing headwinds and uncertainties – including abnormal monetary policy and looming fiscal deficits. And while we can’t really predict what the economy will do in the next year or two (though we think it is getting stronger), we are confident that the world’s greatest economy will regain its footing and grow over the ensuing decade.
But we must take serious action to ensure our success in the decades ahead While our confidence in the next decade is high, for America to thrive after that, it soon must confront some of the serious issues facing it. We need to redouble our efforts to develop an immigration policy and a real, sustainable energy policy; protect our environment; improve our education and health systems; rebuild our infrastructure for the future; and find solutions for our still-unbalanced trade and capital flows.
The sooner we address these issues, the better – America does not have a divine right to success, and it can’t rely on wishful thinking and its great heritage alone to get the country where it needs to go. But I remain, perhaps naively, optimistic. As Winston Churchill once said, “You can always count on Americans to do the right thing – after they’ve tried everything else.”
What we don’t know (and we have a healthy fear of unintended consequences)
Around the world and all at once, policymakers and regulators are making countless changes, from guidelines around marketmaking, derivatives rules, capital and liquidity standards, and more. Many of the rules have yet to be defined in detail, and it is likely that they will not be applied evenly around the world. The combined impact of so much change – so much unknown about the interplay among all these factors and an uneven global playing field – potentially is large.
These unpredictable outcomes and unintended consequences could affect far more than products and pricing. For example, if a business cannot sell certain products or if the cost of selling them is so high that it cannot be adequately recouped, that business risks losing all of its clients. A simple analogy: If a restaurant that sells burgers can’t sell french fries, it risks losing all of its customers. Like it or not, we will adjust to the impact of new regulation on financial products and pricing. But we will remain vigilant about the changes that could threaten or undermine entire businesses. Three of our main concerns are:
First, and most important, we want to ensure that our clients are not negatively affected in a material way and that our ability to properly serve them is not unduly compromised.
Second, we need to be cautious about the creation of non-banks or new shadow banks. This could happen if the cumulative effect of all the regulations not only hampers banks from conducting their business but restricts them so much that the business slowly and inevitably moves to non-banks.
And, third, we need to ensure that American banks are not significantly disadvantaged relative to their global counterparts. The cumulative effect of higher capital standards, too restrictive market-making and derivatives rules, price control and arbitrary bank taxes could significantly impede our ability to compete over the long run. We don’t expect any of these three outcomes to occur – nor do we believe that it was or is the intent of the lawmakers or regulators – but it bears paying close attention.
Although we tend to focus on the downside of unintended consequences, we should recognize that there may be some positive consequences. For example, large changes in business regulations and dynamics often lead to new businesses, innovations and new products. Also, our ability to compete may be hampered in some instances but actually helped in others. For example, the cost and complexity of all the recent regulations, ironically, could create greater barriers for new entrants and new competitors.
Our System Was on the Edge of Chaos, and Governments and Regulators Deserve Enormous Credit for Preventing the Collapse
I have long been on record giving huge credit to the U.S. government and governments around the world for the drastic, bold actions they took to stop this rapidly moving crisis from getting considerably worse. A great number of the actions that the Treasury and the Federal Reserve took, both directly and indirectly, helped sustain numerous institutions and probably prevented many from failure and bankruptcy. These actions were done to save the economy and to safeguard jobs. While we should try to do everything in our power to stop a crisis from happening again, we should recognize two critical points. Markets can be rational or irrational, and fear could freeze markets again. And when there are severe problems, only the government, in some form, has the wherewithal, power and liquidity to be the backstop of last resort.
Effectively changing our exceedingly complex global economic system requires great careWhen this crisis began, it looked as “normal” as any crisis can, but it quickly careened intoa global catastrophe. Most observers pinpoint the key moment as Lehman Brothers’ failure in September 2008. But one of the things that made Lehman’s failure so bad was that it came after the failure of Bear Stearns, Fannie Mae and Freddie Mac, among others.It was the cumulative effect of the collapse of all these institutions, many of which were overleveraged, that was so damaging. Had Lehman’s failure occurred at another time, and been an isolated event, its failure would not likely have been so devastating.
Complex systems – and our global economic system surely is one – often oscillate within relatively normal confines. Our complex economic system regularly has produced“normal” recessions and booms and occasionally a devastating one like the Great Depression or the recent economic crisis.
The factors that occasionally and devastatingly derail a system at any point in time may have contributed only because the table already had been set; at other times, the same factor would have had no effect at all. This phenomenon shows up in complex systems throughout nature.
Scientists dealing with complex systems try to isolate the impact of changing one input while holding all other elements constant. They know that if they change everything at once, it may be impossible to identify cause and effect.
As we try to remake our complex economic system, we need to be cautious and respectful of what the cumulative effect will be of making multiple changes at the same time.
http://files.shareholder.com/downloads/ONE/1218020244x0x457315/cc3470a5-514f-4ade-9084-17db45e870dc/2010_JPMC_AR_letter.pdf
How We View European Sovereign and Geopolitical Risk
The European Union (EU) is one of the great collective endeavors of all time – where participating countries are striving to form a permanent union of nations for the benefit of all their citizens. In the short run, i.e., in the next year or two, we believe that the Euro Zone, in fits and starts, will work through its problems. It has the will and wherewithal to do so.
The politicians of Europe seem to be completely devoted to making this work – as their predecessors were for the past 60 years. The process will be messy, but the consequence of giving up could be far worse: Sovereign defaults could lead to a bank crisis with serious economic consequences. Since it is the same money (if sovereign nations default on their debt, the EU will have to recapitalize its banks by approximately the same amount), it is better to fix the problem without causing additional complications.
Once the short-term issues are addressed, there likely will be some restructuring of the fiscal and monetary agreements between the nations and possibly the restructuring of some of the nations’ debt.
We believe there are ways to do this with minimal damage – particularly if the EU is able to achieve economic growth. When the sovereign crisis started, JPMorgan Chase’s gross exposures to Greece, Ireland, Portugal, Spain and Italy totaled approximately $40 billion – but net of collateral and hedges, our real exposures were approximately $20 billion. We did not run or panic – we stayed the course. While we reduced some of our exposures (essentially, the investment of excess cash for the company), we did not reduce the exposures associated with serving our clients, and we continued to actively conduct business in those nations.
Our position was clear and consistent: to be there for our clients, not just in good times, but in bad times as well. Going forward, this mission will not change. We know the risks, and we are prepared to take them. For example, in the unlikely occurrence of extremely bad outcomes in all these countries, JPMorgan Chase ultimately could lose approximately $3 billion, after tax.
But we are in the business of taking risks in support of our clients and believe that this is a risk worth bearing since we hope to be growing our business in these countries for decades to come.
Our broader perspective on geopolitical uncertainty is that it is a constant state of affairs, which has been and always will be there, whether immediately visible or not.
Such uncertainty is one of the main reasons we control our credit exposures and maintain extremely strong capital and liquidity at all times. Before turning to the economic impact of the crisis in the Middle East, we hope, first and foremost, that the outcome of these historic movements will be to enhance the life and rights of the people in the region.
For our company, in particular, our direct exposures are manageable. The key economic impact is if extreme turmoil leads to extraordinarily high oil prices, which then could cause a global recession. As you know, however, we always run this company to be prepared to deal with the effects of a global recession.
How We View the American Economy —Short Term and Long Term
Five years ago, very few people seemed to worry about outsized risk, black swans and fat tails. Today, people see a black swan with a fat tail behind every rock. The U.S. economy was, is and will remain for the foreseeable future the mightiest economic machine on this planet. America is home to many of the best universities and companies in the world. It still is one of the greatest innovators. The volume and variation of our inventions created in America are extraordinary – from bold new technologies, like the Internet, to thousands of small, incremental improvements in processes and products that, in aggregate, dramatically improve productivity.
America also has an exceptional legal system (notwithstanding my many reservations about the class-action and tort system) and the best and deepest capital markets. The American people have a great work ethic, from farmers and factory workers to engineers and businessmen (even bankers and CEOs). And it still has the most entrepreneurial population on earth. American ingenuity is alive and well.
I mention all this because we need to put our current problems – and they are real – into proper context. Our problems may be daunting, but they also are resolvable. As a nation, we have overcome far worse challenges, from the Civil War to the Great Depression to World War II. Even amid our current challenges, we have begun to see clear signs of stability and growth returning to the capital markets and the U.S. economy.
Almost everything is better than it was a year or two ago. It’s conceivable that we are at the beginning of a self-sustaining recovery that could power through many of the negatives we’ve been focusing on recently. Consumers are getting stronger, spending at levels similar to those two-and-a-half years ago, but, instead of spending more than their income, they now are saving 5% of their income. And consumer debt service costs, i.e., how much they spend of their income to service their debt, have returned to levels seen in the 1990s (due to debt repayment, charge-offs and debt forgiveness, lower interest rates, etc.).
Businesses, large and small, are getting stronger. Large companies have plenty of cash. Medium sized and small businesses are in better financial condition and are starting to borrow again. Global trade is growing – U.S. exports were up 16% in 2010. Job growth seems to have begun. Financial markets are wide open – and banks are lending more freely. U.S. businesses, large and small, are investing more than $2 trillion a year in capital expenditures and research and development.
They have the ability to do more, and, at the end of the day, the growth in the economy ultimately is driven by increased capital investment. The biggest negative that people point to is that home prices are continuing to decline, new home sales are at record lows and foreclosures are on the rise. Our data indicates that the rate of foreclosures will start to come down later this year. Approximately 30% of the homes in America do not have mortgages – and of those that do, approximately 90% of mortgage-holding homeowners are paying their loans on time. Housing affordability is at an all-time high. The U.S. population is growing at over 3 million a year, and those people eventually will need housing. Additionally, the fact that fewer homes are being built means that supply and demand will come into balance sooner than it otherwise would have. That said, housing prices likely will continue to go down modestly because of the continuous high levels of homes for sale. The ultimate recovery of the housing market and housing prices likely will follow job growth and a general recovery in the economy.
Yes, America still is facing headwinds and uncertainties – including abnormal monetary policy and looming fiscal deficits. And while we can’t really predict what the economy will do in the next year or two (though we think it is getting stronger), we are confident that the world’s greatest economy will regain its footing and grow over the ensuing decade.
But we must take serious action to ensure our success in the decades ahead While our confidence in the next decade is high, for America to thrive after that, it soon must confront some of the serious issues facing it. We need to redouble our efforts to develop an immigration policy and a real, sustainable energy policy; protect our environment; improve our education and health systems; rebuild our infrastructure for the future; and find solutions for our still-unbalanced trade and capital flows.
The sooner we address these issues, the better – America does not have a divine right to success, and it can’t rely on wishful thinking and its great heritage alone to get the country where it needs to go. But I remain, perhaps naively, optimistic. As Winston Churchill once said, “You can always count on Americans to do the right thing – after they’ve tried everything else.”
What we don’t know (and we have a healthy fear of unintended consequences)
Around the world and all at once, policymakers and regulators are making countless changes, from guidelines around marketmaking, derivatives rules, capital and liquidity standards, and more. Many of the rules have yet to be defined in detail, and it is likely that they will not be applied evenly around the world. The combined impact of so much change – so much unknown about the interplay among all these factors and an uneven global playing field – potentially is large.
These unpredictable outcomes and unintended consequences could affect far more than products and pricing. For example, if a business cannot sell certain products or if the cost of selling them is so high that it cannot be adequately recouped, that business risks losing all of its clients. A simple analogy: If a restaurant that sells burgers can’t sell french fries, it risks losing all of its customers. Like it or not, we will adjust to the impact of new regulation on financial products and pricing. But we will remain vigilant about the changes that could threaten or undermine entire businesses. Three of our main concerns are:
First, and most important, we want to ensure that our clients are not negatively affected in a material way and that our ability to properly serve them is not unduly compromised.
Second, we need to be cautious about the creation of non-banks or new shadow banks. This could happen if the cumulative effect of all the regulations not only hampers banks from conducting their business but restricts them so much that the business slowly and inevitably moves to non-banks.
And, third, we need to ensure that American banks are not significantly disadvantaged relative to their global counterparts. The cumulative effect of higher capital standards, too restrictive market-making and derivatives rules, price control and arbitrary bank taxes could significantly impede our ability to compete over the long run. We don’t expect any of these three outcomes to occur – nor do we believe that it was or is the intent of the lawmakers or regulators – but it bears paying close attention.
Although we tend to focus on the downside of unintended consequences, we should recognize that there may be some positive consequences. For example, large changes in business regulations and dynamics often lead to new businesses, innovations and new products. Also, our ability to compete may be hampered in some instances but actually helped in others. For example, the cost and complexity of all the recent regulations, ironically, could create greater barriers for new entrants and new competitors.
Our System Was on the Edge of Chaos, and Governments and Regulators Deserve Enormous Credit for Preventing the Collapse
I have long been on record giving huge credit to the U.S. government and governments around the world for the drastic, bold actions they took to stop this rapidly moving crisis from getting considerably worse. A great number of the actions that the Treasury and the Federal Reserve took, both directly and indirectly, helped sustain numerous institutions and probably prevented many from failure and bankruptcy. These actions were done to save the economy and to safeguard jobs. While we should try to do everything in our power to stop a crisis from happening again, we should recognize two critical points. Markets can be rational or irrational, and fear could freeze markets again. And when there are severe problems, only the government, in some form, has the wherewithal, power and liquidity to be the backstop of last resort.
Effectively changing our exceedingly complex global economic system requires great careWhen this crisis began, it looked as “normal” as any crisis can, but it quickly careened intoa global catastrophe. Most observers pinpoint the key moment as Lehman Brothers’ failure in September 2008. But one of the things that made Lehman’s failure so bad was that it came after the failure of Bear Stearns, Fannie Mae and Freddie Mac, among others.It was the cumulative effect of the collapse of all these institutions, many of which were overleveraged, that was so damaging. Had Lehman’s failure occurred at another time, and been an isolated event, its failure would not likely have been so devastating.
Complex systems – and our global economic system surely is one – often oscillate within relatively normal confines. Our complex economic system regularly has produced“normal” recessions and booms and occasionally a devastating one like the Great Depression or the recent economic crisis.
The factors that occasionally and devastatingly derail a system at any point in time may have contributed only because the table already had been set; at other times, the same factor would have had no effect at all. This phenomenon shows up in complex systems throughout nature.
Scientists dealing with complex systems try to isolate the impact of changing one input while holding all other elements constant. They know that if they change everything at once, it may be impossible to identify cause and effect.
As we try to remake our complex economic system, we need to be cautious and respectful of what the cumulative effect will be of making multiple changes at the same time.
http://files.shareholder.com/downloads/ONE/1218020244x0x457315/cc3470a5-514f-4ade-9084-17db45e870dc/2010_JPMC_AR_letter.pdf
