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15 Takeaways From Jamie Dimon's Senate Testimony

June 13, 2012 | About:
J.P. Morgan (JPM) CEO Jamie Dimon voluntarily testified today at a Senate hearing, purportedly about the firm’s recent trading loss. The hearing covered the reasons and reactions to the loss, as well as thoughts on Dodd-Frank and other regulations. Dimon came away unscathed. Here are some of the highlights:

The losses resulted from an attempt to reduce risk. One option for the CIO would have been to reduce overall exposure. Instead, the unit attempted to increase the hedges. Dimon contends that the purpose of the unit was to hedge, but they actually ended up taking on additional risk because traders didn’t understand the risks.

This loss really was a drop in the bucket. The firm lost no customer or client money, and the quarter for the bank will still shows a profit.

The loss was an isolated event. A lot of critics have jumped on it, of course, but J.P. Morgan still has shown a $7 billion unrealized profit from the CIO unit over the last three years.

Oversight by senior members of the bank was not robust enough. CIO traders did not understand the risks of what they were doing. Dimon and other key personnel should have more closely scrutinized the strategy and the trades.

The problem has been identified and steps have been taken to address it. The bank has appointed a new head for the CIO unit. A new risk committee structure has been implemented. An extensive firm-wide review is being conducted.

People should keep things in perspective. J.P. Morgan is a market leader. The bank has more than $30 billion of loan loss reserves. Basel I Tier 1common ratio is 10.4%. Basel III is 8.2% and rising. The balance sheet is a fortress and can easily handle this loss. Fed stress tests determined that J.P. Morgan could handle an $80 billion loss and still maintain an adequate capital cushion.

Republicans used this testimony as an opportunity to re-litigate Dodd Frank and financial regulation. In response to a question from Sen. Corker, Dimon said he didn’t know if Dodd-Frank made the financial system safer. He said higher capital and liquidity requirements were good, but taken as a whole, it’s unclear if the law will prevent industry catastrophes.

Being a large, complex institution is necessary. Dimon said that if J.P. Morgan didn’t provide the services they did, others would. Large corporations need things such as large intra-day loans that can only be provided by large international financial institutions. If American institutions aren’t allowed to do it, overseas banks would.

Regulations are hurting lending. Dimon is okay with high capital requirements, but not knowing what the ultimate requirement will be and when it must be implemented causes too much confusion for the banks. The inevitable result is reduced lending.

The Volcker Rule is unnecessary. Dimon has said this before, and he reiterated it. The Volcker Rule would be difficult to implement and, even so, it hasn’t been written yet so Dimon said he didn’t know exactly what it would be and if it would ban these types of trades.

J.P. Morgan may clawback bonuses for those let go from the unit. The bank has never done a clawback, but they are investigating doing it in this case. Dimon favors the idea.

The best regulations would be simple, strong, and clean. In response to a question from Sen. DeMint, Dimon said regulations are necessary, but are not currently effective. Current regulations lack clarity and make it difficult for banks to effectively carry out their mission.

High capital requirements are the best regulatory tool to protect against loss. What protected J.P. Morgan in regards to this mistake is the strong balance sheet. That’s what a fortress balance sheet is intended to do, and that’s what it did do.

Sen. Merkley isn’t the brightest tool in the shed. I suspect he’s not alone in not understanding the financial crisis. It’s very clear that J.P. Morgan did not need TARP, but Sen. Merkley insisted that J.P. Morgan would have gone under if not for TARP and the AIG bailout. When Dimon attempted to explain it to him and said the senator was “misninformed.” Merkley said they should just agree to disagree, which was laughable.

The hearing was only peripherally about the trading loss. The fact is that most of the Senators didn’t fully understand the specifics of what they were questioning about. The hearing, as most hearings do, turned into a show. Dimon clearly had an intellectual advantage over most of the senators, so when one did challenge him, as Sen. Merkley did, the questioner ended up looking foolish. J.P. Morgan is a market leader and Jamie Dimon is one of the best CEOs in the country. Ultimately, the hearings gave Dimon a platform to demonstrate that.

Disclosure: No position

About the author:

Steven Kiel
Steven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at steven.kiel@arquitos.com or through the firm's website at www.arquitos.com.

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Comments

Josh Zachariah
Josh Zachariah premium member - 2 years ago
On Bloomberg Radio today shortly after the interview, the commentators mentioned that Dimon's statement that the bank changes its valuation models (ie VaR) all the time is bogus. The commentators specifically noted Wells Fargo which never changes its valuation model nor does JPM change it as frequently as Dimon implied.
cor7997
Cor7997 premium member - 2 years ago
I think the most effective questions were from Sen. Jack Reed, in particular here:

: Now let me ask, it appears from looking at some published reports, that essentially these credit default swaps were first made to protect your loans outstanding, particularly in Europe, and that was in the 2007, 2008 time period, which is classic hedging. You have extended credits to corporations, if those credits go bad, you want to be able to be on the other side to insure yourself against that. But then in 2000, well 2011 or 2012 at some point, the bet was switched and now you started, rather than protecting your credit exposures, taking the other side of transaction and selling the credit protection, which seems to me to be a bet on the direction of the market unrelated to your actual sort of credit exposure in Europe, which looks a lot like proprietary trading designed to generate as much profit as you could generate, which seems to be inconsistent again with, if this is simply a risk operation and you're hedging a portfolio. How can you be on both sides of the transaction and claim that you're hedging?

[b]http://www.bloomberg.com/video/94594841-reed-how-can-you-be-on-both-sides-of-transaction.html

HERE I THNK IS THE MOMENT WHERE MR. DIMON CONFESS THAT THIS IS A BET AND NOT AN HEDGE!
[/b][/b][/b]

slkiel
Slkiel - 2 years ago
I happened to think that when you're dealing with these derivatives, they're all bets. It's a bet that the hedge will work, which is not always true. This wasn't a one to one hedge anyway.

Personally, I don't like any of these transactions. Big banks like this are kind of like a necessary evil. I would like to see CDS's banned. Proponents contend they drive down the borrowing rate, which I agree with, but I don't think is a good thing.
Cornelius Chan
Cornelius Chan - 2 years ago
If Congress would re-implement the Glass-Steagall act as necessitated by the run-amok banks, we would not have to waste our time watching the politicians and the banker play verbal ping pong regarding a disclosed loss of $2B.

When the govt. lets the banks turn into "financial holding company" and allows this entity to make gambling bets with asset-backed derivatives using customer deposits, then what happens is the taxpayers of the land foot the bill for damage control when things go south.

Steven Kiel, do you agree or not?

[u][/u]

slkiel
Slkiel - 2 years ago
Well, I agree in theory, but unfortunately the devil is in the details.

Tangentially, I think when these i-banks were actual partnerships, with partner assets involved, the risk of blow-up was reduced. I don't know if a policy can change that, but there is an inherent conflict of interest when they are publicly traded companies. There is a valid reason why law firms, for example, cannot be publicly traded. I also think there is a valid reason why i-banks shouldn't be. You cannot owe a duty to shareholders, clients, and partners without one of them being in conflict. I'm hoping there will be more written about that from someone smarter than me.
AlbertaSunwapta
AlbertaSunwapta - 2 years ago
The hedges may have been been based on sound reasoning regarding intrinsic values, and over time might not only hedge other exposure but even prove profitable. However, when the world knows what you are doing and that you are taking outsized bets near any realistic limits, they can alter short term market conditions to their own benefit.
John Emerson
John Emerson - 2 years ago
I can not envision any senario where selling Credit Default Swaps is a hedge. Selling a CDS is consummate to selling insurance; a hedge implies buying insurance.

More likely, selling the CDS was an attempt to beef up short term trading profits by taking a side on the sovereign debt crisis. Further, JPM was the big whale in a small insolvent market who was attempting to bully out the weaker competition. If you break the competition in a game of chicken it does not matter if your thesis is correct or incorrect in the longer term. In the interim you can assume their positions as you force them out and balance out your other side of the trade.

That is not a hedge; rather it is an attempt to corner the market.

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