Financial Regulation

Did Too Big To Fail Help Make JPMorgan's $2 Billion Loss Possible?


Reuters financial columnist Felix Salmon offers some useful speculation about how JPMorgan Chase's $2 billion loss might have happened, and argues that too-big-to-fail was part of the story.

[Ina] Drew's Chief Investment Office [at JPM]  quadrupled in size between 2006 and 2011, reaching $356 billion in total, and it's easy to see how that happened. On the one hand, it was incredibly profitable, with the London team alone, which oversaw some $200 billion, making $5 billion of profit in 2010, more than 25% of JP Morgan's net income for the year. At the same time JP Morgan accumulated enormous new deposits in the wake of the financial crisis, both by acquiring banks and by attracting big new clients wanting the safety of a too-big-to-fail bank. Historically, JP Morgan has served big corporations by lending them money, but nowadays, as the cash balances on corporate balance sheets get ever more enormous, the main thing these companies want from JP Morgan is a simple checking account — one where they can be sure that their money is safe.

With lots of deposits coming in, and little corporate demand for loans, it was easy for all that money to find its way to the Chief Investment Office, which could take any amount of liabilities (deposits are liabilities, for a bank) and turn them into assets generating billions of dollars in profits.

…Taking a much bigger-picture view, however, what was really going on here was that JP Morgan had hundreds of billions of dollars in excess deposits, thanks to its too-big-to-fail status. And rather than lending out that money and boosting the economy, Jamie Dimon decided to simply play with it in financial markets, just as a hedge fund would.

Obviously the trades didn't work out, and probably should have been managed better. But the implicit subsidy granted to some of the biggest financial institutions by too-big-to-fail status helped make JPMorgan's huge loss possible.

Salmon is quite critical of Dimon and suggests that in the end JPMorgan was behaving badly, making deals that it shouldn't have been making by chasing house profits rather than focusing strictly on hedging risk exposure, which is the primary job of the CIO. In theory, the "Volcker rule" would prevent big banks from pursuing proprietary trading —using client money make trades that create profit for the bank—while allowing banks to take reasonable steps to manage risk exposure through hedges. Indeed, as drafts of the Volcker rule progressed, they actually became more expansive in terms of how much leeway they gave financial institutions to hedge various risks.

And that's important, because as Noah Millman argues, it can be extremely difficult to draw a clear line between hedging risk and trading for profit. Millman's explanation is complex enough that it needs to be read in full, but the broader picture is that, as always, writing rules and regulations to prevent the supposedly bad stuff and only the bad stuff isn't nearly as easy as a lot of folks in Washington seem to think.

It's common enough to hear advocates of financial regulation say that all we really need to do is put the "right rules" in place, but when you spend time looking at the underlying details of the transactions up for review, it's not always obvious what the "right rules" are, which is why much of what Congress passed in Dodd-Frank was sort of TBA regulation that called for a lot of studies and instructed regulators to do something but left it to the regulators to figure out exactly what that something should be. If it were obvious which rules could be followed to avoid only the transactions that result in headline-grabbing multibillion-dollar losses, financial institutions with money on the line probably would have put those rules in place. 


NEXT: Obama Struggles, Sort Of, In the Arkansas Primary

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  1. If TBTF is a reality, isn’t the simplest solution a cap?

    Yes, clearly what counts under the cap is the sticking point. But it would seem to be exponentially simpler to design such a cap than to design a regulatory state around trying to make TBTF also risk-free.

    1. You could make the reserve requirements scale based on market share. The larger the bank gets, the more it has to hold because the impact will be felt much more (and TBTF is more likely to come into play).

      The formula should probably work out such that, if there was only a single bank, it would be required to hold the vast majority of its deposits in reserve, whereas if there were thousands of small banks, they’d all be holding just a minimum amount (2% or so).

  2. The only rule that matters is liability and the normal result of failure. And with TBTF, there is no liability and there is no failure.

    1. There is failure, it just gets transferred to people who were not involved in the failure.

  3. I’m having a hard time reconciling

    “With lots of deposits coming in, and little corporate demand for loans,…”


    “And rather than lending out that money and boosting the economy, Jamie Dimon decided to simply play with it in financial markets…”

    If there is little demand, who exactly is he supposed to lend the money to?

    1. “Me, silly” – Obama

    2. Who else is going to buy T-bills?

    3. The government, obviously. Buy up those T-Bonds, JPM, or feel the wrath of the Administration!

    4. JP Morgan had hundreds of billions of dollars in excess deposits

      If they were “excess”, why didn’t JPMorgan give them back?

      1. Because the owners of the deposits didn’t want them back yet.

        1. The owners wanted a chance to lose them?

          1. “The owners wanted a chance to lose them?”
            See: “FDIC” and “Moral Hazard”

            1. See also: “Too Big to Fail”

            2. But the owners didn’t lose them. JP Morgan still exists, still has sufficient assets and cash flow to cover all likely withdrawal scenarios and still owes them to the owners of the deposits.

              What JP Morgan did lose was about 2 Billion of Stockholder profits but that is all.

      2. Excess= No demand for that much in loans.

  4. In Apprenticeship of Duddy Kravitz Duddy’s rich uncle tries to give him a subsidy so that he can enjoy his life a little, but not use the money on his real-estate deals. He gives Duddy a mansion with the restrictions that it not be rented or sold. Duddy sells everything of value inside the mansion. This is what’s happening with the banks. The bank has an incentive to create large but (what they think are) low-probability risks that will be covered by the taxpayers. Given the creativity of the human spirit, there is no way to create rules that will prevent that. Given the TARP bailouts, there no limit to the ways taxpapers will be left to cover the gambling losses. The solution is to scale-back the FDIC and all other government guarantees. Unfortunately, we are doing exactly the opposite.

  5. On the one hand, it was incredibly profitable, with the London team alone, which oversaw some $200 billion, making $5 billion of profit in 2010

    a 2.5% return? incredible.

    1. On such an amount, not bad.

    2. Wasn’t it the AIG London office which sank them? All that trading going on before the US offices open in the morning, must be hard to supervise.

  6. And another thing.

    Do the government’s Top. Men. listen to themselves *at all* when they pontificate about (e.g.) JPMorgan’s irresponsibility?

    1. The solution is clear. We need topperer men. The toppest.

      I wonder does the author of the “excess deposits” piece in question ever think that he has an excess of readers??

  7. There’s this thing called uncertainty, it’s a really a big factor when you’re trying to predict the future.

    I’m to the point where I’m so sick of everything that happens being attributed somehow to public policy, you can color me skeptical of anything being attributed to public policy…

    When we attribute everything–good or bad–that happens to public policy–or the lack thereof–we invite government intervention into our lives. …our lives become a public policy question.

    At some point, there has to be room for us to say to the public, “I don’t give a shit what you think of my losses”. If you don’t want to be on the hook for my losses, then don’t invest in any of my investments and vote the politicians who put you on the hook out of office.

    Leave me out of it.

  8. Hearing about this supposed problem non-stop on NPR has led me to believe that if their hedge investment had been profitable, the left would be complaining about how the Big Evil Banks were making good money when there are so many people unemployed.

    1. Exactly.

      Where’s the voice of reason that says to people–“Sometimes, what you think shouldn’t matter”?

      There are people in the investment world who care about what I think about what’s going on in commercial real estate. When they want my opinion, they call me. You think I imagine Wall Street shouldn’t get to do anything commercial real estate wise–unless it’s okay with me?!

      This is the real reason why Obama refused to allow the TARP recipients to “pay the money back”–because he needed some justification to impose his own stupid opinion on what Wall Street does.

      Other than that, why should anybody’s opinion of someone else’s losses matter? There’s an old saying that goes something like “mind your own goddamn business”. We should use it more often when people tell us their opinions about what other people should be forced to do about their own investments.

      Investments are risky. Did anyone mention that on NPR? “Risky” means sometimes they don’t pan out. When investment banks take risks, that’s one of the ways we get more economic growth in this country–that’s called making a loan, finding equity…

      But we shouldn’t go through all that with most people. We should just tell them to shut up and mind their own business.

  9. It’s untrue that there is no demand for new loans. Banks have been issuing loans at record levels in the last 2 years (pent up demand for refinancings from late ’08/2009). However, the total level has declined slightly. Regardless, fees paid for issuance and syndication of loans is how banks make money. That’s why the commercial+investment bank model works well and is much more efficient than the Glass-Steagall world.

    The biggest issues overlooked here in my opinion are: 1) if your hedges always pay off, then your assets and lending standards are crap and 2) $2Bn (although it’s only $1Bn net of other trades; details?) is pennies for a company that makes $4Bn in profit per quarter. NPR types say that “it could’ve been bigger and brought the bank down”. But it wasn’t. This proves that JPM DOES have decent risk controls.

Please to post comments

Comments are closed.