STOCK MARKET WATCH -- Monday, 21 May 2012

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4. Investigating JPMorgan Chase By SIMON JOHNSON

http://economix.blogs.nytimes.com/2012/05/17/investigating-jpmorgan-chase/?ref=business

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

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JPMorgan Chase is too big to fail. As the largest bank holding company in the United States, with assets approaching $2.5 trillion as reported under standard American accounting principles, it is inconceivable that JPMorgan Chase would be allowed to collapse now or in the near future. The damage to the American economy and to the world would be too great.

The company’s recent trading losses therefore call for greater public scrutiny than would be the case for most private enterprise – and demand an independent investigation into exactly what happened. (Dennis Kelleher of Better Markets has already called for exactly this.) The investigation begun by the F.B.I. is unlikely to be sufficiently public. Given the strong political connections between JPMorgan Chase and the Obama administration, it would also be better to have an investigation led by a completely independent counsel.

Hopefully, too-big-to-fail is not forever. The Federal Deposit Insurance Corporation is working on a mechanism that could conceivably allow that agency to handle the “failure” of a bank holding company while protecting the creditors of operating subsidiaries – limiting the potential contagion effect. But this mechanism is not yet in place. It does not now apply to cross-border banking (remember that JPMorgan Chase’s losses are in London), and even the F.D.I.C.’s acting chairman, Martin J. Gruenberg, was careful in describing its likely efficacy in a speech last week.

(Disclosure: I’m on the F.D.I.C.’s Systemic Resolution Advisory Committee, and I’ve worked with the F.D.I.C. with some outreach activities intended to help the agency receive constructive feedback on resolution. I am not paid by the F.D.I.C.)

In effect, JPMorgan Chase operates with the implicit backing of the United States government – primarily in the form of actual and potential access to borrowing from the Federal Reserve, with the implication that the Treasury could also provide support. Being effectively backed by the full faith and credit of the government is a great help; it lowers a bank’s financing costs because it reduces the risk to creditors. JPMorgan Chase and the other big banks in the American economy are effectively government-sponsored (and subsidized) enterprises. There is no kind of market involved in determining the franchise value of mega-banks; this is a government subsidy scheme, pure and simple. People on the right of the political spectrum understand this, as do people on the left; see my blog post last week on the extent of cross-partisan agreement on this issue. I would add to that list former Gov. Mike Huckabee, the Arkansas Republican. When I appeared on his radio show on Monday afternoon, we were in complete agreement on the need to break up or otherwise constrain the size of big banks...


Here are five questions that an independent investigation should consider:

1. What exactly was the trade? Who approved and reviewed the trade?

2. To what extent were the mistakes encouraged or condoned by particular quantitative models — for example, those popularly known as value-at-risk? (For a critique, see Pablo Triana’s book, “The Number That Killed Us.”)

3. What did Mr. Dimon know and when did he know it? Was there disclosure to the board and to shareholders with appropriate timing? This is among the specific concerns raised by Mr. Kelleher.

4. Does the board have adequate depth of experience along the relevant dimensions of risk management?

5. What interactions did Mr. Dimon or any of his colleagues have with the Federal Reserve Bank of New York before and while these losses were incurred? Mr. Dimon is on the board of that institution, where his role is described as advisory. But on what exactly did he advise them in recent months and years, particularly with regard to risk management and capital levels in systemically important banks?

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