Skip to main content

Why JPMorgan gets away with bad bets

By William K. Black, Special to CNN
updated 5:39 AM EDT, Tue May 15, 2012
STORY HIGHLIGHTS
  • JPMorgan lost more than $2 billion because of speculative bets
  • William Black: It is simply irrational to allow such a financial institution to exist
  • He says neither Democrats nor Republicans has courage to reform banks
  • Black: Taxpayers pay the price when banks like JPMorgan can gut regulations

Editor's note: William K. Black is an associate professor of economics and law at the University of Missouri-Kansas City. A former senior financial regulator and a white-collar criminologist, he is the author of "The Best Way to Rob a Bank is to Own One."

(CNN) -- JPMorgan Chase can be considered a systemically dangerous institution, which means that it is "too big to fail" because the government fears that its collapse would cause a global financial crisis.

It is simply irrational to allow such an institution to exist, especially when it can easily incur a $2 billion trading loss.

Banks are more efficient when shrunk to the point that they can no longer endanger the world economy. But because JPMorgan and similar banks are the leading contributors to Democrats and Republicans, neither political party has the courage to order them to reform.

The Volcker Rule, which aims to prevent insured banks from engaging in speculative bets, was passed as part of the Dodd-Frank Act over the objections of Treasury Secretary Timothy Geithner and almost the entire Republican congressional delegation.

CNNMoney: JPMorgan investment chief out

William K. Black
William K. Black

Back in 2008 when the financial crisis hit us hard, a host of large institutions were destroyed. AIG, Merrill Lynch, Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual and Wachovia all suffered massive losses on their toxic derivatives, particularly collateralized debt obligations (CDO) and credit default swaps (CDS), better known as "green slime." One would think everyone has learned a lesson. Jamie Dimon, JPMorgan's CEO, now agrees that banks should not invest in derivatives. But government subsidies have a way of encouraging fraud and speculation.

JPMorgan, the nation's largest bank, receives an explicit federal subsidy (deposit insurance) and a much larger implicit federal subsidy. It's improper for the megabank to use these subsidies to speculate in derivatives. And yet it can do so with hardly any serious regulatory consequences.

Follow @CNNOpinion on Twitter and Facebook.com/cnnopinion

Capitol Hill reacts to JPMorgan's loss
Sen. Corker calls for JPMorgan hearing
Sheila Bair on JPMorgan's loss

Financial institutions such as JPMorgan love to buy derivatives because they are opaque, create fictional income that leads to real bonuses and when (not if) they suffer losses so large that they would cause the bank to fail, they will be bailed out.

The Dodd-Frank Act's Volcker Rule was designed to solve the problem.

However, JPMorgan led the effort to gut the Volcker Rule and the provision that requires transparency. JPMorgan is the world's largest proprietary purchaser of financial derivatives -- precisely what the Volcker Rule sought to end. The bank claims that it does not engage in proprietary trading and that it purchases derivatives solely to hedge. That claim is an example of what Stephen Colbert meant when he invented the term: "truthiness."

A hedge is an investment that offsets losses in another investment. JPMorgan's supposed hedges aren't hedges under accounting rules because they haven't been shown to perform as hedges.

JPMorgan bought tens of billions of dollars of derivatives that increased its losses rather than reduced them. It calls these anti-hedges "hedges" -- in other words, it practiced "hedginess." The bank's approach to hedging is that it would like to purchase a derivative if it deems that derivative to be a hedge to something else and voila, it's a hedge.

The draft regulations of the Volcker Rule allow such faux hedges because JPMorgan lobbied to render the rule useless. JPMorgan asserts that these inherently unsafe and unsound anti-hedges are "hedges" as that term is defined in the draft regulations implementing the Volcker Rule. But if hedginess is permissible, the Volcker rule is unenforceable.

It is a travesty for JPMorgan to be able to create an additional $2 billion in losses through investments that are supposed to be allowed only if they reduce losses. The government must revise the regulations and reject JPMorgan's absurd treatment of anti-hedges as hedges.

Faux hedges are a common, dangerous abuse and a lethal form of speculation. From 2003 to 2006, the Securities and Exchange Commission caught mortgage giants Fannie Mae and Freddie Mac violating hedge accounting to maximize their executives' compensation. Fannie's faux hedges, like JPMorgan's faux hedges, increased losses. The Justice Department failed to prosecute, and the senior executives walked away wealthy. Their successors blew up Fannie and cost taxpayers hundreds of billions of dollars.

When a bank CEO is honest but incompetent, faux hedges simultaneously increase risk and create a false complacency that the hedge has offset the risk. This can cause catastrophic losses.

Dishonest bank CEOs use faux hedges to loot the bank by creating fictional income and hiding real losses. The fake income makes the CEO wealthy by maximizing his compensation.

The current JPMorgan speculation in derivatives weakens but will not kill the bank. If it and other systemically dangerous institutions continue to engage in hedginess, it is only a matter of time before we'll get a replay of the financial crisis. And who'll lose out? Taxpayers like you and me, of course.

The opinions expressed in this commentary are solely those of William K. Black.

ADVERTISEMENT
Part of complete coverage on
updated 6:25 PM EDT, Thu July 24, 2014
Pilot Robert Mark says it's been tough for the airline industry after the plane crashes in Ukraine and Taiwan.
updated 11:10 AM EDT, Fri July 25, 2014
Jennifer DeVoe laments efforts to end subsidies that allow working Americans to finally afford health insurance.
updated 8:45 AM EDT, Fri July 25, 2014
John Sutter responds to criticism of his column on the ethics of eating dog.
updated 9:02 AM EDT, Fri July 25, 2014
Frida Ghitis says it's tempting to ignore North Korea's antics as bluster but the cruel regime is dangerous.
updated 2:50 PM EDT, Fri July 25, 2014
To the question "Is Putin evil?" Alexander Motyl says he is evil enough for condemnation by people of good will.
updated 2:03 PM EDT, Thu July 24, 2014
Laurie Garrett: Poor governance, ignorance, hysteria worsen the Ebola epidemic in Sierra Leone, Guinea, Liberia.
updated 9:49 AM EDT, Thu July 24, 2014
Patrick Cronin and Kelley Sayler say the world is seeing nonstate groups such as Ukraine's rebels wielding more power to do harm than ever before
updated 6:05 PM EDT, Wed July 23, 2014
Ukraine ambassador Olexander Motsyk places blame for the MH17 tragedy squarely at the door of Russia
updated 7:42 AM EDT, Thu July 24, 2014
Mark Kramer says Russia and its proxies have a history of shooting down civilian aircraft, often with few repercussions
updated 2:53 PM EDT, Thu July 24, 2014
Les Abend says, with rockets flying over Tel Aviv and missiles shooting down MH17 over Ukraine, a commercial pilot's pre-flight checklist just got much more complicated
updated 9:17 AM EDT, Thu July 24, 2014
Mark Kramer says Russia and its proxies have a history of shooting down civilian aircraft, often with few repercussions
updated 12:37 PM EDT, Thu July 24, 2014
Gerard Jacobs says grieving families and nations need the comfort of traditional rituals to honor the remains of loved ones, particularly in a mass disaster
updated 10:13 AM EDT, Thu July 24, 2014
The idea is difficult to stomach, but John Sutter writes that eating dog is morally equivalent to eating pig, another intelligent animal. If Americans oppose it, they should question their own eating habits as well.
updated 12:30 PM EDT, Wed July 23, 2014
Bill van Esveld says under the laws of war, civilians who do not join in the fight are always to be protected. An International Criminal Court could rule on whether Israeli airstrikes and Hamas rocketing are war crimes.
updated 10:08 AM EDT, Wed July 23, 2014
Gordon Brown says the kidnapped Nigerian girls have been in captivity for 100 days, but the world has not forgotten them.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT