The Friday before last, the Senate Permanent Subcommittee on Investigations convened a hearing to take testimony on huge trading losses taken by JPMorgan’s Chief Investment Office. The CIO was trading in complex derivatives and taking huge positions, the losses from the speculation may hit $7 billion.
Why does this matter? JPMorgan is a too big to fail bank, and if it implodes taxpayers (that’s us, unless you have an account in the Caymans) are on the hook because of the systemic risk involved. And not many people want a repeat of 2008, with a TBTF bank blowing itself up. So in theory, there are regulations written to prevent banks from taking outsized risks and regulators in place (some of them physically at the banks) to make sure that the banks are following the regulations. But somehow that didn’t stop a unit at JPMorgan from sidling up to the green felt at the casino that is the derivatives market and burning through say about 7 billion dollars. Hence the investigation, hence the hearing.
Matt Taibbi has a good half-live and half-after the fact blog post about the hearings here. The second half is particularly worth reading, a darkly funny peek inside what goes on in these banks. As the Permanent Subcommittee on Investigations chairman Carl Levin put it:
It exposes a derivatives trading culture at JPMorgan that piles on risk, hid losses, disregarded risk limits, manipulated risk models, dodges oversight, and misinformed the public.
With testimony like this, and figures like $16 billion in legal fees and $8 billion in settlements paid between 2009 and 2012, you can’t escape the impression that these large banks are simply manufacturers of regulatory and cognitive capture. They create a labyrinth walled with funhouse mirrors and filled with smoke, hiding behind complexity, distortions, and opacity while they siphon up money.
I think part of the solution is to pull away the curtain as much as possible and expose Oz. These hearings I think help, particularly when paired with the entertaining commentary of someone like Matt Taibbi. The kind of commentary that doesn’t help much is this bit from Shiela Blair, former FDIC official discussing these matters with Bill Moyers. This is from the transcript and occurs early on in the conversation:
BILL MOYERS: So for the layman, what is the capital ratio? And why is it so important?
SHEILA BAIR: A capital ratio is simply the percentage of your assets, what’s on your balance sheet, the percentage of that that is funded with common equity.
So when banks have a low capital level, that means that they’re borrowing a lot to support themselves. Whether it’s a household or a big bank, you borrow too much and you don’t have enough common equity to absorb losses you– that’s what it means to fail. You start having losses. You don’t expect them. You have a very thin capital base. You can’t make good on your debt obligations. You fail.
What are the chances that a layman is going to be able to make heads or tails of that “common equity” jargon? I think I have a pretty good basic understanding of the concept of capital ratios but this description just confuses me. At some level this stuff does get murderously complicated, but at heart the concepts involved are easily comprehensible but we desperately need people who can explain them without resorting to obfuscating jargon. They are out there, such as Yves Smith at Naked Capitalism, but we need more.
Another interesting aspect of this episode is the possibility (probability? certainty?) that the trading losses JPMorgan took were at least exaggerated by other market participants, such as hedge funds, getting wind of JPMorgan’s large (and hence hard to get out of quickly) trading positions and taking advantage of them. This makes me think of a line the title character in Babbit has, when he is becoming increasingly dissatisfied with his upper middle class life and increasingly comtemptuous of his upper middle class friends:
All we do is cut each others’ throats and make the public pay for it.
Anyway, we’ll see if these investigations lead to any real consequences for anyone with real power. I won’t be holding my breath.