JPMORGAN, widely considered the best run of all the large banks in America, if not the world, on May 10th provided the kind of news that have become all too common in the financial industry: a $2 billion charge for errant trades. The markets responded within seconds of the opening on May 11th, sending Morgan’s share price down 9%, and its value by $14 billion. Late on May 11th, Standard & Poor’s announced it was downgrading the outlook for the company, and Fitch knocked down its ratings.
But while none of these moves were trivial, they were hardly calamitous. The share price decline was sharp but finite. Morgan’s rating remains among the strongest in the industry. Its capital ratios are robust. And even after the loss, it is still expected to earn more than $4 billion in the current quarter, and produce record earnings for the year. There are no indications that customers were harmed or operations impaired.
The bluntest criticism of Morgan’s failure came from the bank’s own chief executive, Jamie Dimon. He said the losses were the result of self-inflicted “sloppiness”, “poor judgment” and “stupidity”, for which “we are accountable”. Like all large financial institutions, Morgan is already crawling with bank inspectors and other regulators, but—perhaps to deflect potential blame—there were hints of investigations to come. The Securities and Exchange Commission announced it would take a look, as did the Commodities and Futures Trading Commission. Retiring congressman Barney Frank took a final turn in the limelight, asserting Morgan’s loss justified the imposition of ever more regulation. At least one plaintiff law firm trolling for clients announced its own investigation.
And yet for all of this, it is hardly clear what Morgan did wrong. The bank has been careful to avoid providing details, not least to protect its ability to unwind positions. But it appears that the losses were the product of two separate efforts, both—in theory—appropriate. The first was to create a hedge against the bank’s exposure to high quality loans. This is an unconventional strategy for a bank, albeit one that, in principle, is a sound one.
The second move—and the one that may have gone badly wrong—was an effort to ameliorate the first hedge, providing more economic exposure. Losses mounted in recent months, suggesting that the resurgence of global economic problems may have played a role, along with badly executed —and mistaken—trades. Ideally, a hedge works in any environment. This one, no matter how well intentioned, failed. Quiet changes in personnel are expected.
Yet accusations were widespread that the trades were more likely directional bets that went wrong. Such moves would violate the spirit of the so-called “Volcker Rule” now being put in place to keep banks from speculating with deposits and instead trade only to further clients interests. Mr Dimon emphatically denied this, but those interested in evidence will have to wait until mid-summer, when details will be provided after the next earnings release. In the meantime, Mr Dimon warned that many particularly volatile components of the bad trades were still on the bank’s book, and would be until their genuine value could be realised: “We have staying power, and we are willing to use it.”
Good thing too, because, he added, more mistakes were inevitable. So too now are the howls.