The Hubris of Jamie Dimon
Jamie Dimon has the silver mane and piercing, gray-blue eyes of a chief executive officer from central casting, but he talks like one of his own charged-up traders. His blunt words tumble out in a New York hurry. Unlike other financial chieftains, the CEO of JPMorgan Chase seems to relish using those words to berate the lawmakers and regulators that hold his bank’s fate in their hands. “Jamie has taken on this mantle of defending this entire industry,” Michael Driscoll, who worked for Dimon as a trader at the Smith Barney brokerage, told Bloomberg News earlier this year. “He’s combative by nature. And like a lot of these alpha dogs, when he’s backed into a corner, he’s going to bark back.”
Words like comeuppance, schadenfreude, and even Dimonfreude have been laid on liberally since May 10, when Dimon blamed a $2 billion trading loss in JPMorgan’s London office on a hedging strategy that he confessed was “flawed, complex, poorly reviewed, poorly executed, and poorly managed.” (Otherwise, fine.) On NBC’s Meet the Press, he said, “We know we were sloppy. We know we were stupid.” The loss has probably grown as hedge funds attack the bank’s exposed flank.
Anyone who thought Dimon might retreat—say, by giving an inch to regulators who want to tighten rules against risky proprietary trading—doesn’t know the man. On May 15, facing shareholders at JPMorgan’s annual meeting in Tampa, Dimon promised in his brisk style that “all corrective action will be taken.” He made no move, however, to mute his criticism of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was written to regulate the kind of high-risk behavior that caused the 2008 financial crisis. Nor did he give up any of his triumvirate of titles—chairman, CEO, and president—or forgo any of his 2011 pay, which came to $23 million in salary and bonuses. And he kept his prized seat on the board of directors of the Federal Reserve Bank of New York, despite calls from the likes of former New York Governor Eliot Spitzer for him to resign.
Truth be told, JPMorgan’s loss, although it has instigated an FBI probe, did little harm to what Dimon brags is JPMorgan’s “fortress balance sheet.” Analysts still expect a $4 billion profit for the second quarter. But the loss did remind us that even the best managers can get singed when they play with fire. Who can say the next “flawed, complex” hedging strategy by a megabank won’t cause truly damaging losses? Almost four years since the collapse of Lehman Brothers, it’s far from certain that enough has been done to prevent the whole house from burning down again.
Dimon, 56, is a third-generation denizen of Wall Street. As recounted in Last Man Standing, a 2009 biography by journalist Duff McDonald, the family legacy began when Dimon’s paternal grandfather, a busboy in his native Greece, was fired and took a job at the Bank of Athens. He immigrated to the U.S. and became a successful stockbroker, as was his son. Dimon grew up in Queens and later, as the family fortune swelled, on New York’s Park Avenue. After Harvard Business School, he hitched his wagon to Sandy Weill, the deal maker extraordinaire. In 1998, Weill and Dimon pulled off the historic merger of Travelers Group and Citicorp—historic because it needed spinoffs to comply with the Glass-Steagall Act of 1933, which separated commercial banking from investment banking and insurance. Congress obligingly repealed Glass-Steagall the next year.
After years of butting heads, Weill and Dimon parted ways shortly after the Travelers-Citi merger. Dimon, duplicating Weill’s ladder-climbing strategy, became CEO of Chicago-based Bank One in 2000, whipping it into shape and arranging its merger with JPMorgan Chase in 2004. He became CEO a year later.
At JPMorgan, Dimon made his national reputation by avoiding the worst of the mistakes that damaged rivals such as Citigroup and Bank of America. JPMorgan’s financial strength allowed it to beef up during the financial crisis by acquiring the imperiled Bear Stearns with the help of the Federal Reserve and then snapping up Washington Mutual, the nation’s biggest savings and loan. Dimon, a Democrat, became known as President Barack Obama’s favorite banker. Today, JPMorgan has the most assets and the highest profit of any U.S. bank.
Somewhere along the line, though, Dimon developed a sense of grievance. Obama’s reference to “fat cat” bankers irritated him. So did the Dodd-Frank act of 2010, which he said hemmed in good banks like his. So did Occupy Wall Street, which marched to his Park Avenue co-op apartment on a tour of Upper East Side tycoons’ dwellings.
Dimon didn’t disguise his feelings. Last June in Atlanta he challenged Federal Reserve Chairman Ben Bernanke at the end of a question-and-answer session over the cost of bank regulation. Months later, according to the Financial Times, he had an angry confrontation behind closed doors with Bank of Canada Governor Mark Carney over capital requirements. And this February he took on one of the most respected figures in American banking, Paul Volcker, the former chairman of the Federal Reserve whose name is attached to a rule, set to take effect in July, that would restrict risky trading by banks that hold insured deposits. “Paul Volcker by his own admission has said he doesn’t understand capital markets. Honestly, he’s proven that to me,” Dimon said in a Fox Business Network television interview.
Dimon’s relentless opposition to Wall Street regulation, on the grounds that he had everything under control, is what turned JPMorgan’s otherwise unremarkable $2 billion trading loss into a morality tale that has transfixed Wall Street and Washington. The most troubling aspect of the story is not that Dimon has been exposed as a screw-up but that he isn’t and still blew it. Appearing on The View, Obama said, “JPMorgan is one of the best managed banks there is. Jamie Dimon, the head of it, is one of the smartest bankers we got, and they still lost $2 billion and counting.” He added, “That’s exactly why Wall Street reform’s so important.”
Dimon is correct about one very big thing: The government’s prescription for preventing speculation by banks is flawed. The Volcker Rule is supposed to ban speculation while allowing trading for certain narrow purposes: hedging and market-making. But drawing a bright line between what’s legal and what’s illegal is proving to be a regulators’ nightmare. The Office of the Comptroller of the Currency still can’t even say whether the transactions that led to JPMorgan’s embarrassing loss would have been prohibited under the implementation of the Volcker Rule that was drafted by regulators last October. (Once the rule goes into effect, banks have two years to comply.)
Under the 298-page draft, legality depends on intent, and intent is difficult to discern. “Protecting the system, I agree with,” Dimon told Fox Business in the same February interview in which he dissed Volcker. Perched on a tall director’s chair under the Orlando sun, Dimon warmed to his topic. “But talking about the intent? I tell you,” he said, setting up a joke Henny Youngman-style, “every trader, we’re going to have to have a lawyer, compliance officer, doctor to see what their testosterone levels are—and a shrink [asking] ‘What’s your intent?’”
Funny, right? But agreeing that the Volcker Rule is a hot mess is not the same as agreeing with Dimon’s preferred alternative, which is essentially to give the banks a whole lot of latitude. All the big banks used to have officially designated desks for proprietary trading—that is, putting the bank’s own money at risk in pursuit of profit. Most of those prop trading desks have been shut down in anticipation of the Volcker Rule. Dimon says he supports the ban on prop trading.
JPMorgan’s loss, though, shows that prop trading is still going on under a different guise and just as aggressively as ever. That may be the most important takeaway from this episode.
In Dimon’s reality distortion field, JPMorgan’s enormous bets weren’t anything like prop trading. The bank’s Chief Investment Office in London was just hedging—namely, trying to reduce the firm’s risk by putting on one position to neutralize an opposite position elsewhere in the portfolio. Hedging is permitted under the Volcker Rule. This hedge, Dimon says, just happened to go bad.
JPMorgan’s own words and actions belie that explanation. As first reported by Bloomberg News in April, under Dimon’s management the Chief Investment Office was transformed from a risk-mitigating organization into one that became a profit center, overseeing about $360 billion. It is a basic principle of finance that a correctly executed hedge should, on average, lose money. That’s because buying protection is costly. Insurance works the same way. You pay a little bit every year to protect yourself against a devastating loss, and you’re grateful if your premiums “go to waste” because you never collect.
Sure, a good hedge might make money accidentally because of a mismatch between the asset that’s hedged and the asset that’s doing the hedging. That’s known as “basis risk” in the trade. But if a transaction is outright designed to make money for the firm, it is not, by definition, a hedge. It’s speculation. The New York Times reported on May 15 that the anticipated profit from the big trade made by JPMorgan’s Chief Investment Office was called “icing” by insiders, like the icing on a cake. That’s damning.
“Hedging” isn’t the only word that Dimon has redefined for his own purposes. “Guidance” is another. In his May 10 conference call with analysts, Dimon said, “While we don’t give overall earnings guidance and we are not confirming current analyst estimates, if you did adjust current analyst estimates for the loss, we still earned approximately $4 billion after-tax this quarter, give or take.” So he gave guidance while insisting he wasn’t giving guidance.
In the first quarter, trading profits accounted for 15 percent of JPMorgan’s entire revenue, although an unknown portion of that was from trading for clients rather than its own account. The Volcker Rule would reduce those trading profits; by how much is hard to say. “The Volcker Rule is like a comet heading toward earth,” Robert Colby, a partner at the law firm Davis Polk & Wardwell, told Traders Magazine earlier this year. Traders can’t justify big paydays if all they do is plain-vanilla banking.
Well … so what? After living through the worst economic downturn since the Great Depression, one brought on at least in part by the recklessness of big banks, the public is justifiably concerned that bankers will cause trouble again by taking big risks in pursuit of big bonuses. The mischief-making inside the House of Morgan shows that management might not know what’s going on until it’s too late. “It’s very difficult to manage these institutions from the top of the shop, even for Jamie Dimon, whom I have a lot of respect for,” says Sheila Bair, the former chairman of the Federal Deposit Insurance Corp.
Government regulators are even less capable of detecting dangerous behavior in a megabank than CEOs are. And they know it. That’s why it’s important to create a bright line between legal trades and illegal ones, a standard that is easily enforced and obvious to all. One way to do that would be to do something Dimon doesn’t want: rule out all hedge trades except those where there is a clearly identified asset to be hedged on the other side. No more vague “portfolio” hedges, which, like a billowy muumuu, hide a multitude of trading sins. A more extreme measure would be what the British call ring-fencing, keeping commercial banking pure by requiring that all trading for whatever purpose be conducted by a subsidiary.
Bair, whose FDIC must pay off depositors when a bank fails, likes that idea. “I would like to see insured banks be bread and butter,” she says. “Take deposits, make loans.” Volcker is also intrigued by British Prime Minister David Cameron’s plan of structurally separating commercial and investment banking, as in the Glass-Steagall era. “I could argue their approach is much more rigorous than what we have,” Volcker told a Senate banking subcommittee on May 9, the day before the JPMorgan disclosure. The snag in Britain’s plan is that in a crisis, there is huge pressure on regulators to allow the holding company to bail out the subsidiary, putting depositors at risk. “My experience with the ring fence is that the gophers go underneath and the deer jump over, and they’ve got a lot of lawyers to help them,” Volcker told the senators. And even a pure commercial bank can make dumb loans and manage excess cash recklessly. That’s an argument for imposing even tougher capital requirements on the banks—thicker risk cushions so losses are borne entirely by bank shareholders and never by taxpayers.
It’s worth noting that just four banks—JPMorgan, Citibank, Bank of America, and Goldman Sachs—accounted for 94 percent of all derivatives outstanding at the end of 2011. The idea that those four can’t prosper without the ability to trade derivatives on a massive scale “is just a breathtaking condemnation of the larger banks,” says Representative Barney Frank (D-Mass.), a co-author of the Dodd-Frank act.
Frank is, of course, the kind of person who annoys the heck out of Jamie Dimon. He is happier holding forth at Davos, standing in the milling crowd of networkers like a boulder in a trout stream, or visiting the Florentine palazzo known as the New York Fed. But as Dimon himself ruefully observed, his bank’s $2 billion trading loss, which he originally underestimated as “a complete tempest in a teapot,” “plays right into the hands of a whole bunch of pundits out there.” Yes, it does. And yes, it should.