May 24, 2012
Everyone from Congress to the Commodity Futures Trading Commission wants in on the investigation into just how JPMorgan Chase ended up losing at least $2 billion through some poorly conceived trades put in place by an inadequately supervised trader.
In the background of all the investigations – official and unofficial, public and private – will lurk one all-important question: Nearly four years after the banking system teetered on the verge of collapse, how much risk is being accumulated on the books of the surviving giant institutions? And what happens if we tiptoe back to the brink once more?
It’s fortunate that this test case of sorts took place at JPMorgan, which does have the “fortress” balance sheet of which CEO Jamie Dimon continues to brag. Had it taken place at Citigroup, still more fragile and with a less robust track record of risk management, the consequences might have been far more serious.
In a low interest-rate environment, producing reasonable returns seems to require taking unreasonable risks.
But the risky trades that resulted in these losses are the kinds that every big financial institution is going to be tempted to put in place in order to generate the returns that their shareholders want them to deliver. In a low interest-rate environment, producing reasonable returns seems to require taking unreasonable risks. While there are opportunities to invest in low-risk returns in, say, financial services by building a new clearing network for derivatives and other complex over-the-counter transactions – these aren’t likely to be as lucrative.
The problem is that the banking system is still too big to fail. While Martin Gruenberg, acting chairman of the Federal Deposit Insurance Corp., took pains to reassure his audience at the American Securitization Forum conference earlier this week that his organization could oversee and control the collapse of any of the nation’s banks – even JPMorgan Chase – skeptics abound.
Perhaps the new powers given to the FDIC to oversee the unwinding of a busted bank will help regulators ensure that one bad apple doesn’t spoil the whole bunch. But what happens if the problems are replicated industry-wide? What if the politics of the situation become unmanageable?
Some veterans of past crises worry that while our banking institutions today may be too big to fail, we may also be too poor to bail them out.
That’s the nightmare scenario. Some veterans of past crises worry that while our banking institutions today may be too big to fail, we may also be too poor to bail them out if the failsafe measures don’t work or aren’t enough to contain a crisis. Tanya Beder, chairman and CEO of SBCC Group, a risk consultancy that advises banks and other financial services firms, cites Iceland as an extreme example: When that country’s banking crisis blew up, it was in part because the amount of debt (in the form of loans) on the balance sheets of its banks had soared to more than 50 billion euros. At the same time, in 2007, Iceland’s GDP was a measly 8.5 billion euros.
The Big Three in the United States are far less significant relative to the country’s GDP. The assets of JPMorgan Chase, the largest of them, represent only 15 percent of GDP, while those of Citigroup and Bank of America each hover around 13 percent. Toss Wells Fargo into the mix, and you’ve added another 9 percent to the mix. Even added up, that’s only half of U.S. GDP.
It may sound like a massive number, but compare that to France, where BNP Paribas on its own has assets that represent 101 percent of French GDP. Britain’s Barclays has assets that are 112 percent of GDP. In the Netherlands, Fortis is at 155 percent. And UBS, a global behemoth, stands at 376 percent of Swiss GDP.
JPMorgan’s $2 Billion Loss: 9 Who Stand to Gain
Those figures tell us what the real problem is – and that we’ll need more than the FDIC and a lot of luck to avoid another systemic banking crisis. The globalization of financial services along with the rest of economic activity means banks have become “de-linked” from their national origins, with the Swiss banks being the most dramatic example. The Swiss can’t afford to let UBS fail – but its government certainly isn’t going to be able to step in and prevent it, if left to its own devices. What would happen if France’s three largest banks – collectively, 237 percent of the country’s GDP – teetered on the edge of collapse?
If problems hit larger Eurozone nations and ripple beyond their borders, the consequences will be too big for any single nation to handle on its own.
As Europe’s economic crisis festers and becomes worse by the day, the question of how to cope with bad banks needs to become a global discussion. In Iceland’s case, we left it to that country to sort out its woes. Ireland bailed out its institutions – and is struggling with the consequences.
But if problems hit larger Eurozone nations and ripple beyond their borders – if the ongoing banking crisis in Spain and the prospect of Greece’s departure from the euro causes big losses for banks in Germany, Switzerland, France and Britain as well – the consequences will be too big for any single nation to handle on its own. We may view our banks as too big to fail, but if push came to shove, we could probably cope with another bailout. Collectively, however, we’re too poor and too unprepared to cope with the kind of transnational/multinational bailout that could become necessary – even if we were politically and structurally prepared to address it. Which does not seem to be the case.
Think of the JPMorgan Chase losses as a warning shot across the bow, sure. I hope that the bank rigorously overhauls its risk management systems and that investors modify their profit expectations. But I’d also like to hope that regulators, globally, have learned from their experiences on that September weekend in 2008, and understand that a crisis doesn’t need to be confined to a single institution or even a single nation – and that these more complex systemic problems will demand increasingly complex solutions that may no longer be possible to invent on the spot in response to a crisis.