AN OBSERVATION AND A CONFIRMATION

According to reports published today, the banks lost what might be a big one in the argument about the Volker Rule over the strategy known as "portfolio hedging."  You might remember that this was suddenly discovered by regulator and politicians alike (why not before,…who knows) in the debacle in J.P. Morgan's shop in London which became know as the "London Whale" scandal for it was claimed that the activity being undertaken was portfolio hedging.  

Now if Jaime Dimond can be accused of one thing--and I have--is not knowing when to keep his mouth shut.  To claim, as he did, that what happened was "portfolio hedging done badly" was crap.  Worst of all everybody knew it was crap.  Had he said, "these bastards tried to make an extra buck, got it wrong, tried to double down, got that one wrong too and we decided to liquidate the position when everybody in the world knew it was going to be one way traffic and as a result we lost $6 billion, so we fired everyone involved including some seriously senior people," Jamie might have skated…but he didn't.  And given the excuse, the Carl Levins and Crazy Lizzys of the world were give the perfect opening and nailed everybody…maybe.  We'll see how this comes out but if it is as reported, two things will happen: first, the price of credit goes up for everybody.  Remember yesterday's post?  Ain't no competition out there any more or a lot less of it.  Secondly, feeling constrained, banks will look around for something else to do that they know nothing about, immediately become masters of the unknown and at some point screw that up as well.  Hang around to see if I am right.

Which I may be if history is any guide.  Remember a couple of years ago when I suggested that one of the things our buddies the Chinese would love to do is replace the U.S. Dollar as the world's only reserve currency?  As of last month, the Reiminbi or Yuan--take your pick--became the second most used currency in the settlement of international trade replacing the Euro.  It's way behind the dollar to be sure but these guys have been a functioning society for a few thousand years.  They know how to wait.  Repercussions?  heck, I'm not smart enough.  Ask Joe Biden when he resurfaces.  He's our new Sino expert.

LIFE IS CONFUSING

It is, it really is.  For example, If people without sight wear sun glasses, why don't people who are deaf wear ear muffs?  Or in a negative sense, if the nearly a dozen governmental agencies who now have responsibility for the safety and credit worthiness of our banking system are serious about their mandate why do they keep taking actions that are certain to damage individual institutions or the entire system in general.  I give you the curious case of J.P. Morgan Chase.

Now we all know Jamie Dimon who was up to a few short months ago spoken of in hushed, reverent terms as possibly the greatest banker who ever lived.  Jamie was never that but he is hardly the dim wit that his portrayal today labels him.  And whilst Morgan never was possessed with a "fortress balance sheet," it is hardly the dangerous, ill managed institution that it is being forced into admitting.  All of this stems from the saga of the "London Whale, the head of a derivatives trading team working for the bank's internal investment office who got a big trade the wrong way around and like traders have done over centuries fell in love with his position, doubled down and when jilted for a second time doubled down again trying to make it back while all the time concealing his love affair from his boss.  Truth will out is the old saying, and it did with disastrous consequences for all concerned including our friend Jamie, who, not knowing the full extent of the loss did what Jaime was always prone to do and got his mouth working ahead of his mind.  "No big deal" he proclaimed of a loss that finally came to light as being somewhat north of $6 billion a position which put him at odds with most of the people in the world save for Carlos Slim and Warren Buffett.

Enter, stage left, the SEC led by the new head honcho, Mary Jo White formally of the Justice Department's Second Circuit, a small, brilliant and incredible successful former prosecutor of white collar crime.  Following in her wake, like a school of Remora, came every shape and form of regulator types looking to collect creds from whatever chewed morsels might fall fall from Mary Jo's mighty maw.  You see Mary Jo just wasn't in the business of slapping wrists and collecting a few bucks in fines; oh no.  The new game was to get the perp to admit to wrong-doing...I mean we gotta have us a Bang the drum slowly moment!

When I was in law school a professor of mine gave me a bit of sage advice.  He said the scariest thing I would ever see in my live would be the heading on a piece of paper that said

                                                      The United States of America
                                                                           vs.
                                                                 Charles James

"You don't want to ever see that," said he.  "Just think of the power and might and money arrayed against you."  That goes for corporations as well So, it appears that J.P Morgan & Co. will agree that they were wrong, that they knew they were wrong and will settle for about a billion bucks in order to avoid a trial.  Huzzahs all around and the legend of Mary Jo lives on.  We got the bastards!  A new era dawns!

Of course what happens, now having admitted wrongdoing taking one of the major obstacles to law suits off the table, JPM will be visited by Sue Grabbit and Run, Gonif Gonif and Dreck and every other member of the plaintiff bar, all working on contingency fees, with every possible variation of class action suits that can be conjured up in the fertile minds of trial lawyers which JPM will either have to defend or settle.  Call me curious and confused but I'm having trouble figuring out how tying up this company for 25 years in law suits makes for a better banking system.  I can't seem to understand how giving the Whale immunity in order for him to testify against a couple of guys who worked  for HIM gets us to a better banking system.  Nor do I get how the shareholders, who have already lost about $7.5 billion are going to be better off with this approach.  Doesn't it seem better to incarcerate the highest ranking individuals in the institution if crimes were committed?  THAT gets people's attention and influences future actions.  Of course that's hard to do.  You really have to prove stuff.

Anyway, I'm sure there is joy on Capitol Hill over all of this, with Uber Idiot Lizzy crowing how it takes a woman to get thigs done.  I'm sorry for the rant but the politics that has overtaken reason is getting to me.  When harm is done in the name of good I get a bit irrational.  Sun glasses and ear muffs all around.


Carter:  I'm so confused I didn't get the question.  Explain please.

A DIMON HAS IT ROUGH

Poor Jaime got knocked about the head ad shoulders in Davos today.  Seems as though some folks didn't like the results attributed to the "London Whale" and decided that it was all Jamie's fault.  Inasmuch as Jamie had always made it clear in and outside the organization that he was The Man, I suppose this particular shoe fit and to his credit he took the responsibility for the loss and embarrassment.  Also took a hell of a pay cut but don't cry for Jamie Argentina.  He still made a bomb.

Funny thing is, however, we still don't know what really happened other than the Whale and his buddies made a bad bet, doubled down and doubled down again.  There had been allegations that one or more of the folks involved deliberately attempted to mislead management but this has not yet been proven.  I guess the position was so large that half the City knew about It at which point a couple of Hedgies made their own bet that without them the Whale would be able to get out and squeezed Morgan to great success.  Or so the story goes.

Frankly, I don't care who won and who lost.  Morgan, in my experience, has never been staffed with dumb people: arrogant and egotistical perhaps (see: Dimon, James) but not stupid.  And yet a handful of risk managers apparently hadn't a clue what was going on until, essentially, market chatter led them to make, as Scotland Yard likes to say, "further inquiries."  After all is said and done I'll bet dollars to green apples that the real cause of the debacle and the reason these boys had the ability to double down was that that folks in charge of risk evaluation and management didn't understand what they were being told and were loath to admit it.  The classic mis-application of the "Average Intelligent Man Theory of Risk,"  i.e. if the Average Intelligent Man doesn't understand it, it's too much...and these were far more than average intelligent men and women.  Anyway, J.P. Morgan and Jamie will survive; battered and embarrassed but hopefully wiser and driven less by hubris than in the past.  At least that's the way it should work.

Of course part of the fall-out from this episode has been causing Jamie to respond to calls that Morgan and his competitors be broken up on the basis that they are too big to manage.  And yet, if I am correct and I'm pretty sure I am, in the case of the Whale all of the checks and imbalances were in place and actually worked; not as rapidly, perhaps, as one would have expected but the information was there.  It was not a failure of the structure or the complexity of the organization but a failure on the human level, to wit, humans acting like humans, which is another way of saying it's going to happen again if not at Morgan but at some institution just around the corner from Main Street, Wall Street or whatever street in your lexicon.  There will be (and should be) consequences and in this case they have been pretty wide-spread and harsh, but to demand a break-up of what is a pretty focused institution is simply stupid.  Better work can be done by both the institutions and by regulators but let us not delude ourselves that any business--especially one like finance which in some areas requires highly subjective decision making by humans--can be made risk free simply by organizational structure.  It's about people; it's always about the people so find the best you can, train the hell out of them, oversee them as best you can...and hang on!  And the most important thing?  Don't be afraid to admit that there is something you don't understand and for goodness sake ask for help when you need it.  Got it Jamie, and all you other Managers of the Year out there?  Oh, and have a great time spending the shareholder's money in the most expensive place in the world.