Jamie Dimon, the CEO of JPMorgan Chase, appears before the House Financial Services Committee on Tuesday to answer questions about the fail whale trade that cost JPM as yet uncounted billions of dollars. The simple answer is that members of the House can’t hardly do worse than the bought and paid for millionaires on the Senate side. According to Zerohedge, it costs a mere $877,798 to buy a panel of Senators. It’s great to see Tennessee’s Bob Corker is such cheap date, a mere $63K and as Jon Stewart demonstrates, he puts on a show for his money. It doesn’t hurt that so many of the staffers are JPM people; here’s a partial list from Pro Publica.
The House Committee is big, with 34 Republicans and 27 Democrats. There are several Democrats who might ask harder questions, and in that spirit, I offer a couple of lines of inquiry that might prove more substantive than Senator Corker’s embrace of Jamie Dimon.
Question 1. An analyst recently described JPMorgan Chase as “… a $1.3 trillion bank attached to a $76 trillion derivatives clearing operation.” According to the Quarterly Report on Bank Derivatives Activities from the Office of the Comptroller of the Currency for the fourth quarter of 2011, JPMorgan was a party to derivatives with a nominal value of $71 trillion. The report says that the ratio of total credit exposure to total risk-based capital was 256%.
Total risk-based capital is the sum of tier 1 plus tier 2 capital. Total credit exposure is an estimate of the amounts owed by counterparties to the bank. That amount is part of the net worth of the bank, so this ratio demonstrates the risk that the bank would be insolvent if counterparties fail to pay. Full definitions are below.
The question is, how much of the total credit exposure of JPMorgan arises from derivatives where the counterparty is a foreign bank?
Here’s the idea behind this question. One huge factor in the Great Crash was AIG’s credit default swaps. If the US hadn’t intervened to make those CDSs good, the Great Crash would have been much worse. In fact, that “fortress balance sheet” of which Dimon is so proud would have been hit hard, either from direct exposure, or because of losses of other JPM counterparties. Dimon can talk all he wants to about how JPM wasn’t bailed out, but the bailout of AIG played a huge role is salvaging JPM, and several other banks. This point should be driven home in follow-up questions. [cont'd.]
If several European banks get into trouble, it is inconceivable that their governments would bail out the derivatives market, and there is little chance that the US government could get away with that a second time. That would definitely blow a hole in JPM’s balance sheet, and as it is too big to fail, something would be done to save it. This, of course, is a powerful argument for the reintroduction of Glass-Steagall, to separate the derivatives business from the banking business.
Question 2. Press reports consistently call the funds held by the Chief Investment Office “excess deposits”. These are funds that are held on deposit by JPM and are not loaned out. Some of the money is held to fund open lines of credit, but almost all of it exists because there is no demand or because JPM refuses to lend it. That money didn’t just walk in the front door, looking for a bank account to sit in. Here are the questions:
How many people at JPM are involved in soliciting deposits? Describe the kinds of people and entities that JPM solicits for those excess deposits. What is the point of adding deposits when you don’t plan to lend?
What do you pay for those excess deposits? Is there any consideration given to the depositor directly or indirectly other than the contracted interest rate? Since JPM doesn’t intend to lend the money out, how does it expect to profit from the money to pay that interest and other consideration? Is that proprietary trading or should we refer to it as hedge fund operations? Is that why the head of that division was paid so much?
We know JPMorgan has been involved in all kinds of ugly stuff, from bribery in Jefferson County, Alabama, to foreclosure fraud, to selling trashy real estate mortgage-backed securities, to trading with the enemy, and none of them went to jail. It’s time to break it up into smaller units that do not pose such a danger to democracy.
Total Risk-Based Capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders’ equity, perpetual preferred shareholders’ equity with noncumulative dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a bank’s allowance for loan and lease losses.
Total Credit Exposure (TCE): The sum total of net current credit exposure (NCCE) and potential future exposure (PFE).
Net Current Credit Exposure (NCCE): For a portfolio of derivative contracts, NCCE is the gross positive fair value of contracts less the dollar amount of netting benefits. On any individual contract, current credit exposure (CCE) is the fair value of the contract if positive, and zero when the fair value is negative or zero. NCCE is also the net amount owed to banks if all contracts were immediately liquidated.
Potential Future Exposure (PFE): An estimate of what the current credit exposure (CCE) could be over time, based upon a supervisory formula in the agencies’ risk-based capital rules. PFE is generally determined by multiplying the notional amount of the contract by a credit conversion factor that is based upon the underlying market factor (e.g., interest rates, commodity prices, equity prices, etc.) and the contract’s remaining maturity. However, the risk-based capital rules permit banks to adjust the formulaic PFE measure by the “net to gross ratio,” which proxies the risk-reduction benefits attributable to a valid bilateral netting contract. PFE data in this report uses the amounts upon which banks hold risk-based capital.
Page 12 of the Quarterly Report.