In an August 2010 commentary about JPMorgan's losses in coal trades I wrote: "The commodities division isn't the only area in which JPMorgan is vulnerable. Credit derivatives, interest rate derivatives, and currency trading are vulnerable to leveraged hidden bets. Ambitious managers strive to pump speculative earnings from zero to hero."
At issue is corporate governance at JPMorgan and the ability of its CEO, Jamie Dimon, to manage its risk. It's reasonable to ask whether any CEO can manage the risks of a bank this size, but the questions surrounding Jamie Dimon's management are more targeted than that. The problem Jamie Dimon has is that JPMorgan lost control in multiple areas. Each time a new problem becomes public, it is revealed that management controls weren't adequate in the first place.
JPMorgan's Derivatives Blow Up Again
Jamie Dimon's problem as Chairman and CEO -- his dual role raises further questions about JPMorgan's corporate governance -- is that just two years ago derivatives trades were out of control in his commodities division. JPMorgan's short coal position was over sized relative to the global coal market. JPMorgan put this position on while the U.S. is at war. It was not a customer trade; the purpose was to make money for JPMorgan. Although coal isn't a strategic commodity, one should question why the bank was so reckless.
After trading hours on Thursday of this week, Jamie Dimon held a conference call about $2 billion in mark-to-market losses in credit derivatives (so far) generated by the Chief Investment Office, the bank's "investment" book. He admitted:
"In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored."
But lets get back to commodities. For several years, legendary investor Jim Rogers has expressed his concern to me about JPMorgan's balance sheet, credit card division and his belief that Blythe Masters, the head of JPMorgan's commodities area, knows so little about commodities. Jim Rogers is an expert in commodities and is the creator or the Rogers International Commodities Index. He also sells out-of-the-money calls on JPMorgan stock. So far, that strategy has worked out well for him. (Rogers gave me permission to publicly reflect his views and his trades.) Moreover, JPMorgan is still grappling with potential legal liabilities related to the mortgage crisis.
Is Jim Rogers justified in his harsh view of JPMorgan's commodities division? After he expressed his concerns, JPMorgan's coal trade made the news, and it appeared to me that Jim Rogers is on to something. For those of you who missed it the first time, my August 9, 2010 commentary is reproduced below in its entirety. Dawn Kopecki at Bloomberg/BusinessWeek broke the story wherein Blythe Masters' quotes first appeared:
JPMorgan's Losses from Indecent Overexposure - August 9, 2010
JPMorgan Chase's fixed-income revenue fell almost 28 percent to $3.6 billion in the second quarter, down from $5.5 billion in the first quarter, and down from $4.9 billion for the same period last year. JPMorgan blamed an interest rate squeeze and bad results in the credit markets and the commodities markets.
There were no details of its significant loss from unwise, gigantic, wrong-way wartime coal bets. The bank took a short position so enormous that it was oversized relative to the global coal market, and second quarter losses reportedly were in the hundreds of millions of dollars.
Financial Reform Failure
Blythe Masters, managing director in charge of JPMorgan's global commodities group, spent time lobbying in Washington to dilute financial reform. By her own admission, JPMorgan's recent speculation in coal wasn't client driven; the risk was taken on JPMorgan's behalf. The Dodd-Frank Financial Reform Bill does nothing to prevent a repeat -- or even a potentially worse -- debacle.
The commodities division isn't the only area in which JPMorgan is vulnerable. Credit derivatives, interest rate derivatives and currency trading are vulnerable to leveraged hidden bets. Ambitious managers strive to pump speculative earnings from zero to hero.
Instead of transparent and regulated markets, we have dark markets, hidden leverage, proprietary speculative trading, lax regulation and oversized risks.
"Scared Sh*tless" 1
Blythe Masters told her remaining employees that competitors are "scared sh*tless" of JPMorgan's commodities division. She claimed the layoffs of 10 percent of front office staff are not a sign of JPMorgan "panicking" and called the risk taking in coal trading that left JPMorgan wide-open to a massive short squeeze a "rookie error."
For individual traders, JPMorgan doesn't follow the Wall Street maxim: He who sells what isn't his'n, must buy it back or go to pris'n. The United States can count on JPMorgan to continue both long and short market manipulation and take its winnings and losses from blind gambles. Shareholders, taxpayers and consumers will foot the bill for any unpleasant global consequences.
Physical oil traders from JPMorgan's brand new RBS Sempra Commodities LLP acquisition (JPMorgan paid $1.7 billion) left of their own accord to join smaller firms with less capital. Masters said these were "very interesting career decisions."
The defections were all the more interesting, because Masters began her career as a JPMorgan commodities trader. RBS Sempra's oil traders gave Masters a vote of no confidence. Their flight was a loss of "key people," whom she said she needs to replace.
Masters is poised for more debacles:
"All it's going to take is a little pop to the upside. We could be producing a 30 to 35 percent ROE and looking like gods."
Good luck with that. Masters also noted that this potential windfall might come at the expense of others:
"We've got too many banks chasing too little volume and margins have compressed."
The United States is trying to pull out of the greatest financial tailspins in its history. Dice-rolling braggadacio by a key officer at one of the nation's largest banks is exactly the kind of thing Congress, taxpayers and voters should find scary. Arianna Huffington explains the consequences for middle class Americans, who pay a disproportionate share of the bill in her upcoming book, Third World America. 2
Ramp up Risk and Cross Your Fingers
Big unanticipated market moves always result in big winners and big losers among big gamblers. After the fact, most winners claim they were smart -- not just lucky.
When bank managers take a big gamble and lose hundreds of millions of dollars, they don't call it reckless; they spin it as an error of "judgment." The directive is to "put on risk" and "generate results." This may be why Masters cautioned employees:
"I don't want us talking to the outside world, neither about successes nor about failures."
JPMorgan is making big bets and crossing its fingers in a dangerous and volatile market.
Masters takes "pleasure" in the "ballsiest" business, and she wants her traders to get lucky. Moreover, she's engaged in internal spin control and plans a "deep dive" with the Board and the CFO. This may reduce her chances of walking Wall Street.
No one should be concerned for the job security of managers like Masters at JPMorgan, and that is precisely the problem. Delusional risk-taking and lack of transparency at Too-Big-To-Fail banks -- especially in the areas most vulnerable to rampant speculation -- were ignored by so-called financial reform.
1 All words in this article in quotation marks are from Business Week's (Bloomberg News) major scoop after the leak of a tape of an internal JPMorgan July 22 conference call: "Blythe Masters Says 'Don't Panic' as Commodities Slip," by Dawn Kopecki, August 3, 2010.
2 Based on my reading of an advance copy of Arianna Huffington's new book: Third World America: How Our Politicians Are Abandoning the Middle Class and Betraying the American Dream, Crown Books, September 2010.