Bill Black: On JP Morgan’s “Hedge”, Jamie Dimon’s Integrity, and the Epic Conflicts of Interest in the Federal Reserve System


Bill Black is interviewed by Amy Goodman for Democracy Now. Video of the full interview is embedded following these notes.

The story that JP Morgan is telling us: They had about $15 billion in distressed European debt. Europe has been in trouble, so those investments were losing value. Their story, which does not make sense, is that they decided to hedge this position with a derivative of a derivative. In this case, it was an index of credit default swaps, which is the form of derivative that blew up AIG. JP Morgan’s story is that instead of offsetting the risk, the hedge increased the losses dramatically. They woke up one morning, and they had a $2 billion loss.

Why it does not make sense: If you have distressed European debt, you are supposed to have already reserved against the losses in it. So why hedge the position at all? Just sell it. Get rid of these incredibly risky assets before they can suffer any additional losses. If you already have losses, it is not necessary to recognize a loss, because you have already reserved for it. So, you should not have had to hedge, period

Second, the way you would hedge something like this is by buying a credit default swap which is protection against the bad assets. In other words, if you lost on the value of the European debt, the credit default swap would go up in value, and you would be protected against loss. Instead, they have allegedly bet in the opposite direction by buying this derivative of a derivative – so if the European debt lost value, the derivative of the derivative was also likely to lose value. That is not a hedge. That is double speculation in the same direction.

And the reason you are calling it a hedge is that it is illegal, under the Volcker Rule, to speculate in this fashion. So the story coming out of JPMorgan does not make any sense as a financial matter. It seems reasonably clear that these are faux hedges. This is to hedging, as truthiness is to truth. This is hedginess: not really a hedge, but you call it a hedge to evade the law.

Jamie Dimon on Meet the Press: We support getting rid of “too big to fail.” …[We] support “too big to fail.” We want the government to be able to take down a big bank like JPMorgan, and it can be done. We think Dodd-Frank, which we supported parts of, gave the FDIC the authority to take down a big bank, and when it happens, I believe compensation should be clawed back, the board should be fired, the equity should be wiped out, and the bank should be dismantled, and the name should be buried in disgrace. That’s what I believe. We need to put that back in the system, and we’ll work with the regulators to try to get that back in the system.

Bill Black’s response to Dimon’s statement: You cannot have a system work the way he is saying. If the institution is allowed to stay this large, it will be too big to fail, and its creditors will be bailed out; that is to prevent what is feared to be a cascade of failures, in which one big bank would then cause the failure of the next big bank, etc., etc., and you would have a global crisis. Even conservative economists call this crony capitalism, and they say that it creates such competitive advantage for the systemically dangerous institution—JPMorgan in this case—that it is the equivalent, when they compete with smaller banks, of — and I’m quoting — “bringing a gun to a knife fight.”

What is needed to correct the danger posed by Systemically Dangerous Institutions (TBTF banks): The only way this can work is to shrink the systemically dangerous institutions— the 20 largest banks in the United States — down to the point that they no longer pose a systemic risk, they are no longer too big to fail, and, therefore, they will no longer have this implicit federal subsidy that completely distorts competition.

The threat of “too big to fail” to democracy: Having banks this big destroys democracy, because these giant institutions have so much political power.

On Dimon’s integrity in making such a statement: The statement is completely disingenuous because JPMorgan in fact opposes all efforts to get rid of “too big to fail.”

On Dimon’s assertion (see video) that the acquisitions of Bear Stearns and Washington Mutual were beneficial to us all: The world is not made better off by the acquisitions of Bear Stearns and Washington Mutual; the banks made themselves even more powerful and made it even more impossible to have them fail, and therefore vastly increased their political and their economic power.

On the financial sector’s record supporting responsible regulation: The big banks lobbied to create the Gramm-Leach-Bliley Act, which repealed Glass-Steagall. Glass-Steagall had worked brilliantly. It separated commerce and investment. And it would have prohibited and prevented the losses that JPMorgan just suffered. The big banks also pushed the Commodity Futures Modernization Act. If that act had not been passed, we would have avoided much of the entire financial crisis that we just went through, and we might well have avoided the $2 billion loss that JPMorgan has just suffered. The big banks fought tooth and nail, and continue to fight tooth and nail, to destroy the Volcker Rule. Again, if the Volcker Rule had been in place – with real regulations – this loss would have been prevented. The big banks also fought tooth and nail to prevent transparency in the derivatives market – through a clearing house – which also would have prevented this $2 billion loss. That rule is not in effect because JPMorgan led the effort to delay the adoption of these rules and to weaken these rules so much that they are completely unenforceable.

On Elizabeth Warren’s call for Jamie Dimon to resign from his position as Director of the New York Fed: There are 12 regional Reserve Banks in the USA. They have as their directors, overwhelmingly, executives from the banks that they are supposed to regulate. Most regulation in the Federal Reserve is done through the field, through these regional Federal Reserve banks. Timothy Geithner was supposed to be the top regulator in New York in his role as president. But no real regulation occurs, of course, because you cannot expect people to regulate their bosses.

Congress has acted previously to correct an analogous conflict of interest: Congress recognized this in a completely analogous situation. In 1989, in the FIRREA legislation to deal with the savings-and-loan crisis, it looked at the Federal Home Loan Bank System, which was set up in a parallel way to the Federal Reserve banks. And it said this is an impossible conflict of interest. You cannot regulate your bosses. And so, it removed all governmental authority from the Federal Home Loan Banks. The same thing desperately needs to be done in the Federal Reserve, where it is far more damaging because these are much bigger players and much more destructive players.

On the current state of the Volcker Rule: There is a Volcker Rule because it was these derivative positions that caused the global financial crisis. All of the systemically dangerous institutions failed in large part because of these financial derivatives – what we call the green slime. That’s what brought down Fannie and Freddie and Lehman Brothers and Bear Stearns and Washington Mutual, Lehman, Merrill Lynch and Wachovia. After those catastrophic disasters that caused the Great Recession, cost six billion Americans their jobs directly, prevented another five to eight million jobs from being created, helped lead to a global crisis called the Great Recession—after that, the banks still fought to be allowed to do exactly the same kind of derivative trades. And even when the Volcker Rule was adopted, over the banks’ opposition and over the opposition of the Federal Reserve and of Treasury Secretary Timothy Geithner, they gutted the rule—at least the draft rule to implement the Volcker Rule. Unless it is changed, the Volcker Rule will be essentially unenforceable, because the current draft allows financial institutions to simply call their trades “hedges”, even though they operate exactly opposite to the way a hedge would work.

Capitalism Without Failure