BY SARA GILBERT
Ever since JPMorgan Chase’s announcement on Thursday, May 10 that it lost several billions of dollars on derivatives, there has been concern about what that might mean for the rest of us: for stockholders, for taxpayers, for the economy and for the government. Local asset managers have found themselves faced with questions from investors and Congress has been hit with political fallout.
“Taxpayers are frustrated, and understandably so,” says Ken Mahoney, CEO of Mahoney Asset Management. “It reminds them of the 2008-09 bailout. And even though it’s a different situation here, they’re saying ‘don’t come to me as a taxpayer when your risky dealings fail.’”
So, what was JPMorgan Chase doing exactly that caused it to lose, depending on whom you ask, anywhere between two to seven billion dollars? It’s hard to understand exactly, especially because the bank doesn’t seem to be giving very straight answers.
Jamie Dimon, CEO of JPMorgan Chase, has admitted it was a mistake and that he did not know the extent of the problem until it was too late.
According to Oliver Pursche, president of Gary Goldberg Financial Services, “It’s the huge size of the loss,” that is part of what makes it difficult to understand. “It’s staggering and most individuals can’t wrap their heads around it.” Then, there’s the trading component, which is quite complex itself.
The bank was trading derivatives designed to hedge against financial risk, and claims this was not in order to gain profit for the bank. Hedging means taking out an offsetting position in a related security in order to reduce the risk of losing money.
However, many say the company was in fact working to try to make a profit for itself and failed. Most agree that banks should not be playing games, speculating on the market and risking the loss of money as they may have done here.
“There are various schools of thought here,” says Pursche. “On one hand you’re calling it a hedge, but really what you’re [JPMorgan Chase] doing is trading for your own.” According to Mahoney, there’s nothing for taxpayers or bank-users to be concerned about just yet.
And Pursche agrees, “This is by no means the type of trade, in size, scope or nature, that would unravel JPMorgan Chase, bring the bank down or require a bailout.”
Although you are not going to lose your money, Mahoney says, “understand that these banks need to make more prudent decisions, this was a lack of forethought.” And especially after the economic fall in 2008 you would hope they would make more careful decisions.
David Wessel, economics editor of the Wall Street Journal, in an interview on National Public Radio’s Morning Addition, says, this mistake is nothing to sneeze at. Taxpayers will have to pay if the mistake gets bigger than it is, he says. And “what happens at one bank usually doesn’t happen only at one bank. All bank stocks are down on this.” The question, he says, is whether other banks doing this will result in putting the economy at risk like it was a few years ago.
Because of JPMorgan Chase’s risky behaviors, federal regulators are discussing stricter laws. One in discussion is the Volcker Rule, created by Senator Jeff Merkley of Oregon and Senator Carl Levin of Michigan. It would prohibit banks from trading with their own money, what is also known as proprietary trading.
According to Mahoney, this regulation has been in discussion for the past two year. “President Obama already endorsed it and many have been very outspoken about putting it in place,” he said.
One of the reasons this regulation is having trouble being put into law is that “the banks complain they will have less profit as a result and won’t be able to compete with European banks, since they are permitted to trade on their own,” Mahoney says.
The bottom line, according to Mahoney, is that the way these banks have been operating no one knows what’s really going on behind those doors and they’re able to mask what they are doing or claim they were doing something else, since unless you’re inside the operation it’s difficult to tell. And, importantly, the way they’re still operating today reminds everyone of what was so problematic in 2008 and resulted in a severe recession.
Pursche sees the solution as one that is complicated and will take time. “These laws need to be refreshed,” he says, pointing out that most of the regulations are 60 to 80 years old and made sense then but times have changed. And this process takes time because as old legislations are addressed and changes are considered every political position wants to be sure that their opinion is heard.
What should concerned citizens be doing? “We must move the conversation forward by being engaged,” says Pursche. “Push your elected officials to tell you what they are doing to address this issue. Try to get real answers, not just emotional responses.”