Monday, July 20, 2009

Has Patriotism Officially Been Replaced by Profit Motive?

While doing some leisurely reading over the weekend, I came across an article in the New York Times by Jackie Calmes and Louise Story on JPMorgan Chase (JPM) CEO Jamie Dimon. The article describes Dimon’s ascendance over the past couple of years that has allowed him to become the unquestioned king of the US chapter of the Banksters (yes, I think the term should now be capitalized). He has gained so much political clout over this period that he apparently now has Obama’s chief of staff Rahm Emanuel on speed dial and somehow has enough influence to convince Emanuel to graciously accept an opportunity to speak in front of JPM’s board.

According to the article: Mr. Emanuel’s appearance would underscore the pull of Mr. Dimon, who amid the disgrace of his industry has emerged as President Obama’s favorite banker, and in turn, the envy of his Wall Street rivals. It also reflects a good return on what Mr. Dimon has labeled his company’s “seventh line of business” — government relations."

The matter of fact way in which the authors describe Dimon’s candidness regarding the need for lobbying to be as important a part of his company’s business as accepting deposits underscores the extent to which the government has become (for better or worse) the ultimate decider of the future of the banking industry. As a consequence of the number of former Wall Street Banksters now or formerly employed by the government, investors no longer even bat an eye when they read about the increasingly cozy and brazenly out in the open relationships between Banksters and government regulators and officials. We now take it for granted that these individuals will have an outsized influence over the political debate and laws created in response to this everlasting crisis and we are expected to believe that what is best for Wall Street is also in some way good for the rest of us.

Reflecting this theme, the NY Times piece is generally very complimentary and positive in its description of Mr. Dimon’s rise to the top of the Wall Street pyramid. In fact, the success that JPM has had in navigating its way through the financial meltdown has bought JPM and Dimon a significant amount of positive press that has undoubtedly helped the company gain customers. At a time when everyone was looking for stability when it came to financial institutions, it sure didn’t hurt that the media portrayed JPM as an oasis within the decaying financial landscape. To be fair, it also did not hurt that Dimon had the foresight and humility to pen a very thoughtful letter to shareholders that assessed the causes of and potential solutions to the ongoing trouble in the banking sector and economy. In this very sober investigation of what got us to where we are today, Dimon offered what I see as some prudent and surprisingly ambitious remedies for what currently ails the financial system, including:

  1. The need for a systemic regulator with much broader authority
  2. The need to simplify our regulatory system
  3. The need to regulate the mortgage business —including commercial mortgages — in its entirety
  4. The need to fix securitization
  5. The need to get accounting under control
  6. The need to fix Basel II — leading to higher capital ratios but a more stable system
  7. The need for appropriate counter-cyclical policies

Coming from a man whose company benefited tremendously from lax supervision and insufficient monitoring, suggesting such reforms and regulations appears to be indicative of his belief that a stable system is more important than an unsustainably profitable one. Between the media’s coverage of Dimon and the above referenced shareholder letter, even outspoken opponents of the Banksters like myself have become somewhat seduced by Dimon’s mystique. However, one thing has always bothered me a bit. Despite his candidness and claimed willingness to accept reform, the words in the shareholder letter also lack any real sense of remorse or culpability for helping throw the US and the global economies into this mess. While there is certainly an exhaustive list of people and entities to blame, in a very subtle way Dimon consistently seems to be somewhat detached from the reality that is facing many of his competitors.

Take, for example, the following passage in which Dimon discusses some of the many excesses that led to the crisis:

Over many years, consumers were adding to their leverage (mostly as a function of the housing bubble), some commercial banks increased theirs, most of the U.S. investment banks dramatically increased theirs and many foreign banks had the most leverage of all.

In addition, increasing leverage appeared in:

• Hedge funds, many using high leverage, grew dramatically over time. Some of that leverage was the result of global banks and investment banks lending them too much money.

Yes, we have been told a thousand times that so far JPM has escaped relatively unscathed from the crisis that has brought many banks to their knees. We are also well aware that JPM did not get as involved in dangerous structured products as many others. But as of the end of Q2 2009 JPM had a $448.97 billion consumer loan book. So, who was helping the consumer lever up so much? Even without Bear Stearns and WAMU, JPM’s consumer loan portfolio was over $300B. Furthermore, isn’t JPM one of the largest prime brokers in the business? So, if hedge funds were too levered, who was it that was allowing them to become so? These are just two examples but it's hard to believe that when it came to the excesses in the system listed above, JPM was not right in the middle of the fray.

In was with my general concerns about Dimon’s implict denial of his own company’s role in precipitating the near breakdown of the entire financial system that I came across this passage from the NY Times article:

A centerpiece of that effort involves regulating the market for derivatives, which Mr. Dimon’s firm dominates. While JPMorgan favors new reporting requirements for the complex financial instruments, it opposes the administration proposal to force trades onto public exchanges; doing so would likely cut into the firm’s lucrative business of selling clients custom-made instruments. Like other banks, it also opposes a new consumer agency for financial products.

I think we can all agree that consumers being pushed into loans they could not handle and the opacity of derivatives are two of the major contributing factors to the crisis that began in the subprime space and subsequently poisoned just about every asset class. Therefore, wouldn’t those areas by definition be in need of reform? It then dawned on me that maybe Dimon’s letter only offered reforms that suited JPM and ignored those that would diminish profits. Along the same lines, MIT professor and founder of the Baseline Scenario Simon Johnson offers up the following question in his reaction to the NY Times piece:

Why doesn’t Dimon instead seize on greater consumer protection as a way to rebuild legitimacy for finance – and to shape the new rules so as to create barriers to entry and growth for future rivals?

What would John Pierpont Morgan have done?

I think it is a great question. In fact, I think we should establish that as a standard for all Wall Street banks. How nice would it be to see Porsche Cayennes and BMW convertibles with the bumper sticker “WWJPD?” Of course there is no way to know what the original JP Morgan would have done. Since his death the man has gained an almost mythical status, partially as a result of his actions in 1907, detailed here by Newsweek:

"This is the place to stop this trouble!" J. P. Morgan said on the afternoon of Oct. 23, 1907. After the failure of several trust companies (unregulated banks, kind of like today's subprime lenders), the banker had decided that the collapse of the Trust Co. of America would cause too much damage to America's fragile financial system. He pulled together leading bankers and pooled funds to bail out the firm. Over the course of two weeks, as a fevered crisis gripped Wall Street and Washington, Morgan acted time and again: saving brokerage firms, rounding up $25 million in cash in 20 minutes to help the New York Stock Exchange stay open, underwriting municipal bonds for New York City, bringing in gold from Europe to bolster the dollar and replenish Washington's coffers. "He essentially singlehandedly saved New York City from failure," says Sean Carr, coauthor of "The Panic of 1907."

The implication is that beyond the obvious self interest in saving his own finances, the elder Morgan had a sense of a higher duty. If you believe the accounts, Morgan apparently believed that it was worth some personal sacrifice and risk to make sure that the country as a whole did not fall apart. If this was indeed the case, it is this combined sense of patriotism and understandable self preservation that I think is disappointingly lacking today. This is not just a criticism of the Banksters. I think many in Congress are too focused on their upcoming re-elections to put their own interests aside enough to help get the US back on the path to prosperity. In a lot of ways this short termism that borders on being illogical and self defeating caused the crisis and unfortunately is one of the main contributors to its depth and breadth.

I have a completely unsubstantiable theory as to why putting America first in not a common theme anymore. My thesis is that World War I, the Great Depression, World War II, and to some extent the Cold War brought Americans from disparate backgrounds together in a fight against a common enemies. Financial hardship and war are probably two of the most important fosterers of patriotism. In contrast, the Americans who are too young to remember WWII and whose memory of the Cold War has faded have not been brought together by many recent and meaningful moments or conflicts. The Vietnam War inspired a significant amount of anti-American sentiment, even in the US itself. The wars in Iraq have certainly done nothing to unify this country. Even the impact of the events of September 11th, which at the outset had the potential to spur lasting patriotism, seems to have been watered down by the continuing political infighting regarding the rebuilding of the WTC site. People seem to have become myopically focused on their own lives and financial situations. Consequently, instead of seeing this crisis as an opportunity to embrace the America first doctrine, Americans have instead begun screaming “every man for himself!”

I think I should mention that this analysis was not inspired in one bit by JPM’s fantastic Q2 2009 results. If the government insists on handing out money Dimon and his colleagues have a fiduciary duty to shareholders to take advantage of the offerings to bolster the bank’s capital levels and put it in the best possible position relative to the competition. What this is about is my concern that despite their rhetoric, Banksters like Dimon will push back against reforms that could potentially lead to a more sustainable financial system and fewer global crises in the name of trying to get back to the bubble world that existed in recent years. I fully admit that I don’t know what the right policies, regulations and reforms are. Government actions and responses always have unintended consequences. But I can’t understand why anyone in the banking industry would want to go back to the unstable and unsustainable status quo that existed before the housing bubble so unceremoniously popped.

So now I come to the most important question: isn’t it in the banks self interest to create a system without so much risk? Yes, JPM is apparently very strong now but a few years ago Lehman, AIG, and Bear Stearns all thought they were on top of the world. Without some reforms it is likely that these banks will never know when it is their turn to receive a visit from the nefarious grim reaper. Being deemed too big to fail may seem like a nice safety net, but the heads I win, tails the taxpayer loses has a definite detrimental impact on the financial system and the entire US economy. Don’t these Banksters have friends and family who do not make billions of dollars whether the financial world is imploding or not? Have profit motive and self interest really replaced patriotism completely? I sure hope not. Accordingly, this is my call for Jamie Dimon to stand up and take the lead in helping Obama and Congress create a sustainable financial infrastructure that will avoid these terrible busts that affect Main Streets all over the world. From what I know of them, Banksters are great at following the leader (just look at the race to get into subprime securitizations). Therefore, there is no better person to help bring about necessary and positive change than the king himself.

(Picture Courtesy of FPG-Getty Images)