Dimon Lambastes Loans and Expresses His Devotion to Derivatives

By William K. Black

The ongoing U.S. crisis was driven largely by financial derivatives.  Nine of America’s systemically dangerous institutions (SDIs) failed or had to be bailed out – Bear Stearns, Lehman, Merrill Lynch, Fannie, Freddie, AIG, Countrywide, Wachovia, and Washington Mutual (WaMu).  The SDI failures were primarily due to losses caused or aided by the sale and purchase of enormous amounts of fraudulent derivatives, and deregulation, desupervision, and de facto decriminalization proved exceptionally criminogenic.  The Commodities Futures Modernization Act of 2000 and the Gramm, Leach, Bliley Act of 1999, respectively, made credit default swaps (CDS) into a regulatory black hole and repealed the Glass-Steagall Act’s prohibition against banks mixing commercial and investment banking.

The Dodd-Frank bill should have repealed the two deregulatory acts passed near the end of Clinton’s term with broad bipartisan support, but the Obama administration never tried to go back to the legal governance system for finance that worked brilliantly for nearly a half-century and Jamie Dimon and JPMorgan led the lobbying blitz that ensured that the Dodd-Frank Act would have the taste, depth, and substance of light beer made by an enormous commercial American brewery.  The Volcker rule was intended to partially restore the Glass-Steagall Act by restricting banks’ proprietary derivatives investments to hedging.  The rationale was that there is no public policy basis for providing federal subsidies to banks to speculate in financial derivatives.  That public policy argument against subsidizing dangerous bets by banks in derivatives is compelling and cuts across all political spectrums.  Among banks, only the SDIs are massive users and issuers of financial derivatives.  The largest SDIs love financial derivatives.  Merrill Lynch failed because it was the largest purchaser of its own “green slime” derivatives, particularly collateralized debt obligations (CDOs) “backed” largely by endemically fraudulent liar’s loans.  Such purchases were guaranteed to swiftly make Merrill’s investment officers wealthy and destroy the firm.  My most recent columns have quoted Dimon’s dictum about accounting control fraud:

“Low-quality revenue is easy to produce, particularly in financial services.  Poorly underwritten loans represent income today and losses tomorrow.”

Dimon’s dictum is equally true about the purchase of derivatives and the sale of CDS “protection.”  AIG’s managers in charge of selling CDS protection took advantage of a “sure thing.”  They booked income immediately and posted no reserves against the credit risk they were taking.  They grew massively and employed extreme leverage.  Those tactics maximize reported (fictional) income and modern executive compensation.  The catastrophic losses come years later and are borne by others (the government, creditors, and shareholders).  The officers become wealthy through the accounting scam.

The Senators who questioned Dimon last week knew that JPMorgan held more derivatives than any other entity and had just suffered serious, growing losses through proprietary investments in derivatives that JPMorgan claimed to be a “hedge” even though the investments acted to magnify rather than reduce risk.  (JPMorgan’s insistence upon calling an anti-hedge a hedge led me to dub their practice “hedginess.”)  The Senators also knew that Dimon directed the lobbying effort designed to prevent the adoption of the Volcker rule in the Dodd-Frank Act and, when that effort failed, he directed the lobbying effort designed to eviscerate the rule.

Given all this, the thing Dimon feared in his Senate and House testimony was being pinned down under oath about the supposed hedge.  Fortunately (from his perspective), he was the CEO of America’s largest bank and he was in front of the modern U.S. Congress.  His greatest danger was dying of an overdose of fawning.

The questioning was so embarrassingly weak that no one seems to have noticed the “watch my left hand closely” sleight of hand routine that Dimon pulled on derivatives.  In response to a comment by Senator Shelby, the ranking Republican on the Banking Committee, Dimon said:  “The biggest risk we take is credit – loans.”  He used a similar line with Senator Bob Corker (R. Tenn):  “The biggest risk a bank takes is making loans” “Loans are our largest risk.”  By contrast, he claimed that derivatives were essential to protect JPMorgan from systemic risk.

In a few sentences, Dimon sought to reverse the concept underlying the Volcker rule.  Dimon’s axiom becomes: loans are the problem and derivatives are the solution.  The entire role of derivatives in driving the ongoing U.S. crisis – including the massive growth in fraudulent mortgage loans designed to feed the fraudulent CDOs – disappears.  The Volcker rule is made to sound irrational.  The axiom is as clever as it is false.  It assumes the answer.  Derivatives speculation by banks is not hedging.  It does not reduce risk.  It can massively increase losses.  Indeed, there are few things more dangerous than believing that a position is a hedge when it actually operates to increase losses.  The false belief that a risk exposure is hedged leads to complacency that can allow losses to grow dramatically.

But none of this captures the greater risk of fraud through derivatives.  JPMorgan speculates in derivatives through, for example, the sale of CDS protection.  Selling CDS protection (like purchasing a CDO) involves the bank taking on a credit risk that can be exceptionally large.  The banks’ officers have perverse incentives to engage in behavior that Dimon’s dictum on control fraud describes.  “Low-quality revenue is easy to produce, particularly in financial services.  Poorly underwritten loans represent income today and losses tomorrow.”  Poorly underwritten derivatives operate in the same fashion, but with accounting rules that are even more fraud-friendly than deliberately making bad loans and with far less transparency than is true of loans.  The fact that Dimon refused to tell the Congress the nature of JPMorgan’s derivatives position is a vivid demonstration of how much more opaque derivatives remain than loans.

11 responses to “Dimon Lambastes Loans and Expresses His Devotion to Derivatives

  1. I guess when one offers a million dollar mortgage to an immigrant strawberry picker, then loans are the greatest risk. Of course, unless you have a WMD backing it.

    Great piece, thank you.

  2. http://www.commondreams.org/view/2012/06/20
    Why Congress Won’t Touch Jamie Dimon: JPM Derivatives Prop Up US Debt
    by Ellen Brown

    When Jamie Dimon, CEO of JPMorgan Chase Bank, appeared before the Senate Banking Committee on June 13, he was wearing cufflinks bearing the presidential seal. “Was Dimon trying to send any particular message by wearing the presidential cufflinks?” asked CNBC editor John Carney. “Was he . . . subtly hinting that he’s really the guy in charge?”

    “What is going on with this panel of senators?” asked Stewart. “They’re sucking up to Jamie Dimon like they’re on JPMorgan’s payroll.” The explanation in a news clip that followed was that JPMorgan Chase is the biggest campaign donor to many of the members of the Banking Committee.

    That is one obvious answer, but financial analysts Jim Willie and Rob Kirby think it may be something far larger, deeper, and more ominous. They contend that the $3 billion-plus losses in London hedging transactions that were the subject of the hearing can be traced, not to European sovereign debt (as alleged), but to the record-low interest rates maintained on U.S. government bonds.

    The national debt is growing at $1.5 trillion per year. Ultra-low interest rates MUST be maintained to prevent the debt from overwhelming the government budget. Near-zero rates also need to be maintained because even a moderate rise would cause multi-trillion dollar derivative losses for the banks, and would remove the banks’ chief income stream, the arbitrage afforded by borrowing at 0% and investing at higher rates….

    Is there no alternative but to succumb to the Mafia-like Wall Street protection racket of a covert derivatives trade in interest rate swaps? As Willie and Kirby observe, that scheme itself must ultimately fail, and may have failed already. They point to evidence that the JPM losses are not just $3 billion but $30 billion or more, and that JPM is actually bankrupt.

    The derivatives casino itself is just a last-ditch attempt to prop up a private pyramid scheme in fractional-reserve money creation, one that has progressed over several centuries through a series of “reserves”—from gold, to Fed-created “base money,” to mortgage-backed securities, to sovereign debt ostensibly protected with derivatives. We’ve seen that the only real guarantor in all this is the government itself, first with FDIC insurance and then with government bailouts of too-big-to-fail banks. If we the people are funding the banks, we should own them; and our national currency should be issued, not through banks at interest, but through our own sovereign government….

    [I guess the best way to rob a country is to own one]

  3. RyanVMarkov

    Because both major US parties are bought by the 1%.
    There is no democracy when $1 = 1 vote.

  4. Susan Pizzo

    Just curious. Have followed your discussions of the criminogenic nature of the GFC and am wondering – at what point does fraud cross the line to something more serious and sinister? At what point are we allowed to connect the dots across the global economic system and determine economic warfare is being waged by a few against the rest? Greece especially seems to me to be rife with examples of economic crimes against humanity (Africa and South America too, of course, but the most obviously pitched battles of the moment are most critically in the “developed world”). This would seem to be the punchline of the neoliberal joke…

  5. You used very complex wording in this article which is not understandable for us.

  6. Sean Fernyhough

    I believe that Dimon went as far as to suggest that banks were doing all this hedging because of Basel III.

  7. Have you been listening to CNBC as the commentators comment on how Jamie Dimon schooled Congress on the economy? If there is an even more fawning, groveling bunch of boot licking sycophants than the US Congress they must be in the media. I really would like to know if you have any idea how much longer before this sick financial system, with its demented overseers, has before it dies. Is is a matter of months years or decades?

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  9. http://billmoyers.com/episode/full-show-how-big-banks-victimize-our-democracy/

    On this week’s Moyers & Company, Rolling Stone editor Matt Taibbi and Yves Smith, creator of the finance and economics blog Naked Capitalism, join Bill to discuss the folly and corruption of both banks and government, and how that tag-team leaves deep wounds in our democracy.

  10. Hey There Itai

  11. Pingback: Lords of Disorder: Billions for Wall Street, Sacrifice for Everyone Else - Page 4 - Defending The Truth Political Forum