The Passion of Jamie Dimon

“A friend in need is a friend indeed,” is a charming expression of the Judea-Christian tradition.  Financial markets are godless, however.  Supply and demand, fear and greed are the markets prime motivators.  In our case soulless sharks corral the wounded “London Whale” of J.P. Morgan. Jamie Dimon’s investment group’s sin was to sell the CDX ID 9 credit derivative swap.  A positive bet on the growing possibility the US Economy might improve and for the 125 companies the index represents their credit situation would positively track the overall improvement of US economy.  Proven wrong he is publicly humiliated by too big to fail firms on the other side of the trade and, even worse, by administration officials who wonder how Jamie Dimon could be so confident and so arrogant as to suggest that administration policies might actually  succeed. The gall of the man is absolutely staggering.

Nor do administration officials grasp the nature and character of the position. The SEC, CFTC, FDIC, Fed officials installed in the bank premises and gumshoes from the FBI are all investigating the balance sheet maneuvers of a $2.3 trillion battleship galactica whose size is just short of the Federal Reserve’s (also TBTF) own precarious credit position.  Ironically JP Morgan balance sheet is better capitalized than the Fed.  This bank is clearly too big to fail but the loss of $3 billion is too small to matter. Scale matters.  If political hacks want banks to remain big…then get used to big numbers.

JP Morgan cash deposits exceed loans balances by approximately $354 billion. This excess is a staggering amount – I suspect more than the combined assets of the top 5 banks of 20 years ago.  What regulatory process allows bank to achieve this size is fodder for a blog to be issued later. 

Regardless, the cardinal rule of a bank’s Treasury is that no money sits idle. Typically, in the preTBTF days the Treasury’s Investment Department invests excess cash, resulting from slack loan demand, in US Treasury Notes and Bonds.  Slack loan demand is of course a sign of a recession or in our situation an undeclared depression.  Buying US Treasury Bonds at low depressed interest rates means buying bonds at very high prices.  The department is fully aware that a later pick-up in loan demand, an improving economy, and thus higher interest rates results in a decrease in those bond values.  Treasury also understands that swapping bonds for loans results in an immediate loss on the bonds but offset by the higher rates on newly obtained loans.  This procedure is classic bank balance sheet management.  Precisely for this reason Financial Accounting Standard Board rules allow banks to defer investment gains and losses until the bonds are actually sold. Those bonds purchase are after all funded with deposits placed at the previously low rates of suppressed demand for monies.  Unfortunately FASB rules do not allow gains on those liabilities to be realized as an offset.  Bankers deal with the hand they are dealt -- accounting is a fiction now that Congress bullies the independent FASB into rules of its own liking.

My old friend Gil was a sole investment manager for a money center bank back in those days long gone.  Gil was very good natured about running his portfolio.  He was fully aware that continually selling bonds at a loss was part of the asset-liability process.  His job was to manage the bonds in a way that would minimize his overall exposure.  Losses are inevitable…that is part of the plan.  The pain is eventually offset by the yield of new loans in a healthier economic climate. This approach to asset-liability management preceded Gil’s tenure at the bank at least 50 years. I always admired Gil for his cheerful demeanor in accepting those positions as credit derivatives were not part of the lexicon of the 1980s. 

Today Chase has a score and one traders to manage a similar feat. Each trader is fighting for fame and fortune – all guaranteed by hapless taxpayers.

The House of Morgan’s ignoble sale of $100 billion or so in credit derivative swaps makes for great press.  In practice and in financial pricing, the sale is essentially equivalent to the simultaneous unloading of Treasuries and purchase of loans.  Somewhere in JP Morgan the asset-liability committee determined that the economy is improving and authorized the swap.  Oh the arrogance of these fools!!

On April 16 an article from that capitalist rag, The Wall Street Journal, points out that a peculiar ‘London Whale’ established a massive short position in the CDX ID 9 credit default swap. The sharks circled.  Treasury prices rose, rumors of Greece impending default surfaced, Spanish Bonds yields hit the unsustainable 6 percent level.  Credit markets shudder.  Market participants in Credit Default Swaps are not illiterate; they will not help The House of Morgan.  JPM bids to buy back the short position but the few sellers remaining in our TBTF world purposely and collectively go on strike; the whale is wounded --let it fester.  Even better, the hapless Federal Reserve rounds up the usual suspects to suggest another session of quantitative easing …. Physically purchasing the bonds JP Morgan is synthetically short.  Ironically, corporate bonds yields barely moved throughout the debacle.  The losses stems solely from the ever increasing demand for US Treasuries. Congress meanwhile fiddles though a depression era election year and will not issue the Bonds the markets raptly demands.  Woe to the bankers of JP Morgan Chase!!

Had JP Morgan Chase invested in actual physical loans, the loss if any might be buried in either A) reduced net interest margin or B)  the nebulous line item of loan loss reserves.  Transparency is the rule of the day and JP Morgan is forced to acknowledge its position and announce to the world that it is incredibly arrogant, stupid and irresponsible to assume that the US economy could possibly improve.  The loss of $3 billion on an investment portfolio of $354 billion is just unbelievable the pundits say… a true black eye on the career of Jamie Dimon.   Now a fourth grader can divide the two numbers above by 10 and point out that the loss is equivalent to a stock drop from $35.40 to $35.00 per share. Never mind the loss on the actual capital of the firm. Shocking!! The internet darling, Facebook, meanwhile first print on the NASDAQ is $42.05.  Three trading days later it closes at $32.00 per share.  Mark-to-market accounting and the loss of relative scale subjects Jamie Dimon to Robespierre-like interrogation from self-appointed prosecutors at CNBC, NBC,ABC, Bloomberg, NPR and etc. Yellow jingoism is by no means dead. Nary had a single talking head ever worked in the boiler room of a Treasury operation. Guillotines are sharpened financially and politically.   Jamie must be tossed from the NY Fed, the banks must severely curtail their ‘risk’ taking, and bankers are the ruin of western civilization.  Investors see this perverse reaction and dispose of $12 billion in market capitalization on a $3 billion loss.

In short it is very hard to run a bank that is too big to fail.  The sheer magnitude of numbers means that only Faustian souls with a pathological sense of value can distance themselves from the daily decisions they make.  FASB transparency rules force the banks to disclose their position to the few remaining counterparties -- hardly a way to portray the poker face made so famous by Edmund Rothschild.  Administration officials and regulators seize the jingoism with Machiavellian ease hoping the outcome will be a flood of campaign donations for silence, or jobs for political hacks seeking to graze on the pasture of depositors monies.  The political apparatus after all did lose Freddy and Fannie Mae and surely needs a replacement.

Jamie Dimon is forced to testify in front of Congress. That great hall where Romanesque legislators worry about Guam tipping over, the budget they can never seem to pass, or the building the bridge to nowhere can now redirect populace anger at Jamie Dimon alone seating squarely in front glaring TV lights.  The occupiers in the gallery will demand…’Crucify him! Crucify him!’  Congress will then adjourn, wash their hands and the loss will be a minor footnote of history.

I post my blog at 5:31 am this morning.  I read my Chicago Tribune and Wall Street Journal. I hop on my bike and ride to work.  I glide past the sunrise over Lake Michigan, enjoy the south wind blowing across my face.  A voice whispers...'Faith and Reason Jamie.... Faith and Reason.  Double down and you will prevail.' Nuts to the sharks and their pilot fish!! The US economy always bounces back.

You shall not crucify mankind upon a cross of paper!!

“Be careful what you wish for”, they say, “as you might just get it.”  The quip is brutally common in the social science called economics.  The cardinal rule of economics -- you cannot interfere with the law of supply and demand.

In this case we direct the quip towards the Roosevelt economists who flat out reject the notion of returning to the gold standard.  Gold is economic relic and too restrictive as it does not guarantee that currency base will grow at the pace of the economy.  Gold bugs are equivalent to those crazy people who cling to guns and religion.

Dare we reconsider? 

The current deflationary cycle is suffocating our debt fueled economy.  In this election year, political gridlock and policy paralysis slowly tightens a noose around the nascent economic rebound of the last three quarters.  Capital flight out of Europe and Russia and into US Dollar denominated assets creates a needlessly stronger dollar combined with artificially low interest rates.  Artificial, as those rates are below the current inflationary figures and suppressed by the bond purchases of the Federal Reserve.  The credit spread between corporate bonds and US Treasuries is widening not because cash-flush corporations are a bad bet but for the reason that capital flight is seeking an immediate safe haven.

 The Fed in its infinite wisdom purchased over $1 trillion in these bonds the weary huddled masses Europeans so eagerly demand.  Paul Krugman the Nobel Prize NY Times columnist cries out that the Treasury Department should take advantage of this situation and supply the market more of these coveted bonds via Treasury auctions and use the proceeds to purchase labor (i.e. shovel-ready projects) so recently and long term out of favor.  He rightly suggests the Federal Reserve print more money to counter the rapid appreciation of the US Dollar and supply the public with the money to offset the deflationary debt trap.

And yet, both institutions cannot do the right thing.  Policy maker’s hands are effectively handcuffed.  First, the Fed, after two rounds of quantitative easing, must not act as a stooge to the current administration whose political fortunes are now directly tied to the health of the economy.  It must maintain the facade of independence.  Secondly, amid record deficits and the specter of yet another deficit spending ceiling debate, our Treasury Department husbands its political and financial resources until after the election.  Deficit reduction is the mind-set of those pesky populists seeking the stern policy of austerity.

There you have it…gridlock and paralysis from two powerful quasi-independent organizations. 

High gold prices signal producers that consumers demand more of the relic of monetary policy.  The old adage… ‘The solution to high prices…is high prices” comes into play. Producers willingly respond.  Old mining operations are refurbished and new discoveries exploited.  Billionaire executives from Silicon Valley invest part of their wealth to capture the super-nova detritus in space containing Atomic number 78 and 79.   No political discussion necessary. 

                                                                                                         

The law of supply and demand naturally creates the currency the nation so desperately seeks.  No government mandate or ceiling to interfere -- just raw greed to replace legions of stymied policy makers.  Economist Milton Friedman in his Nobel prize treatise “A Monetary History of the United States: 1867 to 1960” points out that all too often Federal Reserve policy makers know the right policy moves during a time of crisis but are handcuffed into making the wrong decision because of political expediency-- not making a decision is the wrong decision in financial markets. 

The Fed should print dollars to purchase bullion from any willing seller of gold.  The new inventory of gold is an asset the balance sheet of the Fed, currency the offsetting liability.  As the economy recovers the Fed would chose between two assets it could sell to drain cash from the system – bonds or gold.  There is strength in the diversity of policy choices.


Practically the policy is automatic. Ordinarily money supply growth should correspond to the target growth of the economy of say two percent of $13 trillion. If gold purchases comprised of 20 percent of monetary growth, the Fed could easily buy 1200 Gold Futures contracts (100oz) discretely throughout the day to create these monies. The Fed takes delivery of the gold and those monies are now permanent in the system. The physical gold exchanged with the Treasury and Gold certificates received in return as is the current practice. Simple. Think of this policy executed daily as a drip line to the private economy. A $2000 linux box is all that is required.

To paraphrase Walter Bagehot, history’s first central banker, ‘Lend freely but at an exacting price’.  The Fed lends freely but its coveted bonds are locked in a digital vault in New York.  Selling those bonds at a tidy profit to our desperate Europeans is a contraction of money to central bank watchers and would send the market into a tailspin. A simple solution is re-instating gold bullion as part of the repertoire of monetary tools.  Gold does not necessarily need to a standard but it can certainly be a diversified outlet of money to the economy.  Buying more bonds only distorts the current pricing mechanism of interest rates and enriches the fortunes of entrenched bankers.  Money creation through gold sales directly distributes money to the entrepreneurial class and is not trapped in the arcane world of excess reserves.  Banks would no longer have a monopoly on the issuance of new monies and might be force to compete for the cash available from the completive outlet of gold purchases.  The scarcity of gold would ensure that such purchasing power is not abused.

The tragic irony in this tale: the liberating fiat currency is now a conservative shackle and the ancient gold relic just might be a liberating stimulant.