Two giant financial institutions, Goldman Sachs and JPMorgan Chase, emerged intact, if not unscathed, from the wreckage of the global financial crisis that began almost exactly five years ago today with the collapse of Bear Stearns. In the years that followed, they not only survived but thrived, grabbing market share from weaker rivals and profiting from a host of businesses – debt underwriting, mortgage refinancing and trading.
Even a flurry of new regulations from Washington didn’t seem to dampen their growth much, much less dent investor enthusiasm for their shares: While the S&P 500 index is up 108 percent from its March 2009 lows, JPMorgan Chase has seen its stock price soar more than 220 percent.
Could this all now be in jeopardy?
To be sure, talk of breaking up ‘too big to fail’ institutions like JPMorgan Chase remains nothing more than talk – albeit at an increasingly high level, with even U.S. Attorney General Eric Holder voicing wariness about the matter in recent testimony to Congress. And so far, while Goldman Sachs has had to pay out hefty sums to settle regulatory issues that arose during the financial crisis and has had to embark on campaigns to try to restore its public image, the bank has been able to continue doing business in a way that some insiders describe as being remarkably unchanged since the financial crisis.
But there are some signs now that this state of affairs may not last, starting with last week’s comments by the Federal Reserve on the results of its most recent ‘stress tests’ on the country’s financial institutions. No one expected any of the major banks to fail these ‘tests,’ and none did. But no one expected the Fed – the major regulator of both Goldman and JPMorgan – to express reservations about the adequacy of the capital planning at the two financial institutions.
The regulators aren’t worried about the size of the capital cushions at the banks, both of which have long since bolstered their reserves in response to new industry standards. Rather, the Fed says its anxiety has more to do with the ability of the two institutions to gauge the size of their potential losses in the event of another big economic shock.
That’s a slap in the face to Goldman’s Lloyd Blankfein and Jamie Dimon at JPMorgan Chase. In the years since the events of 2007 and 2008, both CEOs have repeatedly argued that their ability to navigate and survive the financial crisis demonstrates their skill in identifying and managing risk. Now, with its statement, the Fed appears to suggest that some institutions, like Citigroup, that struggled to survive may be better prepared for a future crisis.
Underpinning the Fed’s critique – which won’t stop the banks’ ability to pay out higher dividends in the short term, but will require both institutions to overhaul their capital plans within six months – is the complexity of these banks’ businesses. In both cases, it seems, the Fed’s own assessment of how much the banks would lose in a future crisis varied significantly from those produced by the two institutions themselves, to an extent that prompted the regulators to dub them “significant enough to require immediate attention.”
But the Fed’s reservations aren’t likely to do more than build on the comments by those like economist Simon Johnson of MIT, who have been clamoring for a breakup of giant banks for years, and on the reservations of those in Congress who listened to Holder ponder the possibility that size may make these organizations ‘too big to jail.’
The timing couldn’t have been worse for JPMorgan Chase, which is emerging as a test case both of complexity and of oversight and governance. Within hours of the Fed’s comments last week, a new Senate report on last year’s “London Whale” trading scandal at the bank’s chief investment office was making the rounds. It offers depressing evidence that even a bank that rode out the storm of 2008 still struggles to identify and manage its own risks.
Congressional investigators pointed out that the chief investment office breached key risk controls on no fewer than 330 occasions in the first four months of 2012, before the losses became public. Moreover, while Jamie Dimon testified that he couldn’t remember approving a temporary change in the way the bank computed and modeled risk – a change that ultimately enabled the losing trading position to grow larger and produce a larger loss – the Senate report cites an e-mail from Dimon himself specifically signing off on the step.
So far, the “London Whale” losses amount to some $6 billion. Still, JPMorgan Chase’s stock has climbed 22.4 percent in the last year, recovering all the ground it lost last spring. The question now is whether the bigger picture painted by the report and by last Friday’s testimony by Ina Drew, the top JPMorgan Chase exec who oversaw the chief investment office, will create even bigger problems for the bank – not only with regulators but also among Washington legislators.
Until now, Dimon has taken refuge behind a kind of CEO shield: He trusted his deputies, Drew among them, to keep him fully informed, and they failed to do so. In contrast, Drew testified that Dimon was kept up to speed on all the investment decisions and other events within the chief investment office. Then came another blow, when former CFO Douglas Braunstein testified that regulators received only “summary information” about the “London Whale” trades, rather than the kind of detailed daily reports that would have enabled those regulators to monitor any systemic risks associated with the losses.
Despite the occasional populist blustering in Congress, few in Washington really expect Wall Street to treat all its clients equally, just as many of those clients themselves are wise enough to approach all their dealings with banks with wariness. (As one Wall Street client explained it to me, “You need to assume that they’re out to screw you and all you need to figure out is how they’ll do it. That way, you’ll always be prepared for whatever happens.”)
Outright fraud and clear instances of deception can be punished by regulators. The greater risk to the whole financial system and thus a greater source of concern is the extent to which these institutions simply can’t manage risk. And the case of JPMorgan serves to remind us all of how important that question is and how difficult it is for any big institution to do so successfully and consistently.
Is breaking up the big banks the answer? That is far from certain. What is obvious, however, is that the declarations by crisis survivors that they have earned the right to be trusted to manage risk need to be treated with more than just a few grains of salt.