Fed’s Stress Test: Should JPMorgan Chase Have Gotten a Second Chance?

By Pam Martens and Russ Martens: June 28, 2019 ~

Jamie Dimon, Chairman and CEO, JPMorgan Chase

Jamie Dimon, Chairman and CEO, JPMorgan Chase

How many second chances should a criminal recidivist get? JPMorgan Chase has logged in guilty pleas to three criminal felony counts in the past five years; it has a criminally-charged precious metals trader singing to the Feds currently as JPMorgan admits in regulatory filings that it’s under a new criminal investigation in that matter; the bank has paid $36 billion in fines for wrongdoing since the financial crash, including $1 billion for trading exotic derivatives in London with bank depositors’ money and losing at least $6.2 billion of those depositor funds (the London Whale scandal). And in just the past year it has proven that it’s “game on” for more regulatory fines and illicit profits. (See Could JPMorgan Chase Be Hit with a Fourth Felony Count for Rigging Precious Metals Markets?)

Despite all of this, yesterday the Federal Reserve announced that it had given JPMorgan Chase a second chance at passing the regulator’s stress test.

According to the announcement from the Fed, all 18 mega banks it submits to stress testing had passed the second leg of its stress tests known as the Comprehensive Capital Analysis and Review (CCAR). It did require one bank, Credit Suisse, “to address certain limited weaknesses in its capital planning processes.”

But JPMorgan Chase, along with the much smaller and zero-felony-count Capital One, were only able to pass the stress test because the Fed allowed them to resubmit their plan a second time. (That’s like failing your licensing exam on Wall Street that you have months to prepare for and then being allowed to take an open text exam.) The Fed said this about the matter:

“In the supervisory severely adverse scenario, Capital One Financial Corporation (Capital One) and JPMorgan Chase & Co. (JPMorgan) were projected to have at least one minimum post-stress capital ratio lower than minimum required regulatory capital ratios based on its original planned capital actions. Capital One fell below the minimum required common equity tier 1 ratio, tier 1 capital ratio, and total capital ratio on a post-stress basis. JPMorgan fell below the minimum required common equity tier 1 ratio, tier 1 leverage ratio, and the supplementary leverage ratio on a post-stress basis…However, both Capital One and JPMorgan were able to maintain their post-stress regulatory capital ratios above minimum requirements in the severely adverse scenario after submitting adjusted capital actions.”

The word “leverage” is used two times in that paragraph and, in both cases, it pertains to JPMorgan Chase. To what might the Fed be referring? According to the most recent report from the Office of the Comptroller of the Currency (OCC), as of March 31, 2019 JPMorgan Chase held $59 trillion in notional (face amount) of derivatives, which netted out to $348 billion of credit exposure from derivatives versus $201.5 billion of risk-based capital, giving the bank a 173 percent total credit exposure to capital ratio. (See Table 4 in the Appendix of the OCC report here.)

But that’s just the capital risk the public and regulators know about. According to excellent reporting by Emily Flitter at the New York Times last July, “A decade after a financial crisis fueled in part by a tangled web of derivatives, regulators still have an incomplete picture of who holds what” in the $600 trillion global derivatives market. That’s because the mega banks “don’t have to disclose to American regulators their holdings of derivatives housed in certain offshore entities.”

A spokesman for JPMorgan Chase told Flitter that the amount of derivative trades not reported to its U.S. regulator “account for less than 10 percent of all the bank’s derivatives.” Ten percent of $59 trillion is $5.9 trillion, not exactly chump change, and if these are the high-risk credit derivatives that blew up much of Wall Street in 2008, that’s not a minor matter.

Hiding problematic stuff is not far-fetched when it comes to JPMorgan Chase. When the U.S. Senate Permanent Subcommittee on Investigations released its 300-page report on the bank’s London Whale losses, it revealed the following: As of January 16, 2012, JPMorgan Chase’s Chief Investment Office, located within its Federally-insured commercial bank, held $458 billion (notional) in domestic and foreign credit default swap indices. Of that amount, $115 billion was in an index composed of corporations with junk bond credit ratings, which the insured bank was not allowed to own in order to comply with safety and soundness requirements.

To dodge its junk bond problem, JPMorgan “transferred the market risk of these positions into a subsidiary of an Edge Act corporation, which took most of the losses.” An Edge Act corporation refers to the ability of a bank to obtain a special charter from the Federal Reserve. By establishing an Edge Act corporation, U.S. banks are able to engage in investments not available under standard banking laws.

Pay close attention to which Federal regulator it was that gave JPMorgan Chase this loophole to climb through. It was the Federal Reserve, the same body that just gave the bank a second run at passing its stress test.

We knew this year’s Federal Reserve stress test results were going to be a big illusion wrapped in an expensive PR campaign in early March when the Fed rushed through a rule change without the customary 30-day delay. The rule change removed the so-called “qualitative” measure as a tool for flunking a bank on its stress test. The message the Fed sent to the recidivist banks like JPMorgan Chase is that you don’t have to worry about some gutsy bank examiner causing you to flunk your stress test for writing you up for things like failing to report and/or control money laundering, insider trading, bribery, or market rigging, because we’re simply dumping that qualitative measure of how you run your bank.

Following news of the rule change, Dennis Kelleher, President and CEO of the nonprofit watchdog, Better Markets, issued this statement:

“The Fed seems to be enacting a double standard for transparency that favors the biggest banks over the public and market discipline. On the one hand, the Fed is going to provide those banks with substantially more information about the stress tests. On the other hand, the Fed is no longer going to disclose its qualitative evaluation of those banks to the public.

“Both changes are unwise and will impair the ability of the public and markets to fully and fairly evaluate the condition of the nation’s largest banks or the quality and robustness of the Fed’s tests.”

Related Articles:

Treasury Drops a Bombshell: Fed’s Stress Tests Get It Wrong

After Passing Stress Tests, Wall Street Banks to Spend Like a Drunken Sailor – on their Own Stock Buybacks

Fed’s Powell Says Financial Risks Are “Moderate”; These Charts Don’t Agree

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