By Pam Martens: June 14, 2012
If you want to trade securities at any brokerage firm in the U.S., you’ll need to study intensively for about three months, memorize dizzying rules and regulations, then take a six hour licensing exam. (The exam is so rigorous that it’s compared to the CPA exam. I don’t know if it’s fact or lore, but I was told exam rooms in past decades had puke buckets in the corners. My room didn’t in 1986.) Then, you’ll need to get fingerprinted, pass a background check, register with a host of stock exchanges, make sure you have a supervisor who holds a principal’s license, get approved in each state in which you plan to conduct business, and take ongoing continuing education classes to keep your licenses.
Or, you could skip all of that and earn $14 million a year trading – without a license – stocks, bonds, swaps, options, futures with $374 billion of bank depositors’ money at JP Morgan Chase’s Chief Investment Office – a unit few on Wall Street had ever heard of until it reported losing billions of dollars in May in the same derivative transaction that made AIG a ward of the taxpayer in 2008.
An “Investment” office sans licensed investment brokers is the latest deregulatory mutation on Wall Street. The other mutation is the JPMorgan model to create an art form out of depicting itself as a “fortress balance sheet” while holding $156 billion of Tier 1 capital and $66 trillion (with a “t”) in notional derivative contracts according to financial filings for March 31, 2012 with the Comptroller of the Currency.
Ina Drew, the head of the Chief Investment Office at JPMorgan in New York earned $29 million total for years 2010 and 2011. She was paid on a par with a hedge fund manager because, in essence, she was a hedge fund manager. She held no securities licenses so she was ineligible under securities law to supervise others who did hold a license; sort of like an operating room full of unlicensed brain surgeons who never went to medical school.
But even though Drew was not licensed as a principal, she was somehow supervising traders in London who were registered with the Financial Services Authority (FSA), the UK securities regulator. That included the infamous London Whale, Bruno Michel Iksil, whose trades in a credit derivative index were so large that he effectively cornered the market, pushing up the cost for American businesses to buy credit insurance on exposure they legitimately held on their balance sheets. We used to prosecute people who corner markets. But that’s so yesterday. Today, Congress just wants to study “lessons learned” like it’s fallen under a Vatican trance – there are no bad men or prosecutable crimes, just evil temptations.
The unit’s trading bets paid off big in the past two years. But like your average hedge fund manager that takes huge risks and collects big paydays as long as the market goes in the right direction, the music eventually stops abruptly, dumping excruciating losses on investors. The hedge fund manager has fully mastered heads I win, tails you lose: he doesn’t give back any of his outsized pay for the winning years, even if his investors give back all those gains and then some. JPMorgan’s Chief Investment Office has racked up an acknowledged $2 billion in losses as of May 10 and a street estimate of $4 to $8 billion currently. Drew left the firm last month.
According to records at the Financial Industry Regulatory Authority (FINRA), the U.S. regulator, Ina Drew skipped all the licensing requirements during her 30-year career at JPMorgan Chase and its predecessor banks. (An email and a phone call to JPMorgan on the matter went unanswered.) Drew came up through the ranks of the banking side of JPMorgan Chase, first at Chemical Bank, then in its merger with Chase in 1995; culminating in the purchase of JPMorgan by Chase in 2000, following the repeal of the Glass-Steagall Act which had prevented banks holding insured deposits from merging with Wall Street trading firms.
Under securities law, if all Drew and her traders were doing was hedging the bank’s risk exposure by buying conservative instruments like U.S. Treasury notes, the typical function of a Treasury Department at a bank, no securities licenses were needed, providing they did not make transactions with customers.
In the spring of 2003, the SEC adopted new rules governing trading within banks to address exceptions that resulted from the repeal of the Glass-Steagall Act, which occurred when Congress passed the massively deregulatory Gramm-Leach-Bliley Act. The relevant wording reads: “The question of whether a bank acts as a ‘dealer’ that must register with the [SEC] Commission therefore turns upon a two-stage analysis. The first stage of the analysis, which is the general ‘dealer/trader’ distinction, focuses on two factual questions: (1) whether the bank is ‘buying and selling securities’ for its own account; and (2) whether the bank is ‘engaged in the business’ of that activity ‘as part of a regular business.’ A bank would not be a dealer unless both of those factual tests are met.”
According to documents and job advertising placed by JPMorgan Chase, the Chief Investment Office was a morph between a proprietary trading desk making bets for the firm’s account, a hedge fund operating off the regulatory radar screen, and a typical investment bank engaging in market making for its customers. What it clearly was not was a conservative T-note desk investing the bank’s surplus insured deposits in liquid government securities as a hedge against another U.S. credit seizure or a banking tsunami in Europe.
One job ad for a mortgage trader for the Chief Investment Office indicated the following under Key Job Functions: “Provide liquidity to our lender customers through market making functions…Develop and maintain relationships with dealers and lender customers.” Oops. There’s that word, “customers;” the very word that requires a license to trade securities and registration with the SEC as a broker dealer.
Other job advertisements indicate that London is not the only outpost for the Chief Investment Office. JPMorgan says in the ads that the Chief Investment Office operates in London, New York, Hong Kong and it is opening a unit in Shanghai. If JPMorgan’s regulators weren’t aware of what was going on in the London operation, are they equally in the dark about the other corners of the globe?
Another red flag for a unit that is supposed to be a liquid, risk management operation is that the Chief Investment Office also has a private equity component – it’s investing in share holdings of companies that are not publicly traded and are valued at whatever someone is willing to say they are worth. (Think liar loans, or even better, Facebook.) There is limited price discovery on private equity as well as limited liquidity.
An online announcement by Johnson Publishing Company, publisher of Ebony and Jet magazines, indicates that “during June 2011, the Special Investment Group of JPMorgan Chase & Co. acquired a minority stake in Johnson Publishing…The Special Investments Group is a private equity group within the Chief Investment Office of JPMorgan Chase & Co.”
Thus far, the story presented to the public is that the Chief Investment Office was not overseen by the SEC because it was operating within a unit of the bank – a unit called “Corporate.” But the unit placing the job ads for the Chief Investment Office was not the bank, JPMorgan Chase, N.A. but the holding company, JPMorgan Chase & Co.
The FBI is investigating the matter but won’t say why. Five other regulators are also investigating but are vague on just what they’re investigating. The theory on the street is that JPMorgan had simply moved its proprietary trading desk to London to fly below the radar of its myriad Federal regulators in the U.S., as Wall Street firms were supposed to be winding down, not ramping up, proprietary trading under financial reform legislation. As the theory goes, Ina Drew, who had a long history of managing surplus deposits as a Treasury function for the banking operations, was put in charge to cement the story that this was a risk management operation.
On May 14, JPMorgan announced that Matt Zames would be replacing Ina Drew as head of the Chief Investment Office. Zames was formerly the co-head of fixed income (bond trading) in the investment bank – which is overseen by the SEC. Zames is registered with FINRA. Not only does he hold a Principal’s license making it legal for him to supervise others, but he holds registrations with the New York Stock Exchange Arca, NASDAQ, Chicago Board Options Exchange, Chicago Stock Exchange and numerous others. Jamie Dimon, Chairman and CEO, to whom the unlicensed Ina Drew reported, also held all the required FINRA registrations and stock exchange licenses, meaning he can’t claim ignorance of the laws.
This presents an interesting quandary for JPMorgan. Does it concede that it was running an unlicensed rogue outfit and pay its typical slap on the wrist fine. Or does it marshal its legions of lobbyists and outside law firms to fight acknowledging any breaches of law. In 2010 and 2011, the firm that President Obama recently heralded as one of the best managed on Wall Street, paid a total of $8.9 billion in litigation expense. That’s not a typo. That’s the new business model. Skirt the laws all you want as long as you make enough to pay the lawyers to keep you out of jail with a little left over for the lobbyists.
It is ironic that the Wall Street Frankenbank model that is now devouring Dimon’s reputation and his bank’s balance sheet, was crafted by none other than himself and his prior mentor, Sandy Weill. Dimon’s father, Ted Dimon, was one of Sandy’s top brokers at Shearson. The young Dimon eventually went to work for Weill and remained his loyal first lieutenant through various shakeups, eventually helping Weill craft the merger of Travelers insurance, which owned the Smith Barney brokerage firm and Salomon Brothers investment bank, with Citicorp, an insured depository bank. The merger was illegal at the time under the depression era Glass-Steagall Act which separated deposit taking banks from high risk Wall Street trading operations to prevent another 1929 crash and Great Depression. But Weill and Dimon correctly counted on their pals in Washington to make that problem go away. Their Frankenbank creation, Citigroup, required $45 billion in TARP funds and $301 billion in Federal guarantees to stay alive during the financial crisis. Long term shareholders have lost 94 percent of their investment in Citigroup but Sandy Weill received in excess of $1 billion in compensation during his decade at the firm. Heads I win; tails you lose, just like a hedge fund manager. Dimon left the firm not long after the merger when his relationship with Weill soured. He left as a multi-millionaire.
I testified against that merger on June 26, 1998 before the Federal Reverse Bank of New York. Here’s part of my testimony:
“It is amazing how soon we forget. It was just 60 years ago that 4,835 of America’s banks went broke and closed their doors, leaving shareholders and depositors destitute. The underlying reason that this happened was the lack of moral courage by our regulators and elected representatives to just say no to powerful money interests. Instead of just saying no, Washington handed the banks the equivalent of an ATM card to the Fed’s discount window to speculate in stocks.
“At a time when Japan, the second largest industrialized nation, is reliving the 1930s in America, complete with banking insolvency, it is amazing and preposterous that we should be discussing rolling back Glass-Steagall.
“We also want to remember that the political dynamics that created the backdrop for the banking meltdown in the ‘30s grew from a corrupt cozy culture between Wall Street and Washington. U.S. Supreme Court Justice William O. Douglas, (who knew a thing or two about the matter, having just served as chairman of the young, new SEC, before he went to the Supreme Court) called it what it was, chicanery and corruption.
“Frank Vanderlip, coincidentally, an actual former president of National City Bank, wrote in the Saturday Evening Post at the time that lack of separation of banking and securities contributed to the stock market losing 90 per cent – I’d like to repeat that, 90 per cent – of its value from 1929 to 1933. The public was so sickened by the hubris and corruption that an entire generation stayed away from the stock market. It was not until 1954, 25 years later, that Wall Street once again reached the level it had set in 1929.
“There is a compelling body of evidence that suggests a corrupt cozy culture has once again enveloped the brains of Washington. We can hardly look to the safekeepers of the public trust when they are falling over themselves to reap campaign windfalls from Wall Street.”
In 1912 John Pierpont Morgan was summoned to testify before the Senate over ingrained corruption at JPMorgan. In 1933, the son, J.P. Morgan, Jr., repeated the performance. Jamie Dimon, who has managed the Morgan firm for a brief eight years and presided over multiple scandals during that time appeared once again before the Senate on June 13 to be grilled on the trading losses.
The only thing useful we learned from Dimon was that “hundreds” of Federal examiners are permanently stationed at the firm. This sounded like house arrest to me. I called the Bureau of Prisons to find out how many staff and correctional officers are assigned to the Federal super maximum security prison in Florence, Colorado. The answer is 350 but that includes shift work. So America’s largest bank by assets now operates on a par with a facility for people who are “the most dangerous and in need of the tightest control.” And we call this financial modernization.