A one-in-three-billion year bank CEO
James Saft on Jamie Dimon and the banking universe.
Jamie Dimon wants credit for being smart but also wants you to believe he’s living in a banking universe populated with unicorns. The JP Morgan chairman and chief executive in his most recent letter to investors, which was also clearly meant to be read by regulators, complains that the Fed’s stress tests “built into every bank’s results some of the insufficient and poor decisions that some banks made during the crisis.”
I don’t quite know what an insufficient decision is, but Dimon seems to be implying that his track record of smart moves should qualify him, and JP Morgan, for a kind of big kid hall pass. But this claim is undermined later in the letter when Dimon, bemoaning the lack of liquidity in financial markets he blames, rightly, on regulatory changes making it more expensive for banks to take risks, writes:
“Then on one day, October 15 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations – an unprecedented move – an event that is supposed to happen only once in every 3 billion years or so.”
Wow - once every three billion years. What lucky people we are to be living in such a time of wonders. I want a ticket to the unicorn zoo.
It is both demonstrably false and tremendously self-serving for a too-big-to-fail bank CEO to cite this kind of risk metric. Financial market movements don’t follow a normal distribution. There is a long and ugly history of risk managers making capital allocation decisions based on the hope that markets won’t bite them in the behind with a massive move, only to see it happen, and a lot more frequently than every billion years.
That Dimon speaks this language indicates that, to borrow a phrase, some of the decisions may not be sufficient. Dimon goes on to say that a one-in-three billion year move in a 200-year- old market should make you “question statistics.” It isn’t the statistics that are the problem, it is the way in which they are used to justify usually profitable but occasionally disastrous capital allocations.
This is exactly why the Fed needs to assume poor or self-serving decisions by bank managers, no matter how they came through the last crisis.
The price of risk
There is an irony, of course, that risk-suppressing measures by regulators might cause risky and sudden moves in financial markets, as appears to have been the case in October.
Dimon goes on to argue that the regulatory changes put in place will have a big impact on the role banks will play in the next crisis, though even he says they make it less likely that the crisis comes from banks.
Banks, he says, will all rush for the same safe assets, which due to regulatory changes (not to mention official actions) will be in shorter supply. Banks will also be less- willing to play the role of relationship bank - extending credit, rolling over loans and doing the other kinds of helpful things he says Morgan did last time round.
And don’t count on those nasty non-banks to lend in a pinch, because they won’t be there.
In his letter, Dimon writes that “banks continued to lend at fair prices in the last crisis because of the long-term and total relationship involved. Banks knew they had to lend freely because effectively they are the ‘lender of last resort’ to their clients as the Federal Reserve is to the banks.”
This isn’t so much special pleading but an attempt to make us see how letting banks take on more risk is good for us, too. But it isn’t true.
The most important relationship a too-big-to-fail bank has, as Dimon’s actions show, is not the dispensable one with its clients but the iron-hooped one it has with its regulators, who are the effective guarantors of its ability to weather what storms may come.
To say that banks are “lenders of last resort” to their clients is, obliquely, to acknowledge their quasi-government status. Only a central bank can be a true lender of last resort, and central banks shouldn’t be in the habit of sub-franchising to private banks, even very large and well-run ones. It isn’t fair and it isn’t healthy.
The price of credit will go up, and many will be hurt by this. But the allocation of credit will, over time, improve, as banks respond to market forces. That will lead to steadier and more fairly distributed growth.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)