Learning from JPMorgans $2 billion loss
JPMorgan Chase chief Jamie Dimons admission last week that the bank blew $2 billion — maybe more — on a "terrible egregious" trading mistake isnt just a warning that President Obama hasnt fixed finance. Its also one that Gotham remains dangerously dependent on a business thats still one desperate day away from catastrophe. Next years mayoral candidates need to be wise to the risk — and plan accordingly.
The banks blunder shouldnt have been a surprise. In the decade before the 2008 financial crisis, Wall Street doubled its annual profits — to $20.9 billion — by making massive bets.
As Wall Street regroups, the industrys remaining shareholders wont hear of lower profits. Because shareholders of firms like Lehman Brothers took big losses in 2008, they want even bigger profits now. The week before JPMorgans loss, the chiefs of all the big banks announced so-so earnings and promised shareholders that profits would rise — somehow.
But how? The economy isnt so great — so such staid business lines as providing advice to companies are slow. Bankers need to do something — so they take bigger gamble
A 2-week-old report from SNL Financial, analyzing banks, highlights the problem. Last quarter, JPMorgan saw its revenues from more old-fashioned businesses drop by 23 percent compared to the same time last year — and thats unacceptable to shareholders.
JPMorgan lessened the blow because revenue from other activities, including the far more risky trading business, fell by only half that figure.
Such figures explain why Dimon looked the other way while some folk in London took a trading shot. The banks London office created a financial instrument — a kind of "insurance" — that other financial firms could buy to protect against the possibility that companies would default on debt.
JPMorgan figured that if it could create enough of the stuff, it could control the market — and reap the profits. But some other folks were smarter than its traders.
Dimon said that the bank was trying to reduce its risk, not raise it. But banks are already vulnerable to the risk that companies will default on their debt. They lend money, remember? Taking on more such risk — in fact, creating it — hardly constitutes prudence.
Nor can the bank easily fix the mistake. Now that the product exists, JPMorgan cant simply conjure it away. The bank may have to create some other instrument, which could carry new problems.
Its not as easy as selling a money-losing stock. Its like a trip with Alice in Wonderland.
What JPMorgan did still makes sense, however. The company wanted to make a profit on this trade, and maybe if its traders were just a bit cleverer and more secretive about what they were doing, so others couldnt so aggressively bet against them, they would have. If Dimon was announcing a $2 billion gain, nobody would ask questions. Shareholders would be thrilled, and regulators wouldnt know better. Thats capitalism.
New York needs to plan for this rational "insanity," however. As Wall Street struggles not to shrink, it will make more Hail Mary passes — sometimes winning, sometimes losing.
That means New Yorks next mayor can expect even wilder swings in tax revenue — one year, too much; the next year, not nearly enough.
It takes enormous discipline to run a budget in such an environment. What if, one spring, revenues come in higher than expected because the Alice-in-Wonderland bets are working out and the bankers are in good moods?
Will the next mayor stash the money — or will he or she give it to the "advocates" who will want everything from retroactive raises for city unions to more after-school programs?
And despite Wall Streets best efforts, were likely to have more lean years than salad days.
The next mayor already faces a $3.5 billion deficit — one that could quickly double if he or she makes promises to give years worth of retroactive pay raises in return for union support. (Mayor Bloomberg hasnt given out raises since shortly after Lehman collapsed.)
New Yorks would-be mayors could avoid that bad trade now, by standing together and saying that they agree that the city cant afford retroactive raises, so lets get it off the table.
Dimon would love such an easy fix for his problems.
But New York pols have the same problem that Wall Street execs have: They cant help themselves, and theyre not sure they want to.
Original Source: http://www.nypost.com/p/news/opinion/opedcolumnists/bankers_mayors_UTeBO2vujMKBp7JZIX2PFI