US banking regulators have released new proposals to require banks to have higher leverage ratios, counterintuitively meaning lower leverage, and you can go read them here, or read about them here or here. Briefly: in addition to regular Basel III risk-based capital requirements, banks are also subject to a backstop equity-divided-by-assets0 leverage test, and internationally the minimum is 3%, but in the US it’ll be 5% for the biggest bank holding companies and 6% for the biggest insured banks. The OCC estimates that the banks are in total about $84 billion or so short of that requirement, though they have five years to get there, so it’s not, like, go sell $84 billion of stock right now or whatever.1
Once upon a time there was a whale, and he had a synthetic credit portfolio, and one day he did terrible terrible things with that synthetic credit portfolio, and the next day he woke up and realized he had lost $5.8 billion, and he was sad. The question for you is: was that a disaster? I think a sensible answer is:
Having a sense of proportionality here is a good idea. For one trader, losing six billion dollars, give or take, really is in the far left tail of Worst Things You Can Do, and so the whale himself was fired in infamy, though an infamy mixed with a certain envy. For his direct manager and that manager’s manager, it is probably even worse, since failing to prevent your direct report’s $6 billion loss lacks the “wow-that-takes-balls” element of actually going out there and losing six billion dollars like a whale. So they were fired too. For the bank … meh. For the Second Bank of North-Central Indiana, I’m sure losing six billion dollars would be the sort of existential disaster that would require firing the CEO, tearing down the building, and salting the earth on which it stood, but there’s a reason this didn’t happen at the Second Bank of North-Central Indiana. It happened at JPMorgan. For which it wasn’t all that much of a disaster.3
What about for JPMorgan’s regulators? I go with, like, our financial system is still here, not really any the worse for wear, but others disagree, and regulators don’t have the same “well we were profitable for the quarter” defense that JPM had.4 And so today the Fed and OCC engaged in a well-lawyered barn-door-closing exercise, issuing consent orders to JPMorgan that basically say (1) you done fucked up, but (2) you fixed it, so (3) keep doing what you’re doing. Here is the Fed: Read more »
You Misplace 5 Or 6 Billion Dollars And All Of A Sudden People Stop Trusting You To Keep Track Of Your MoneyBy Matt Levine
When JPMorgan’s whale drowned a lot of people asked “where were the regulators?” and that was a silly question, because the people with the most incentive and ability to keep the whale afloat were, in descending order, (1) the whale, (2) the whale’s bosses, (3) the whale’s bosses bosses, (4) the regulators, and (5) the people asking “where were the regulators?,” so if categories 1-3 missed the problem then there’s no reason to get all mad at category 4. “If X’s could do Y they wouldn’t be X’s” is an important tool to keep in your mental toolkit, and if regulators could distinguish good from bad trades they’d be at least risk managers and probably, like, Warren Buffett.
What regulators are supposed to do, ideally, is not pick trades but rather set up systems to prevent bad trades from having ruinous systemic effects, and a major method of doing so is capital regulation. JPMorgan lost $5.8 billion on whale-failing, and if you or I lost $5.8 billion we would probably be scaling back our vacation plans, but Jamie Dimon isn’t because JPMorgan had lots and lots more money where that came from. Capital!, in both senses of that exclamation.
Volcker Rule Would Have Required JPMorgan Whale To Look Himself In The Mirror And Ask “Is This Really What I Want To Do With My Life?”By Matt Levine
It looks like London Whale Bruno Iksil is currently vacationing in a quantum state between fired and not-fired, which I suspect is relatively pleasant compared to, like, trading credit indices, and his immediate supervisors have all moved on to bluer oceans. But layers and layers of people above them continue to have to tug at their collars and worry about the whole why-didn’t-we-stop-his-whaling-and-what-does-it-mean-for-our-jobs thing. Jamie Dimon has done a certain amount of that, but today the regulators in charge of JPMorgan got ther chance to do some collar-tugging in front of the Senate. Let’s just assume that was enlightening.
This is shaping up to be CFA week for me, and with my impending triumph/humiliation I’ve pretty much stopped thinking about much else. I’ve also stopped reading about much else, putting aside Trotsky temporarily to focus on those six stupid books. Yesterday was corporate finance – I can now unlever and relever betas like a champ – and portfolio management, which I got about halfway through before falling asleep. Today is equity and fixed income. The end is in sight!
But there’s still occasionally time to think about blast-from-the-past favorite topics, like the slow-motion disaster that is the US regulatory effort to end official reliance on ratings agencies. The latest is the OCC, which released a proposed rule today that will change the definition of “investment grade” securities, which banks can invest in, from “rated in one of the four highest rating categories by two or more NRSROs” to this: Read more »