Dimon's gambit

Dimon's gambit
By Henry C K Liu

In an interview on PBS NewsHour, US Treasury Secretary Tim Geithner commented on JPMorgan Chase chairman, president and chief utive Jamie Dimon's conduct regarding the bank's recent investment loss, and used the "diplomatic language of Treasury communications" to tell Dimon to resign from the New York Federal Reserve Board.

Dimon as head of one of the nation's largest banks should resign from the Federal Reserve Board, but not because JPMorgan lost  $3 billion and counting in CDS (credit default swaps) positions.

As I pointed out last week (JPMorgan not so dumb, Asia Times Online, May 18, 2012, and Top Wonks website), the Federal Reserve itself, together with the Treasury, created regulatory rules that not only permit but invite banks to take on CDS to reduce their capital requirements as derived from the amount of risk exposure, allowing banks to show bank regulators that much of their risk exposure has been hedged with CDS so that banks can lend five times more loans from the reduced capital level than would be permitted without CDS hedging.

Dimon should resign from the Fed Board for another reason: it is a fragrant conflict of interest to have the head of a regulated financial institution sit on the board of the Fed, the bank's regulator.

The bottom line is that JPMorgan made money to the tune of $4 billion net in the same quarter that it lost $2 billion from credit derivative positions because its risky CDS positions allowed JPMorgan to make larger profit from more lending to more than cover the loss from the same CDS position. That is how risk hedging becomes a profit center for banks. Dimon would love to have the derivative play make profit as well as icing on the cake, but even without the icing, the cake is very good.

Dimon elects to take off-target criticism by pretending that the CDS play was a sloppy mistake. He does this to divert attention from the real problem, which is the structural regulatory regime that allows banks to make high profit by avoiding high capital requirements as a percentage of its risk exposure. Dimon's mea culpa strategy is aimed at preventing the enforcement of the Volcker Rule to restrict banking from trading.

The fact remains that:
1. The $3 billion lost by JPMorgan did not vanish into thin air. It stayed in the financial system, going from JPMorgan into the pockets of hedge funds; and
2. The guilty parties are not the banks that play by the rules set by the regulators. The guilty parties are the regulators, that is, the Federal Reserve and the US Treasury.

Thus Geithner once more is merely grandstanding, this time at the expense of Dimon, who will recover as a hero when shareholders begin to understand the actual facts behind the multi-billion dollar loss. The loss was really an investment to facilitate high profit from bank loans.

There are a lot of things wrong with our banking system and its regulatory regime. But forcing Dimon to resign from the Fed Board obscures the real issues.

Henry C K Liu is chairman of a New York-based private investment group. His website is at www.henryckliu.com