Breakingviews

Too big to fail anxiety fuels Jamie Dimon circus

By Agnes T. Crane 

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

One thing binds the politicians, pundits, protesters and investors outraged by JPMorgan’s loss of some $2 billion on dodgy trades. None of them believes that U.S. taxpayers are really off the hook for Wall Street’s future, and probable, failures. The real loser of the debate – which today saw the CEO of a well-capitalized, profitable private financial institution hauled before the Senate – is the Dodd-Frank Act.

First, the loss – though painfully embarrassing for a bank that prides itself on risk management – still pales against the $5.4 billion earned last quarter and the $4 billion expected for this one, according to consensus estimates compiled by Thomson Reuters.

Yet, ever since Jamie Dimon told the world about the boneheaded trades in May, JPMorgan has become the focal point for frustration and anger among those who believe the United States wasted a financial crisis by keeping alive the notion that certain banks are too important to let fail. On Wednesday, protesters started calling Dimon a crook at a Senate Banking Committee hearing before he could even tell lawmakers how the bank stumbled.

Calls for a modern-day Glass-Steagall Act – the Depression-era legislation that kept commercial and investment banking separate – have grown louder as many across the political spectrum say the landmark financial reform passed two years ago has made matters worse. Complicated rulemaking such as the Volcker Rule is unwieldy and calling big banks systemically important reinforces the belief that the government still implicitly backs Wall Street.

Sure, regulators now have the explicit ability to wind down big, complicated financial institutions, but it’s untested. And if JPMorgan is too big to manage, what makes anyone think the government can break it or other large banks up, if need be, without sending shock waves through the financial system?

UK banks’ euro zone firewall needs government help

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

UK banks’ euro zone firewall needs strengthening. Despite a range of support measures introduced after the 2008 financial crisis, the Bank of England’s arsenal for managing a pan-European liquidity freeze looks underpowered when compared with the European Central Bank’s three-year loans. But if the euro zone cracks, UK lenders would be better off turning to the government for support.

The BoE has three conventional liquidity support mechanisms. Banks can borrow against liquid collateral for up to six months via its Indexed Long-Term Repo (ILTR) auctions. More troubled banks can swap illiquid collateral for gilts for up to a year through the Discount Window Facility (DWF). And, since late last year, lenders have been able to use the Extended Collateral Term Repo facility (ECTR), which uses an auction system that allows banks to pledge ropier collateral, albeit for a higher fee.

The ECTR is the nearest British rival to the ECB’s longer-term refinancing operation (LTRO), under which euro zone banks have so far borrowed 1 trillion euros. But there are two big differences. First, UK banks can only borrow from the ECTR for 30 days, while the LTRO runs for three years. Second, unlike the ECTR, the LTRO is unlimited. If a Greek euro exit caused the market for bank debt to freeze, UK banks would be at a significant disadvantage.

But that doesn’t mean the BoE should rush to mimic the ECB. Long-term liquidity facilities encumber large chunks of banks’ balance sheets, making unsecured bank lending less attractive. Moreover, central banks are only supposed to field liquidity shocks, not long-term funding freezes.

Fortunately, the UK has an option not available to most euro zone lenders: government support. When the market froze in 2008, the UK Treasury’s Credit Guarantee Scheme provided 250 billion pounds worth of multi-year guarantees on bank debt, almost all of which has been repaid. A new CGS would help to prevent a credit crunch while preserving the BoE’s integrity and taking advantage of the UK’s historically low bond yields.

Citi looks too accident-prone to make it to 300

By Martin Hutchinson

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Happy 200th birthday Citigroup – shame you are unlikely to make it to 300. At the very least, it’s hard to envision the accident-prone New York bank will make it to 2112. Founded in 1812 as the City Bank of New York, Citi’s first century was more successful than the second. By 1912 Citi was the largest U.S. bank with worldwide operations, a top-three underwriting business and one near-death experience, in 1837. Since then it’s had several costly expansions and four more near-fatalities.

At its founding, Citi was a blue-chip operation; its first president, Samuel Osgood, had been in President George Washington’s cabinet, and its money came from former sponsors of the shuttered first Bank of the United States. The bank’s first century saw only one major hiccup, when it suspended specie payments on May 10, 1837, but was bailed out by John Jacob Astor, who installed his protégé Moses Taylor as director. Taylor ran the bank from 1856 to 1882 as the financial services arm of his iron, coal and railroad business empire.

James Stillman, who bought effective control of the bank in 1891, was as rich as Taylor, but with an international reach, having financed the 1876 coup that installed Porfirio Diaz as president of Mexico. By 1912 the bank was America’s largest, and was referred to in the “Money Trust” hearings of 1913 as one of its three leading issuing houses. Only foreign branches were lacking – illegal until the 1913 Federal Reserve Act.

But Citi’s second century has been marred by too many near-death experiences to assure it makes it to 300 intact. It flirted with insolvency in 1920 after Cuban sugar loans went sour. Then “Sunshine Charlie” Mitchell, its 1920s-era president, was prosecuted for tax evasion; describing his role in the 1929 financial crisis, Senator Carter Glass said: “Mitchell more than any 50 men is responsible for this stock crash.”

During the Great Depression Citi’s stock par value was cut by 40 percent and it was bailed out by the Reconstruction Finance Corporation. Then, after another exuberant burst of international expansion in 1959-1980, during which chairman Walter Wriston claimed “countries don’t go bust” it was bailed out in 1991 by Prince Al-Waleed bin Talal. In 2008, losses in the U.S. mortgage market necessitated another rescue, this time by U.S. taxpayers.

California shows way through tricky pension mess

By Agnes T. Crane

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

San Jose and San Diego want current public workers to make sacrifices for their pensions, like contributing up to 16 percent more of salaries to fund retirement schemes. The proposals, overwhelmingly backed by voters in elections this week, look to be a sensible way forward in the thorny thicket of pension reform.

Since the downturn, new hires have borne the brunt of belt-tightening in the nation’s public sector. They, not their elder cubicle mates, have had to swallow diminished expectations for their golden years. This unfair two-tier system is likely to further discourage the young and talented from considering a career in the civil service. In addition, such marginal reform won’t be enough over the long term to fill a $700 billion shortfall in America’s public pension system. A better approach is burden sharing – something San Jose and San Diego are trying to push through.

Their proposals, though different in form, both demand sacrifices from those already on each city’s payroll, and voters agree. San Jose won 70 percent for its measures, while San Diego got the backing of two-thirds of the electorate. The southern California city wants to freeze salaries for five years in a bid to slim future liabilities.

Silicon Valley’s Anchor City, meanwhile, is pushing for something more interesting. It hopes to encourage, but not force, workers to opt for what could be a cheaper, less generous, benefit scheme. If employees want to hold onto current benefits – like retiring by 55 – they’ll have set aside up to 16 percent of their salary for pension contributions. If everyone took that option, the city could save $25 million a year – potentially reducing the city’s own payout by around 10 percent. Alternatively, employees could keep their pension contributions as they are and instead help the city save money by accepting reduced perks like halving standard-of-living adjustments and not retiring until they turn 62.

None of the options, however, is pleasant for workers. Unions have already filed suits to contest the proposal in San Jose. Yet such burden sharing looks inevitable. Historically, markets have done the heavy lifting for pension funds. Beefy 8 percent annual investment gains, however, look increasingly unrealistic. Many state and local government budgets, meanwhile, are already stretched to the breaking point. That leaves employees, who have traditionally contributed the least, to step up if they hope to have any pension at all. Better to try to find a solution now than wait until it’s too late.

BofA reject wins Fannie Mae booby prize

By Daniel Indiviglio and Agnes T. Crane The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

No good deed goes unpunished. Fannie Mae has chosen Timothy Mayopoulos, its general counsel, as its new chief executive. His promotion won’t improve already tense relations with Bank of America – the mega-bank fired him in 2008 after he questioned mounting losses. But his integrity and background make him a decent fit for the job.

As the top lawyer at BofA during the crisis, he counseled executives they didn’t need to disclose Merrill’s mortgage-related losses if they didn’t creep too high. But as Greg Farrell points out in his book “Crash of the Titans,” new estimates just days after shareholders had approved taking over the Thundering Herd “had busted through the outer limit of what Mayopoulos had been using as his guideline.” A day after trying to raise it with BofA’s finance chief, he was fired.

Running the mortgage zombie could make for some awkward conversations with his old firm. While Fannie’s general counsel, Mayopoulos recused himself from dealing with a long-running spat over who should take the hit on faulty mortgages BofA had sold to the agency. But as chief he may now have to deal directly with Brian Moynihan, who briefly replaced him before being put in charge of the investment bank and, ultimately, all of BofA.

He’s also taking a $2 million pay cut to move to Fannie’s corner office. That’s a rare and humble step in the world of finance and a welcome attribute in an organization like Fannie Mae better known for accounting shenanigans, eye-popping CEO pay and now a $116 billion bailout tab.

A hard-nosed, principled lawyer is just the kind of leader Fannie needs. Mayopoulos’s in-depth knowledge of corporate and contract law should serve the agency well, as clawing back money from lenders who sold it dodgy mortgages will remain a priority. That surely beats having a more traditional business leader – Fannie’s role in financing mortgages is, after all, slated to diminish.

It’s a good fit for Mayopoulos, too. With New York Attorney General Andrew Cuomo immortalizing him by claiming BofA bumped him as “the man who knew too much,” getting another job on Wall Street might be hard. Running the Fannie briar patch looks a good fit for both of them.

Pricey Chesapeake medicine highlights its sickness

By Christopher Swann and Robert Cyran

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Pricey medicine can help. But in Chesapeake Energy’s case, it shows how sick the company is. The embattled energy firm is borrowing $3 billion at 8.5 percent to repay a loan whose terms might otherwise prevent asset sales. This buys time. But it makes even more obvious Chesapeake’s unsustainable reliance on selling assets to fund its persistent cash drain.

Chesapeake, America’s second-largest natural gas producer, has been cash-flow negative for a decade. Fitch Ratings reckons it faces a $10 billion shortfall this year. Aubrey McClendon, the chief executive now beset by questions over financial conflicts of interest, recently sounded characteristically confident that the gap could be bridged by asset sales. The company is targeting up to $14 billion of them this year.

But the firm’s quarterly filing with regulators on Friday – curiously delayed – painted a less optimistic picture. Chesapeake said it might have to delay and rejig asset sales to avoid flogging off assets needed as collateral or cutting cash flow below the level required by its debt covenants. The shares slumped 14 percent, and have lost about half their value in the past year.

The main stumbling block appeared to be the firm’s $4 billion revolving credit facility. The new, much more expensive loan from Goldman Sachs and Jefferies unveiled later on Friday will repay that, easing concerns that a cash flow squeeze could force more asset sales only to have lenders demand repayment, creating a fresh cash deficit.

But it’s a temporary reprieve. Chesapeake still needs to reduce its debt and wring more dollars from its wells. Selling choice oil assets while gas properties suffer with ultra-low prices only whittles away further at the company’s long-term earning power.

Dimonfreude is irresistible, but may be dangerous

By Rob Cox

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

It’s easy to sympathize with the collective glee that greeted JPMorgan’s shock revelation of some $2 billion of trading losses. The bank and its chief executive Jamie Dimon have received their long-awaited comeuppance. But this emotion – Dimonfreude, if you will – is dangerous. If one of the few big banks that managed to sidestep most of the credit crisis is proven fallible, confidence in the system itself will be shaken.

Dimon and JPMorgan deserve a good knocking, to be sure. After all, this is the firm widely credited, if somewhat unfairly, with hammering the final nail into the coffins of not just Bear Stearns – which it bought for a pittance in 2008 – but also of Lehman Brothers and later MF Global, mainly through collateral calls. Rivals on Wall Street and in financial centres across the world may take some satisfaction from seeing JPMorgan stumble.

And Dimon has not taken kindly to the march of new regulation of the financial industry. He has called tough capital standards proposed by the Basel Committee “anti-American.” A little over a year ago he publicly carpeted Ben Bernanke over whether the Fed had properly analyzed the costs and benefits of the Dodd-Frank Act. Regulators everywhere may find succor in JPMorgan’s failed whaling voyage.

All this may prove salutary if it serves as a reminder to Dimon and his managers that they, too, are human, and like all humans prone to err. As a consequence, the bank should toughen up its controls, take its lumps, stamp down its rhetoric and conduct a more rigorous and honest appraisal of its businesses. It might even soften Dimon’s stance on accepting new capital standards, and perhaps lead to some comity with regulators over interpreting and implementing admittedly complicated rules like the one named after Paul Volcker.

By all means, those who have been on the receiving end of JPMorgan’s arrogance or flexing of financial power – be they rivals, regulators, politicians, customers or even journalists – may savor this moment. But they must be careful what they wish for. A swift but humbling lesson in fallibility would do some good. A prolonged loss of confidence in the financial system could bring back some pretty dark days.

Jamie Dimon’s Ahab meets his Moby Dick

By Antony Currie

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

JPMorgan’s Ahab has met his Moby Dick. Chief Executive Jamie Dimon has toiled at length to build a bank strong enough to withstand the greatest of storms. The $2 billion hedging hit the bank disclosed late on Thursday will put JPMorgan to the test. Its capital buffers may be safe for now, but the ramifications are apt to be broader.

The losses come from the bank’s chief investment office. That’s part of the core treasury function at JPMorgan, responsible for managing the entire firm’s balance sheet. That it was being “poorly monitored,” as Dimon conceded, is even more worrying than the discovery of a random rogue trader.

The CIO has made news of late because of reports that one of its overseas traders, Bruno Iksil, was taking such large positions in a credit index to hedge JPMorgan’s risk that he was distorting the market. Rivals labeled him the London whale. Dimon declined to discuss specifics.

But just last month, on the bank’s first-quarter earnings call, executives defended the CIO. Finance chief Doug Braunstein said the bank was “very comfortable” with its positions. Now, Dimon admits a revised hedging strategy was “flawed,” there was “sloppiness” and that “egregious mistakes” were made.

Investors have come to expect such disarming honesty from Dimon. But the mess is reminiscent of similar failings at JPMorgan before his time. In fall 2001, the bank was adamant that its overall exposure to Enron was around $900 million, before later revealing the amount was almost triple that figure. A year later, executives hosted an emergency call with investors – like the one hastily assembled on Thursday afternoon – to announce that all its trading desks had lost money even though all had remained within their risk limits.

U.S. mortgage lessons lost in student debt policy

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The lessons of the U.S. mortgage crisis seem to be lost on policymakers tackling student debt. A decade ago, government subsidies and guarantees helped expand the “dream” of homeownership to many Americans who would have been better off renting. Today, it’s college education being made more accessible with cheap funding provided by Uncle Sam.

The U.S. Congress, which rarely agrees on anything these days, is achieving quick consensus on the matter. Without action, interest rates on student loans, which are unsecured, are set to double in July. But lawmakers have been scrambling all April to find a way to collect more revenue or cut spending to maintain subsidies and keep the rates down.

The effort is all too familiar. Government mortgage guarantees, accompanied by encouragement to make the American Dream available to lower income and less creditworthy borrowers, sent home prices soaring at an inflation-adjusted annual rate of 8 percent over the decade ending when they peaked in late 2006, according to Yale economist Robert Shiller, whose name adorns a closely watched home price index.

The price of college has been growing near that rate for even longer, according to College Board data. Over the past 30 years, private nonprofit college tuition and fees, after adjusting for inflation, have increased 6 percent annually. Public university prices have grown at 9 percent.

Like homeownership, college education has been exploited as a moral good. Anyone aspiring to earn decent wages needs a degree these days. Even jobs that haven’t traditionally required such academic training, like police work, now do. This shift has pushed the average student loan balance up by 25 percent annually over the last decade, according to finaid.org. These debts now exceed $1 trillion, more than even enthusiastic U.S. consumers have accumulated on their credit cards.

Ultra-cheap loans too often encourage young adults to start their working lives with excessive debt. And it’s the federal guarantees that prime the pump. To curb the unsustainable growth in higher education costs requires scaling back the government’s involvement. There’s still some time to keep student debt from turning into a mortgage-like crisis, but probably not much.

The rupee looks vulnerable

By Jeff Glekin The author is a Reuters Breakingviews columnist. The opinions expressed are his own. India’s ballooning trade deficit means it has to run just to stand still. Without steady capital inflows, the currency will collapse. But without a steady currency, it is hard to attract foreign capital. The rupee’s 19 percent fall against the dollar over the past year is worrying.

During most of the last decade, the current account deficit has been funded without great difficulty. Foreign direct investment, portfolio investments and about $60 billion a year of remittances have usually exceeded the shortfall in trade. India has accumulated around $300 billion of foreign currency reserves, equivalent to 17 percent of GDP.

But the annual trade gap has widened from $104 billion to $185 billion. At 3.7 percent of GDP, the current account deficit is the highest since 1980, when the International Monetary Fund starting collecting data. High energy prices are the main culprit for the recent deterioration – oil accounts for two-thirds of the country’s import bill. Of course, the blow would have been less painful if India had a stronger export sector.

The support of foreign investors is more necessary than ever, but New Delhi’s mismanagement has discouraged them. Foreigners bought an average of $3 billion dollars a month of Indian debt and equities in the first three months of 2012, according to the Securities and Exchange Board of India’s website. So far in April, they have been net sellers of $403 million.

The currency’s fall threatens to create a negative spiral. More expensive imports are inflationary and put pressure on corporate profits. Government subsidies of domestic fuel prices become more costly, adding to the fiscal deficit, which swelled to 5.9 percent of GDP in the fiscal year that ended in March. Furthermore, the rupee’s slide creates financial stress for Indian companies that have borrowed in dollars.

India’s currency reserves provide a buffer. But if capital flows turn sharply negative the reserves could melt away quickly. And if investors start to believe that the rupee is a one-way downwards bet, they will race for the exit. Predictions of a declining currency – UBS suggested a further 6 percent fall last week – could prove self-fulfilling.