JPMorgan Chase and U.S. Regulators: Who’s Holding the Leash?

In 2008, we saw the cost of banks doing business as they pleased—and it was expensive—for taxpayers, anyway. For JPMorgan Chase, the 2008 financial crisis was more of a benefit than a cost.

JPMorgan Chase was the third largest U.S. bank in 2007, owning about 70% in assets of what the largest U.S. bank—Citigroup—had at the time. Today, JPMorgan Chase is the largest U.S. bank, holding $2.74 trillion in assets, a whopping 75% increase since 2007.

How the financial crisis and the Fed gave JPMorgan a leg up

When the 2008 financial crisis hit, the Federal Reserve gave JPMorgan Chase a special gift basket:

  • $391 billion of the $4 trillion in emergency Fed funds while using JPMorgan Chase as clearinghouse for emergency lending programs
  • $29 billion in financing to acquire Bear Stearns
  • Taking risky mortgage-related assets off of Bear Stearns balance sheet before the acquisition
  • An 18-month exemption from risk-based leverage and capital requirements

At the same time, JPMorgan Chase’s CEO Jamie Dimon was a Federal Reserve board member.

Coincidence? The non-partisan investigative arm of Congress, the Government Accountability Office (GAO), didn’t think so. The GAO’s 2011 study found that electing members of the banking industry to the Fed’s board of directors created, “an appearance of a conflict of interest” and “reputational risks” for the Fed.

Dimon wasn’t the only highlight of the study. For instance, Stephen Friedman was the chairman of the NY Fed’s board of directors and sat on the Goldman Sachs board in 2008. During that time, Goldman Sachs got approved for cheap Federal Reserve loans, owned Goldman Sachs stock—a blatant violation of Fed regulations—and received a conflict of interest waiver from the Fed, unbeknownst to the public at the time. 

Is the Fed policing banks or enabling them?

Among other central banking tasks, the Fed was made to moderate the economy, supervise banks, and protect consumers.

The Fed acted like a nurse to the financial markets when it needed it, injecting liquidity and adjusting interest rates as needed. From the 1987 stock market crash to the Gulf War to Y2K, the Fed was always there to help banks and investors when they needed it.

Eventually, investors began displaying moral hazard—exposing themselves to more risk because they know they’re insured. Why should banks be so careful if the Fed will be there to pick up the pieces? Especially when Glass-Steagall was repealed in 1999, the act that kept commercial and investment banking separate, protecting consumers’ deposits from risky bets.

Cue the 2008 financial crisis and the Great Recession. While the Fed was being pat on the back for how it handled the fallout, others criticized the Fed for “privatizing profits and socializing losses.”

The Dodd-Frank Wall Street Reform and Consumer Protection Act, a.k.a. Dodd-Frank, was made in response to the crisis. It increased reserve requirements, tightened derivatives regulations, and created the Consumer Financial Protection Bureau.

Importantly, Dodd-Frank included the “Volcker Rule,” restricting commercial banks from certain risky activities, like hedge funds and private equity funds. The Volcker Rule is a sort of modern Glass-Steagall, protecting consumers’ money from high-risk trades.

So where are we now? Did Dodd-Frank and the Volcker Rule work?

JPMorgan Chase and the London Whale

While Dodd-Frank was enacted in 2010, it was enacted with a lot of fill-in-the-blanks for regulators, including the Volcker Rule. Before the Volcker Rule was finalized three years later in 2013 (and finally implemented in 2015), JPMorgan Chase took one last bet—and lost.

In 2012, federally-insured JPMorgan Chase lost $6.2 billion from gambling with high-risk derivatives in London—the exact kind of situation the Volcker Rule seeks to avoid. The huge trading loss, nicknamed after a trader known as the London Whale, led to a senate probe calling for a tougher Volcker Rule. Only a few months prior, Dimon called the Volcker Rule, “unnecessary.”

Banking scandals: who takes the fall?

While the $6.2 billion London Whale trading loss led to the London unit’s CIO stepping down, Dimon remained CEO of JPMorgan Chase. Dimon’s pay dropped from $23 million to $11.5 million, and JPMorgan Chase was fined $920 million in fines.

This stands in contrast to Wells Fargo’s three CEOs in three years in the wake of their large scandals. Wells Fargo’s account fraud scandal cost them $185 million in fines, which pales in comparison to JPMorgan Chase’s $920 million in penalties from the London Whale fiasco.

Jamie Dimon: oblivious CEO or untouchable crime boss?

JPMorgan Chase’s CEO Jamie Dimon didn’t only keep his throne through the 2008 financial crisis and the London Whale losses.

Dimon remains uniquely unscathed after JPMorgan Chase pleaded guilty to three criminal felonies and racketeering under the RICO statute; the latter is typically reserved for prosecuting organized crime, such as the Gambino crime family.

Is the use of RICO to prosecute three traders at JPMorgan Chase for a precious metals criminal enterprise in 2019 a sign that the U.S. is stepping up its game? Or is it the opposite—the most remarkable display of just how untouchable Jamie Dimon is? The Motley Fool might have been on to something when they joked that, “Jamie Dimon is practically an institution by now.”

Besides the forex scandal felony, JPMorgan’s two other felonies were for money laundering as part of the Bernie Madoff Ponzi scheme. Senator Carl Levin of the Congressional probe into the case said that JPMorgan had, “piled on risk, hid losses, disregarded risk limits, manipulated risk models, dodged oversight, and misinformed the public.”

While the bank admitted fault and was put on a three-year probation with $2 billion in fines, “no individual was charged at the bank.” JPMorgan Chase was given a deferred prosecution agreement, which means the prosecutor granted amnesty to the bank in exchange for it agreeing to fulfill certain requirements.

Jamie Dimon’s tenure as CEO at JPMorgan Chase is an anomaly. To date, no other bank’s CEO has remained CEO through three guilty-plea felonies, let alone through a RICO statute.

Big bank lawsuits and felonies: the cost of doing business

From consumer protection violation and toxic securities abuses to bribery and even energy market manipulation, JPMorgan Chase is used to violating the law—and they’re not alone.

One violation tracker estimates JPMorgan Chase has racked up around $34.5 billion for 135 penalties since 2000, as of this writing. Taking the silver as the second-largest bank in the U.S., Bank of America steals the show with $82.6 billion for 182 penalties over the same time period. Citigroup and Wells Fargo—the third and fourth largest U.S. banks—paid $25 billion for 97 penalties and $17.3 billion for 136 penalties, respectively. 

It’s clear that penalty fines are a regular cost of doing business for America’s big banks.

Nowhere is this more transparent than the 2015 forex scandal involving JPMorgan Chase, Citigroup, Barclays, and other banks. They were charged with a felony for rigging foreign currency trading for at least a decade.

Chatrooms among senior-level investors had colorful names including, The Cartel, The Bandits’ Club, and The Mafia. One Barclays vice president involved in the forex scandal wrote in an online chatroom, “if you aint cheating, you aint trying.”

This quote, along with the regular law-breaking and settlement payments, signals the need to cheat in order to compete. Like with competitive athletes, those who cheat have a competitive advantage. If most everyone is cheating, those who aren’t will lose.

For big banks, repeated violations of the law implies that the benefit of cheating outweighs the cost of getting caught. That means that Dodd-Frank’s Consumer Financial Protection Bureau and other regulatory agencies are better at collecting fines than they are at deterring criminal activity.

JPMorgan Chase is pushing the envelope

While the Volcker Rule might limit the money big banks have to play with these days, JPMorgan Chase has been making some eyebrow-raising big changes in the last year.

Obscuring liquidity

Dodd-Frank requires banks to have a high enough Liquidity Coverage Ratio. The idea is that banks should have enough cash on hand—or other “high-quality liquid assets”—to stay afloat on their own in case financial markets go south. That way, the Fed wouldn’t have to step in to pick up the pieces as they’ve historically done, using taxpayer money to pay for risky bets that big banks lost.

JPMorgan Chase fulfilled most of its Liquidity Coverage Ratio with cash deposited at the Fed until recently. It took out $145 billion from the Fed from September 2018 to September 2019, leaving $199.8 billion there.

To keep on fulfilling its Liquidity Coverage Ratio, it bought things like “U.S. Treasuries” and “sovereign bonds.” Ex-Wall Street bankers Pam Martens and Russ Martens of Wall Street on Parade note that, “none of these securities are as liquid as cash and without knowing the foreign countries associated with these “sovereign bonds” it is impossible to say just how liquid they are.”

Increasing risk

Over the same year that JPMorgan was trickling cash out of the Fed, it increased its off-balance-sheet exposures from $6 billion to $687 billion by increasing trading assets and decreasing its loans. 

Data collected by the Federal Reserve for regulators shows that JPMorgan Chase is the riskiest bank of its peers in seven out of twelve financial metrics. Its “intra-financial liabilities”—risk it has sitting at other banks—is more than $100 billion larger than the next two banks on the list.

Even more concerning is the $45.2 trillion JPMorgan Chase has in “over-the-counter (OTC) derivatives,” with Citi and Goldman Sachs not far behind. Risky derivatives are what brought down AIG in 2008, an insurance company who was underwater in Wall Street derivatives. It was so bad that the Fed even lent them money, even though AIG was an insurance company, not a bank.

The most concerning is JPMorgan’s “payments” it was responsible for, which is nearly double that of the next bank on the payments list.

Spreading QE unwind fear and economic cheer?

One of the many tools the Fed used to help revive markets after the 2008 financial markets was quantitative easing or QE. QE is an unconventional strategy where the central bank buys a lot of bonds back from the market. This results in a higher money supply and low interest rates, encouraging lending and investing.

In September 2018, the Fed announced that it would begin to unwind its QE program. Since the economy is doing relatively well and unemployment is down, it’s no surprise the Fed would stop artificially propping up the economy with liquidity. With a potential recession looming on the horizon, it makes sense for the Fed to unwind QE so that they can redeploy the strategy when it is really needed again, like it was in 2008.

In June 2019, Dimon was one voice among many that warned of the potential consequences of the QE reversal. What’s notable is that Dimon, unlike others, simultaneously expressed both worry over the QE rollback and a positive market outlook. Other prominent financial figures worried about QE are also worried about a major stock market pullback.

A dubious look ahead

JPMorgan Chase, the largest U.S. bank, has spent the last year obscuring its required liquidity reserves, increasing risk, and sending mixed messages. Are they preparing for the next recession while wearing an ‘everything’s fine’ face for shareholders? Or are they up to something else altogether? 

Time will tell, but so far, it looks like business as usual: trillions in risky bets, billions in criminal penalties, and everyone waiting for the other shoe to drop. It’s looking very possible that despite Dodd-Frank, the lawsuits, and the felonies, our next recession could be the usual Fed bailout of big banks on the taxpayers’ dime.

As long as the U.S. government lets breaking the law outweigh the cost of getting caught, big banks and their CEOs will continue to do as they please.