JP Morgan Chase’s Mysterious $13B Payment

Community bankers could be expected to rejoice at the news of JP Morgan Chase’s agreement to pay $13B in “settlements” to various federal and state agencies. None of this is good news. This strange transaction is another tightening of the toxic embrace between the TBTF banks and the regulatory agencies who sponsor, nurture, regulate and favor these banks. Big government needs big banks. TBTF institutions are no longer merely integral to the Keynesian myth of government sponsored prosperity; they have now become a material revenue source to an unaccountable collection of state and federal employees. Many political and regulatory career legends are being spawned in this groundbreaking transaction. I have no doubt that the public employee architects of this transaction will ultimately cash in by becoming become employees of the TBTF financial institutions or, better yet, high paid “independent” consultants who offer “protection” from regulatory trouble. Referring to this as a political shakedown is not mere rhetoric. The public should insist on knowing what this money is paid for and where it is going.  There have been vague references to $4B going to the “victims” of this murky malfeasance, but how can we identify victims of unprosecuted crimes? This is horrible public policy at many different levels. The TBTF institutions are a real cancer in the economic body. This transaction exploits public fear and anger and will actually accelerate the growth of the tumor. Who would want to solve such a profitable problem?

I offer these comments from the standpoint of a banker who competes with these institutions and operates within the same regulatory framework.

1. The matters in question range from predatory mortgage origination practices, selling fraudulent mortgage investments to the losses associated with the bungled investment strategy known as the London Whale. While all of these things are bad, it is not clear that these were violations of laws or regulations in place at the time of the activities. Instead of actually investigating and punishing illegal activities, it appears the US Army’s notoriously ineffective “don’t ask don’t tell” policy has simply been redeployed to the financial sector. Allegations are made and a settlement arrived at, but there are no clear conclusions that victims or other financial institutions can draw from the events. If there is a discernable message it is, “don’t tick off powerful government guys and if you are wondering what you can and can’t do they‘ll tell you after you have done something. When they do, don’t argue, just pay enough to quiet things down. If they give subtle or direct input on where they would like institutional resources directed, one is well advised to comply with the spirit of regulatory indications without insisting on clear direction.”

2. The absence of a clear admission of regulatory incompetence in the build-up of the mortgage bubble is the reason why we have no visible chance at coaxing the TBTF genie back into the pre-crash bottle.  A clear assessment of pre-crash regulatory oversight would cause us to question whether more and tougher government oversight is an effective remedy.  We have not seriously confronted the ways that the federal economic and regulatory framework caused and failed to prevent the crisis. As an industry insider, I know that the TBTFs exploited both their customers and the implied public subsidy provided by their systemic importance. I have watched the market share of the 20 largest institutions grow consistently over my 30 years in banking. The growth since 2007 has accelerated.  This isn’t because they are good. It is because centralized political/economic power needs large, subservient institutions. Community banks aren’t losing ground to better bankers, they are in effect competing with the Federal desire to centralize and control financial markets. We are tolerated, but our structural competitive disadvantage is denied or ignored. Sharp community bankers can still thrive, but they have to present a compelling value proposition. They have to get across why the publically subsidized institutions are bad for people.  We can’t just sound like small time losers whining about the refs.

3. There has been a consistent barrage of angry political and regulatory rhetoric directed at the TBTFs. There have even been semi-serious initiatives to unwind the public subsidy shareholders of these institutions enjoy. We know these are not working because the measure of success at reversing this subsidy must be a decline in their share prices. No one is even saying we have a public interest in reducing the equity value of these entities, but that is exactly what removing a public subsidy means. The stock market has clearly been very unimpressed by the aggressive flexing of political vocal muscles. If the purpose of this payment is to teach JP Morgan’s shareholders and board a lesson, clearly the market regards this $13B payment as a minor cost of doing business.

4. We have regular interaction with federal regulatory agencies. We consistently find the people we deal with to be competent, insightful and fair-minded. They come into our institution and do a thorough evaluation of everything we do. I don’t agree with everything they say, but I respect what they are trying to do which is to fairly assess whether we are operating in a safe, sound and compliant manner. Critical to the integrity of the process is the knowledge that they have no financial stake in the outcome. There is no question in my mind that the emerging trend toward harvesting revenue from banks will work its way down the regulatory food chain and corrupt the integrity of the process. I will be looking across the table at people whose career prospects depend on the subtle extraction of revenue.

5.  Jamie Dimon is the most admired and respected banker of our generation. He is a very smart, savvy guy, but above all he understands the political nature of modern finance. He had the drive, the discipline and the foresight to position JP Morgan as the go-to player when the Feds needed someone to help mask their incompetence. If he made any mistake, it was daring to question whether more federal power was the antidote to the crisis that federal policy did so much to foster and so little to diffuse.  He is on a safe glide path to wind down a dazzlingly successful career. The JP Morgan Chase directors will select a successor who is more careful to avoid offending politicians and regulators. They can be secure in the knowledge that their business model of constructive government entanglement remains intact. They have simply negotiated a new and less predictable revenue sharing understanding. Meanwhile Treasury Secretary Tim Geithner is quietly moving to a hedge fund in order to monetize his regulatory contacts and experience. Ben Bernanke will soon find a more tasteful way to accomplish this. Meanwhile, former Treasury Secretary Hank Paulson is still ensconced on his South Carolina Island with his $500 million of tax free gains on Goldman stock sold in 2006 so that he could enter “public service” free from conflicts of interest.
I studied some of Karl Marx’s writings as a part of my training in economic thought.  Thirty-five years ago his prediction that capitalism would consume itself seemed like the dark musings of another mad German intellectual.  Twenty years ago we all celebrated the fall of the Soviet communist empire and saw this as the death of Marxist thought.  I am afraid that today’s policy makers are restoring credibility to Marx’s belief that capitalism would collapse of its own moral corruption.  The right defends the indefensible and the left is blind to the corrupting dynamic of Federal control.

These kind of troubling developments are common to professionals across most industries. A few short years ago the American way of doing business was the model for and envy of the world. Last week I came across an article about the hopelessness of the Afgani civil order where policemen require payment for passing their road blocks. It is amazing that we can still summon moral outrage about corruption in the third world. We barely survived the private sector malfeasance evident in the crash of 2008. The image of corrupt bankers drinking Amaretto from their Gucci loafers seems quant compared with the spectacle of the new federal revenue generating regulators. I can hear tomorrow’s guitar hero regulators practicing their riffs, while in the Washington salons the federal elites and their sponsors negotiate how to divide $13B in spoils. At least when Robin Hood robbed from the rich, he actually gave the money to the poor.