Tuesday, October 15, 2013

Feds Continue To Pick the Pockets of JPM Shareholders

Going back to JP Morgan's own internal report on the "London Whale," everything is there for an interested party to see. The need to fix the way JPM goes about its businesses was lost in a referendum on CEO Jamie Dimon keeping his Chairman of the Board position. Now as the Feds grab another $11 billion from the shareholders, it is once again open season on a celebrity bank CEO.  This is ridiculous and more befitting a reality television show than talking about the management of one of our largest banks.

Let's try to put some things in context.
Over the past five years, eyeballing raw charts from Schwab, JP Morgan's stock is up about 30%, which looks slightly better than Wells Fargo's rise of about 23%.  The big losers are Bank of America (-40%) and Citigroup (-70%).  Here's what Andew Ross Sorkin wrote in the print edition of the New York Times,
"When I called Dennis Kelleher, president of Better Markets, a nonprofit Wall Street watchdog (he was playing golf when I reached him), he put it this way: "By any objective measure, Jamie Dimon should be fired. The compliance failures are egregious and systemic."   
What objective measures are those?  Everyone of the big four banks are digging out from under the mortgage mess, and if WFC is now considered a darling of the sector, JPM's performance has been on a par or better.  This is a ridiculous suggestion, and shareholders see it differently.
However, the age old question about having a global investment bank together with a global commercial bank and a global asset manager is an appropriate question to ask.  Not necessarily because of "systemic risk," since nobody can really define what this means, but because the cultures of these businesses are distinctly different and they are operationally impossible to manage effectively together.  [on the issue of not being able to define systemic risk, see NBER  working paper 185 (2012) from Nobel Laureate economist Lars Peter Hansen].   The London Whale report makes it clear that layers of executives and multiple complex regulatory schemes cannot inoculate shareholders from outsize trading losses.  It's happened in the past, from the beginning of mortgage backed asset trading, and it will happen again in some market.

What's to be done?  Split up commercial banking and investment banking, at a minimum.  However, the Volcker Rule is eons from implementation, so this is tilting at windmills.  It is interesting to note that Warren Buffett likes commercial banking and asset management, and he owns both these businesses through his investment in Wells Fargo.  He also likes global investment banking because of his investment in Goldman Sachs.  He could have bought a financial supermarket through Citigroup, Bank of America, or JP Morgan Chase, but he didn't.  Instead, he bought what he regarded as best in breed for each business in the public market.  JP Morgan's board should think about this, after all there's always something to be learned from Mr. Buffett's investment behavior.

For JP Morgan shareholders, they should think about a few things:

  • Strengthening the board and making it more than a rubber stamp.  Bring some people in to help in the real areas of weakness, like risk management. Comments about the board's failure to monitor their own systems of internal control and to align compensations structures with governance are right on the money.  What's in place for a company of this size and complexity has been shown to be woefully inadequate. 
  • Think about the continuing legal settlements and the implications for future liability.  $11 billion for acquired mortgages in a shotgun acquisition at the behest of the Feds themselves?  How could the board have signed off on this?   Bank of America CEO Brian Moynihan seems to have a better handle on managing this issue than does JP Morgan; have a board member give him a call and compare notes. 
  • Look at the whole mortgage business itself.  The originate-to-distribute model and the structure of MBS deals needs to be reset.  Wells Fargo seems to be tuning down its mortgage engine.  The servicers effectively hung their clients out to dry and have escaped unfazed.  Does the board understand how this business operates?  
  • Assign a team from the CFO's office to help the board manage the legal bills.  An $8 billion quarterly bill?  I used a blended bill rate of $1,000 an hour, assumed minimal sleep for all, and the number of people involved in a quarter is nonsensical.  Next time, admit nothing, put up no resistance, and offer to pay $8 billion on the spot; you're $3 billion to the better and the Feds are better off, since their costs are largely fixed. 
  • Pick a lead director to interact with the CEO on a weekly basis.  This is to make sure that he has someone to talk to besides his self-interested lieutenants, who clearly let him down during the trading crisis.
  • Think about a different corporate structure, portfolio and business model for JPM.  Value is being destroyed on a large scale with the current model. 

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