The Tale of a Whale

The precariousness of JP Morgan Chase

The New York tourist sitting next to me with the map of London spread out on his lap asked where he could find the London Whale. Seriously. Unlike the London Eye, I told him, the London Whale was a human being, albeit a metaphorical landmark.

The London-based JP Morgan Chase trader’s nickname derived from his large positions in the credit market, which in the summer of 2012 resulted in the bank declaring a $5.8bn loss. It subsequently faced major fines from both the UK and US regulators for, among other things, its lax supervision and for not “adequately updating” its audit committee on the findings of an internal review, in the words of the Securities and Investment Board (SEC). The bank agreed to around $20 billion in legal settlements in 2013, almost equal to a typical year’s profit, for a range of misdemeanours.

Bereft of its gobbledygook, SEC’s phrase can be translated as “deceitful behaviour.” In other words, culture.

A recent survey highlighted that two thirds of global banks agree that a big part of the financial crisis was due to culture but only one third of banks thought there was anything wrong with their culture (my italics).

Transforming an institution’s culture is a lengthy journey, rather like chasing Moby Dick, the symbolism-laden whale in Nathaniel Hawthorne’s classic book of that name. As well as obvious factors like overhauling compensation, banks need to exercise integrity through sound judgement and rewarding decision-makers who have the guts to say no.

A very sensible suggestion on culture put forward in the Salz Review (an assessment of what went wrong at Barclays Bank pre and post the financial crisis ) was for bankers to spend two years on secondment to the financial regulator and vice versa. It appears to have sunk without a trace, despite the fact that there is a model for how to do it in the Takeover Panel, the UK’s M&A regulator, which regularly hosts top bankers and lawyers who then return to their firms.

Box-ticking is not the way forward. Unfortunately, though, the plethora of rules spewing forth from different regulators, like water from a whale’s blowhole, makes it overwhelmingly necessary. How else can universal banks active in a number of countries deal with the US’s Volcker Rule, the UK’s Vickers, the EU’s Liikanen, let alone Basel III, which appears to already be disintegrating? In fact, each country seems to be setting its own rules and banks are retreating home, capital in tow.

To add insult to injury, no sooner have banks complied with a rule that the regulator changes it. The Basel Committee admitted this autumn that perhaps securitisations per se were not “bad.” Without saying it in so many words, the implication was that forcing banks in 2009 to post higher capital requirements against them – as though all securitisations were similar to sub-prime mortgages – was wrong. The Committee is set to review the issue sometimes in 2014.

Meanwhile, the absurdity of zero or very low capital requirements on holding sovereign debt has steered banks to load up on it. This may be very useful for over-indebted governments, but as Jens Weidmann, President of the Bundesbank noted late last year, “the current regulation’s assumption that government bonds are risk-free has been dismissed by current experience.”

In truth, it doesn’t take familiarity with the last few years to realise that ‘risk-free government bonds’ has always been an oxymoron. In the best of cases their value has been damaged by inflation or currency devaluation; at the worst it has been destroyed by restructuring or default.

Moby Dick evaded his pursuers, but most of the crew of the Pequod, the whaling ship, met their death because they dared not stand up to Captain Ahab and his lack of judgment.

JP Morgan Chase’s Chairman cum President cum CEO Jamie Dimon – yes, truly three titles – admitted a few weeks ago that some investigations into the bank were just beginning, which does not bode well for 2014 results.

In May Mr Dimon fought off a shareholder revolt that would have seen him lose his position as chairman by letting it be known he would walk from the bank if this happened. The blackmail worked. He kept his triumvirate of titles and continues to lead the largest bank in the US.

This is a sell notice. It has the same whiff of omnipotence that marks the reigns of presidents who succeed in changing constitutions to allow them yet another, and another, and another term in office.

The Pequod had a problem of culture. We shall see how the tale unfolds for some of the banks, not least JP Morgan Chase. But the omens are not good: absolute power really does corrupt absolutely.*

*This column originally appeared in The Dialogue Review, an academic journal.

The CEO’s case for rocketing equity markets

Middle East and Korean peace in the offing

A year after writing about the unsustainability of the French economy, I found myself this August once again amidst the glory-on-earth that is inland Provence. The economy is in worse shape, even more of the profit-making elite have left the country and President Francois Hollande is beyond a blancmange.

Demand for places in the South Kensington Lycée is such that a new one is being built near Wembley football stadium. London’s gain is France’s loss.

And yet I join a select group of forecasters who have to date been proved wrong. We continue to hammer away at our theme of the bankruptcy of the French state while enjoying the delights of long lunches with saucissons de sanglier, the local rosé and the dream of owning our own estate. The head and the heart do not always move in sync. Why France will fall next.

The time to invest in equities is now. Ignore the pundits who declare them overpriced. Dismiss the majority view which emphasises these five certainties: anaemic world growth is set to persist for the foreseeable future; China is set to become a superpower; the North-South Korea stand-off is unlikely to change anytime soon; US supremacy is at an end; the Israel-Arab conflict will endure.

Instead, read the fascinatingly contrarian world vision that a well-known, cerebral CEO recently shared with me.

“China will struggle more than many investors expect, particularly in the context of what could be the Asian strategic surprise of the next few years: Japan. Chinese growth well under double digits at 7-8% will not be enough to sustain the socio-political compact which has kept it as a unitary state with a quiescent population. The subversive power of the internet, growing income inequality devoid of the hope that a rising tide will lift all boats, local corruption, Muslim extremism in some provinces and regional separatism, will lead to domestic problems which the Communist Party will not be able to contain. It could lose power while the country messily breaks up into smaller areas of influence, although it is worth keeping in mind that “smaller” in Chinese terms is still large by any other.

The Koreas will unify as the Chinese reconsider the cost of supporting the existing North Korean regime. South Korea will pay for re-unification, just like the West Germans paid for the East. After a decade or two of domestic integration focus, Korea will be born as an even more powerful economic entity, playing a much larger role on the world stage.

The US looks set to continue as a superpower. With the Republican Party in a mess, Hilary Rodham Clinton could be elected on a landslide at the next election, bringing the House along with her. The US will continue its upward trajectory, based on cheap shale gas and its flexible, innovative economy, with no one country able to challenge it.

Peace is due to break out in the Middle East within the next 3-5 years as the Shia axis surely will be broken when Bashar is ousted. He may not be out of power yet, but the prospects of continued Alawite domination of Syria (12% of the population) grow dimmer by the day as Sunni support for the rebels continues to grow. Syria’s fall would effectively defang Hezbollah and creates much improved prospects for peace with Israel. The new military government in Egypt may transition into a civilian government over time, but likely will continue to curtail arms trafficking across their border into Gaza, further weakening Hezbollah. Shia Iran, the main backer of Hezbollah, would end up being further isolated and surrounded by Sunni powers.

The Arab Spring has brought to the surface the main threat to existing regimes in the Arab world: a lack of growth and diversification with its consequent unemployment, especially youth unemployment – under 25’s being the largest (and growing) segment of the population in the Arab world. The monarchies and dictatorships have used the conflict with Israel as an excuse for their lack of progress, but this is no longer enough.

Peace with Israel will allow the focus to shift to growth. Informal approaches to Israel from the Saudis have already been made. For Israel, which does not have the military capacity to fully disable Iran’s nuclear capabilities, a comprehensive peace settlement may have allure. Not least because Arab Israelis are set to be a majority of the population within a decade.

The confluence of these unexpected factors, including the enhanced power of the US and the shock of a Middle East and Korean settlement, means equity markets will take off on the back of the boost to world growth.”

Hopefully, this radical vision will more likely happen than this Column’s dire French predictions.