The Financial Services Club's Blog

Not bashing bankers' bonuses but bankers' bonuses bashed

Fancy a tongue twister?

Howsabout bankers big bonuses bashed by broadcasters but better being bashed by bank bosses.

Nah.  Doesn't quite work as well as six swans swimming, swim swans swim, six swans swam, well swum swans, but it almost works. 

What's all this about?

Well, Bloomberg released the latest news on bankers' bonuses this morning, and here's the league table:

Company            Compensation  Employees   Compensation per Employee

Bank of America      $26.3bn          284,169           $92,723
Citigroup                $18.64bn         258,000           $72,264
Credit Suisse         CHF11.23bn        50,500     CHF222,337
Deutsche Bank        EU9.59bn           82,504       EU116,285
Goldman Sachs        $13.72bn           35,400         $387,655
JPMorgan Chase      $21.55bn         236,810           $91,014
Morgan Stanley       $11.99bn           62,864          $190,682
UBS                      CHF13.14bn         64,583     CHF203,506

Note: 1CHF:1.02US$ and 1EU:1.41US$

You may be going "wow", but take note: "While average pay per employee has dropped 0.8 percent this year at the eight banks, it has fallen 11 percent at six that focus most on trading, such as Goldman Sachs and the investment bank unit of Credit Suisse Group AG."

 

Revising MiFID and RegNMS for HFT

Gawd, I hate acronymns and look at that!  Three in one blog entry title!!!

Anyways, for the nerdy-nerd equities guys, this will grab their attention.

It's all to do with trading in European and American stocks and shares using High Frequency Trading (HFT) systems, and the regulations therein with EU MiFID rules applying over here and USA RegNMS rules applying over there.

These rules are going to be overhauled soon thanks to the Flash Crash, that dreaded thing that caused US stock markets to go haywire on May 6th.  There has been lots and lots written about the Flash Crash of May 6th, but there’s not been a great deal saying it was a good thing ... until you meet JPMorgan.

In this week’s Eye on the Market, they identify five things they like about the Flash Crash, namely:

[1] Stock-specific circuit breakers.

The U.S. has been slow to install circuit breakers on major exchanges, relying instead on “clearly erroneous trade rules” that cancel trades after the fact. In Asia and Europe, circuit-breakers have been around for a while. In Asia, trading is restricted outside of pre-specified daily bands of 5%, 10% and 15% (different by market). In Europe (e.g., Deutsche Bourse), trading is halted for 5 minutes after a 3%-10% move, and then reopened. In the wake of the Flash Crash, 10% circuit breakers are now applied to a few stocks as part of a pilot program (they have already been triggered on Citigroup, Anadarko and the Washington Post Company). If we are going to exist in a world with automated robots doing the lion’s share of daily trading, circuit breakers may be needed to prevent unintended and unmanageable meltdowns.

Another topic under discussion by the SEC: prevent HFTs from having “unfiltered, naked access” to the exchanges by requiring them to live by the same pre-trade risk management controls that clearing members do. Why? As noted by the Chicago Fed, “high-frequency trading has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment”.

[2] More balance to the HFT discussion.

HFT supporters claim they are providers of liquidity to the market, and that HFT makes U.S. markets more efficient than ever. Suggestions to the contrary have been deemed “utterly laughable” by firms defending them. However, the Flash Crash highlights the uncertainties around these assertions.

While volumes have tripled in the last few years, there’s a big difference between volume and liquidity (the ability to transact without moving the price). In an industry barometer survey1 conducted by the Tabb Group in May of this year, barely half the participants had a high degree of confidence in the US equity market structure; 73% did not believe the market structure is “orderly”.

One of the survey recommendations: HFTs should be required to register as broker-dealers.

To be sure, there were weaknesses in the old specialist system as well2. But specialists were required to maintain a fair and orderly market, and post quotes that were part of the National Best Bid and Offer system; their reputations mattered. HFTs have no such requirements (no minimum shares or minimum quote times); one proposal would require quotes to be valid for at least one second. The SEC has broadened the trader reporting system in order to analyze HFT activity more closely.

[3] Proposals requiring HFTs to act more like the floor specialists they’re replacing.

With the advent of HFTs, cancelled orders have soared. Today’s ratio of 30 cancelled orders for each one executed means that 97% are cancelled.

To curb abusive practices, some market participants recommend applying a fee to HFTs for an excessive number of cancelled orders. The increase in cancelled orders is one reason we do not agree that increased order depth on S&P 500 stocks at the NBBO is a clear indication of greater liquidity, as some market research alleges. Quotes pulled within a nano-second of being posted, and which are part of an algorithmic order detection exercise, don’t seem like liquidity in the traditional sense. Ameritrade’s representative on the recent SEC Roundtable referred to this as “opportunistic liquidity”.

[4] More discussion around HFT “co-location”.

Some HFTs co-locate computer servers inside stock exchanges3 to minimize the milliseconds (or nanoseconds) required to scan existing orders, and have algorithms act on this information. As trading execution and IPO listing fees declined, exchanges have tried to make up the difference by selling access to market data. Some exchanges have products which give clients a faster look at quotes, in exchange for a fee. As a result, some HFTs end up with access to information sooner than institutional or retail investors who rely on more standard venues (such as SIP Quotes).

The search for co-location benefits has existed forever (in polite company, “order anticipation strategies”). Broker-dealers in past decades argued that being closer to floor traders on the CBOT was an advantage to their clients. But historical parallels can lose their meaning when the instruments of battle change: one HFT computer can reportedly decode more than 5 million messages per second. The Flash Crash has increased the debate around whether co-location confers advantages to HFTs, and whether there should be obligations and responsibilities that accompany them.

[5] Asset managers learn that “cheapest <> best”.

After the NYSE moved to decimalization in 2001, bid-offer spreads fell almost in half on S&P 500 stocks (less so for the Russell 2000 stocks, where HFTs are less active). Schwab retail commissions fell from $35 in 2003 to less than $10 in 2009. This trend is confirmed by broader research from the American Association of Individual Investors. So if the prism of success is bid-offer costs and commissions on individual trades, the battle has been won.

But is that the right prism to define what makes an optimal marketplace? Part of the HFT industry tracks the order flow of larger investors who leave electronic footprints4. Using algorithms which include spraying the tape with thousands of quotes, the intentions of large investors is ferreted out. This can result in higher trading costs for such investors, and by extension, their clients, who include 401k investors, and pensioners participating in state and corporate plans. Quantitative Services Group computes analyses of HFT impacts on execution costs. They estimate that HFT tracking algorithms can drive execution costs up 1.5 to 3 times, even when institutional investors parcel trades into smaller orders to avoid detection.

There’s lots more of interest in their report, which you can read in full and download if you want:

JPMorgan's Eye on the Market

Meanwhile, you may note that a lot of it is about High Frequency Trading (HFT), which I’ve written quite a bit about recently:

• Who's afraid of HFT, HFT, HFT?
• High frequency trading in jeopardy thanks to flash crash
• More Banking Statistics: Algo and High Frequency Trading

as have many others.

This means that this area is going to get regulated, and it will mean significant restructuring.  For example, back in January, the SEC started a consultation through the Concept Release - a request for public comment on securities issues - on HFT and more.

Key areas under review include:

Market Quality Metrics

What are the best metrics for assessing market quality for long-term investors and have these metrics improved or worsened in recent years?

Fairness of Market Structure

Is the current highly automated, high-speed market structure fundamentally fair for investors?

High Frequency Trading

What types of strategies are used by the proprietary trading firms loosely referred to as high frequency traders, and are these strategies beneficial or harmful for other investors?

Is the overall use of any harmful strategies by proprietary firms sufficiently widespread that the Commission should consider a regulatory initiative in this area?

Co-Location

Do co-location services (which enable exchange customers to potentially route trades faster by placing their computer servers in close proximity to an exchange's computer system) give proprietary trading firms an unfair advantage?

If so, should the proprietary firms that use these services be subject to any specific trading obligations?

Dark Liquidity

Has the trading volume of undisplayed trading centres (such as dark pools) reached a sufficiently significant level that it has detracted from the quality of public price discovery?

If more individual investor orders were routed to public markets, would it promote quote competition in the public markets, lead to narrower spreads, and ultimately improve order execution quality for individual investors beyond current levels?

Are a significant number of individual investor orders executed in dark pools and, if so, what is the execution quality for these orders?

Lots of comments have been received on the Concept Release, and its conclusion cannot be far away.

Now we have a European response to this area with Kay Swinburne, rapporteur to the Economic and Monetary Affairs committee of the Parliament, producing a draft report last week. This report provides indication of much of what might be in the revised MiFID and very little is left untouched.

Jeremy Grant over at the Financial Times, has picked out some of the more interesting nuggets from Kay’s report:

• She suggests it may be necessary for “informal market makers” – read: HFTs – to be subject to mandatory liquidity provisions;
• Calls for an “ongoing regulatory review” of the algorithms used by HFTs;
• Seeks an examination of HFT to determine whether market flow generated automatically is providing “real liquidity” to the market and what the effect of this is on overall price discovery;
• Suggests that, “in the interests of equitable treatment”, rules need to be introduced so that MTFs (multilateral trading facilities”, like Chi-X Europe) are subject to the same level of supervision as exchanges, under certain circumstances;
• Calls for new provisions under Mifid for “broker crossing networks”, including requirements that they submit to authorities “orders matched in the system”, and “details on access to the system”; and
• Suggests a minimum order size for dark pools.

This is pretty dramatic stuff and Jeremy finishes his column by referencing David Doyle, a regular speaker at the FSClub, returning to the London meeting on 12th January 2011 for our annual EU regulatory update.

David presented on the key changes in MiFID at a conference at the London Stock Exchange last week, stressing that “the whole review of MiFID will have as its driving principle investor protection – that is, the interest of the retail investor, not the operators of exchanges, dark pools and HFTs.”

Too true David, too true.

If you’re interested in more of what David had to say, here are his slides:

Mi fid, david doyle, july2010

View more presentations from Chris Skinner.

The World's Top 20 Banks 1994-2010 ... Anglo-American Banking Rules!

I’ve just received this month’s Banker magazine which the editor, Brian Caplen, describes as their most important issue of the year as it covers the latest Bank 1000 listings.

This year’s listings show a surprisingly stable crew of American and British banks.

World   Bank                               Tier One              Pre-tax
Rank                                            Capital                profit
                                                      $m                    $m
1        Bank of America Corp        160,387.77           4,360.00
2        JP Morgan Chase & Co       132,971.00         16,143.00
3        Citigroup                          127,034.00          -8,445.00
4        Royal Bank of Scotland       123,859.00          -4,366.29
5        HSBC Holdings                   122,157.00           7,079.00

Considering the crisis was meant to have killed these banks, you may find it surprising to see that Citigroup and RBS have maintained their leading positions.

This is down to the fact that the Banker measures a bank’s strength by its Tier 1 Capital, and so their positioning is more of a reflection of the sheer size of these firms than by their brand or market capitalisation, which is used in some other studies of size.

The Banker’s data is fascinating though, as the database also contains profitability, revenue, cost-income ratio and more, so it’s a useful tool in all senses.  And the online data goes back to 1996, so you can do some useful comparisons.

Mind you, my data - old Banker magazines - goes back even further so I quickly took a snapshot of a few useful year’s – 1994, 1999, 2004, 2008 and 2010 – to see how things have changed.  Mapping out the Top 20 banks of the world for each year makes for an interesting picture (doubleclick the picture to see a larger version):

Back in 1994, Japan ruled the world.

Then their economy went South and Origami Bank folded, Sumo Bank went belly up, Bonsai Bank cut back their branches and something fishy went on at Sushi Bank where staff got a raw deal.

Post-Japan’s slump, the Anglo-American financial system ruled. So you would think that, as that system failed, it also would have gone South.

Not the case.

Maybe that’s a reflection of the sheer scale of investment American and European firms have put into these economies to avoid such a crash.

Well worth spending time looking at the data and looking forward to playing around with it further.

Jamie Dimon's Shareholders Letter (Part One)

Jamie Dimon’s letter to JPMorgan Chase’s shareholders was released over the weekend.

It’s a great 36-page read and, although I don’t normally do this, I thought it worth reprinting some of the key aspects here as it provides a fascinating insight into a global bank’s operations.

This takes the form of four posts.

This first one provides an insight into JPM's operations.

The second is a few comments related to banker's bonuses and TARP.

The third is a key section of the letter that outlines Jamie Dimon's views on regulatory reform.

The fourth is a few summary notes from key industry observers’ views about his comments.

First, here’s a review of JPM’s business ...

“For JPMorgan Chase, these past two years have been part of a challenging, yet defining, decade. We began it as three separate companies: Bank One, Chase and J.P. Morgan, with each facing serious strategic and competitive challenges ... on March 16, 2008, we announced our acquisition of Bear Stearns at the request of the U.S. government; on September 25, 2008, 10 days after the collapse of Lehman Brothers, we bought Washington Mutual ...

“Our revenue this year was a record $100 billion, up from $67 billion in 2008. The large increase was due primarily to the inclusion for the full year of Washington Mutual (WaMu) and the dramatic turnaround in revenue in our Investment Bank. Profits were $12 billion, up from $6 billion in the prior year but down from $15 billion in the year before that. While these results represent a large improvement over 2008, they still are an inadequate return on capital – a return on tangible equity of only 10%. Relative to our competition, our company fared extremely well. We did not suffer a loss in any single quarter over the two-year crisis (we may have been one of the few major global financial firms to achieve this). In absolute financial terms, however, our results were mediocre ...

“As we entered the most tumultuous financial markets since the Great Depression, we experienced the opposite of a run on the bank as deposits flowed in (in a two-month period, $150 billion flowed in – we barely knew what to do with it). At JPMorgan Chase, our deposits always exceeded our loans; deposits always have been considered one of the safest sources of funding for a bank. The average bank has loans that are generally greater than 110% of its deposits. For JPMorgan Chase, loans were approximately 75% of deposits. In fact, our excess deposits greatly reduced the need to finance ourselves in riskier wholesale markets. In the long-term wholesale unsecured markets, we borrowed on average $270 billion. Only $40 billion was borrowed unsecured in the shortterm credit markets – an extraordinarily low amount for a company of our size ...

“We maintained an extremely strong Tier 1 Common ratio, which stood at 8.8% at year-end. We also increased our loan loss reserves over the course of the year from $23.2 billion to $31.6 billion, an extremely strong 5.5% of total loans outstanding ... our total technology and operations and corporate overhead costs would be more than $9 billion higher today if they were running at the same cost per dollar of revenue as in 2005 ...

“We have 220,000 employees around the world ... 19,000 programmers, application developers and information technology employees who tirelessly keep our 80 data centers, 55,000 servers, 225,000 desktops and global network up and running – and who were a major part of completing the Bear Stearns and WaMu conversions in record time. 80,000 employees fulfilling operations functions globally and thousands of customer service colleagues. In 2009, they responded to more than 245 million phone calls ... 13,000 people in Legal & Compliance, Risk, Audit, Human Resources and Finance ...

“The Investment Bank (IB) delivered record performance across the board: net income of $6.9 billion on revenue of $28.1 billion. These results were led by best-ever Global Markets revenue of $22 billion and record investment banking fees of $7.2 billion. The IB generated a return on equity of 21% on $33 billion of allocated capital, our best result in five years ... trading is perhaps the least understood area of our investment banking activities. We have 6,500 professionals on approximately 120 trading desks in 25 trading centers around the world; these professionals include more than 800 research analysts who educate investors on nearly 4,000 companies and provide insight on 40 developed and emerging markets ... we execute approximately 2 million trades and buy and sell close to $2.5 trillion of cash and securities each day. On an average day, we own, for our account, approximately $440 billion in securities ... at the end of 2009, we announced that our U.K. joint venture with Cazenove Group Limited would become a wholly owned part of J.P. Morgan. Our initial investment in Cazenove in 2005 was extremely successful – among other things, it increased our U.K. investment banking market share (as measured by total fees) from 5% to 13% ...

“Retail Banking, which includes Consumer and Business Banking, earned $3.9 billion, primarily by serving customers through bank branches in 23 states. Consumer Lending lost $3.8 billion because of continued high charge-offs in the home lending business ... our 61,000 people in 5,154 Chase branches in 23 states served more than 30 million U.S. consumers and small businesses ... retail operations teams processed 700 million teller transactions, 3.5 billion debit card purchases, 100 million ATM deposits, close to 6 billion checks and more than 1.3 billion statements ... we added 4.2 million mobile banking customers and another 5.2 million new online banking customers ... loan origination in 2009 was down 58%, as customer demand decreased significantly and our underwriting standards became more disciplined.

“Card Services lost $2.2 billion (compared with last year’s profit of $780 million) ... our 23,000 Card Services employees around the world provide financial flexibility and convenience to customers who, in 2009, used Chase credit cards to meet more than $328 billion of their spending needs. With more than 145 million cards in circulation held by approximately 50 million customers with $163.4 billion in loan outstandings ... in 2009, in addition to the terrible environment, the U.S. credit card business faced fairly dramatic changes because of a new law enacted by Congress in May. The new law restricts issuers’ ability to change rates and prohibits certain practices that were not considered consumer-friendly. These changes alone are expected to reduce our after-tax income by approximately $500 million to $750 million ... we reduced limits on credit lines, and we canceled credit cards for customers who had not done business with us over an extended period. In fact, the industry as a whole reduced limits from a peak of $4.7 trillion to $3.3 trillion ...

“Commercial Banking reported net income of $1.3 billion with an ROE of 16% ... highlights included a 20% boost in revenue to $5.7 billion; a 25% improvement in operating margin to $3.5 billion; double-digit increases in both average liability balances, up 10%, and average loan balances, up 30%; and a 20% jump in gross investment banking revenue to $1.2 billion – a full 25% above plan ... the average length of a Commercial Banking client relationship with us is more than 18 years ...

“Treasury & Securities Services reported net income of $1.2 billion with an ROE of 25% ... vs. $1.8 billion in the prior year. The business delivered net revenue of $7.3 billion, down 10% from the previous year. We describe TSS as our “Warren Buffett-style” business because it grows with our clients and with inflation; delivers excellent margins and high returns on capital; and is hard for would-be competitors to replicate because of its global scale, long-term client relationships and complex technology ... more than 6,000 TSS bankers serve more than 40,000 clients from all of our other lines of business in 60 locations around the world. TSS provides clients with critical products and services, including global custody in more than 90 global markets, holding nearly $15 trillion in assets; corporate cash management, moving an astounding $10 trillion a day of cash transactions around the world for clients; corporate card services, providing 27 million cards to more than 5,000 corporate clients and government agencies ...

“Asset Management reported net income of $1.4 billion with an ROE of 20% ... the Corporate sector reported net income of $3.7 billion ...

 

Part Two: Jamie's views on banker's bonuses and TARP.
Part Three: Jamie's views on regulatory reform.
Part Four: Industry observers’ views about Jamie.

Jamie Dimon on Bank Bonuses and TARP (Part Two)

Jamie Dimon’s letter to JPMorgan Chase’s shareholders included some interesting comments related to banker's bonuses and TARP:

“Many commentators, in an attempt to measure fairness and reasonableness of a company’s compensation payouts, have looked at total compensation as a percentage of revenue. On this basis, JPMorgan Chase’s total compensation (salaries, benefits and bonuses) was 27% for 2009; this number averaged 33% over the previous several years. For our Investment Bank alone – the part of the company receiving the most scrutiny – compensation was 33% of revenue, down from an average of 44% over the last five years. The chart on the next page compares these same percentages with a wide mix of businesses (double click to see large version):

“For the average U.S. business, total compensation as a percentage of revenue is approximately 16%. In general, at businesses that are people-intensive and not capital- or intellectual property-intensive, such as professional services companies, a high percentage of the company’s revenue is paid out to the employees. Law firms, for example (which are not included in the following table), pay out more than 80% of their revenue to their employees. In highly capital-intensive companies, like telecommunications or certain manufacturing companies, payout ratios are considerably lower ...

“We know there are people in this industry who have been extraordinarily well-paid – and, in some cases, overpaid. Some of these people have benefited from profits that turned out to be ephemeral or were the result of excessive leverage in the system. Some benefited from extreme competition for their specific talents, often from hedge funds and other such businesses. While no firm can claim it gets compensation right every time, we at JPMorgan Chase do think we have generally been disciplined when it comes to our decisions ...

There's a long section on the use of $25 billion in TARP funding that JPMC felt compelled to accept ...

“We did not anticipate the anger or backlash the acceptance of TARP capital would evoke from the public, politicians and the media – but, even with hindsight, I think we would have had to accept TARP capital because doing so was in the best interest of the country. I do wish it would have been possible to distinguish between the healthy and unhealthy banks in a way that didn’t damage the success of the program – so as not to create a situation where the public was left with the impression that all banks were bailed out. Last, I do regret having used the FDIC guarantee because we didn’t need it, and it just added to the argument that all banks had been bailed out and fueled the anger directed toward banks ...

“Surviving banks have paid for the cost to the FDIC of the approximately 200 bank failures since the beginning of 2008. Of those failures, the largest one, WaMu (with assets exceeding $260 billion), has cost the FDIC nothing. That is because JPMorgan Chase bought WaMu. All of the other banks that have failed were far smaller (the next largest failure was IndyMac, with $32 billion). All of these failures combined have cost the FDIC an estimated $55 billion ...

Part One: An overview of JPMorgan Chase's Operations.
Part Three: Jamie's views on regulatory reform.
Part Four: Industry observers’ views about Jamie.

Jamie Dimon's Regulatory Reform Recomendations (Part Three)

Jamie Dimon’s letter to JPMorgan Chase’s shareholders included a whole section on the crisis and his solutions.  Because Tim Geithner and Barack Obama listen to every word Jamie utters, I think it's worth reproducing the whole section here to see whether, in a year or so, his recommendations are implemented:

“Banks are not fighting regulation

“We at JPMorgan Chase and at other banks have consistently acknowledged the need for proper regulatory reform, and I also spoke about this topic in great detail in last year’s letter.

“Looking back, one of the surprising aspects about the recent crisis is that most of the specific problems associated with it (global trade imbalances, the housing bubble, excessive leverage, money market funds, etc.) were individually well-known and discussed. But no one, as far as I know, put together all of the factors and predicted the toxic combination it would become – and the crisis it would cause.

“So what can we do to help fix the situation going forward? We must focus on the problem: bad risk management. This not only caused financial institutions to fail, but it also revealed fundamental flaws in the system itself. These flaws existed at both a macro level, where the interplay of the numerous critical factors was missed, and a micro level: for example, the failure to prevent AIG from taking excessive, one-sided positions in trading derivatives and the failure to limit mortgages to families who could afford them and to keep loan-to-value ratios to a more reasonable 80%-90%.

“Over the last 50 years, we have allowed our regulatory system to become dangerously outdated. The structure is archaic and leaves huge gaps in the system. Today, in America, banks account for only one-third of the credit outstanding, with all kinds of non-banks taking and trading risks and providing credit to the system. So the idea that banking is confined to deposit-holding entities is inaccurate and deceptive. The failure of so many firms in a range of sizes and categories – from Bear Stearns and Lehman Brothers to IndyMac and WaMu to Fannie Mae, Freddie Mac and AIG, as well as local community banks – proves that regulation needs to be administered by product and economic substance, not by legal entity. We have a chance to simplify and strengthen our regulatory system, and, if we do it right, it will not only be able to handle the complex challenges we face today but will be able to do so in a way that will be flexible enough to continuously adapt to our changing world.

“We support a systemic regulator

“Going forward, we will need a systemic regulator charged with effectively monitoring the spread and level of risk across the financial system in its entirety. Think of it as a “super risk” regulator. Such a regulator would not eliminate all future problems, but it would be able to mitigate them. If we had eliminated just some of the problems, it might have stopped the crisis from getting this bad. Congress appears to be well on its way to creating just such a regulator, and we hope it succeeds.

“Some issues the systemic risk regulator should keep in mind are the following:

• Focusing the process on managing risk. This should not be a political process. It should function like a strong risk management committee.

• Eliminating gaps and overlaps in the system. For example, mortgages were regulated by multiple entities, some of which did a terrible job, causing a “race to the bottom” as even good companies started to do bad things to maintain market share.

• Analyzing areas like the mortgage market and other elements of the consumer-finance system to ensure that when new rules are written, they create a sound, safe, effective and consumer-friendly mortgage market.

• Carefully tracking new products, as they often are the source of many problems.

• Reviewing credit across the whole system – including “hidden” extensions of credit, such as enhanced money market funds and SIVs.

• Aggressively monitoring financial markets and potential excesses, or bubbles. It may be hard to detect bubbles, and it may be inadvisable, once detected, to exert a direct influence on them with macro economic policy. However, it is appropriate to try to minimize the collateral damage bubbles can cause. It also would be appropriate to try to manage bubbles, not by using monetary policy but by restricting credit on specific markets (i.e., it would have been appropriate to ask lenders to reduce loan-to-value ratios in mortgages or to minimize speculation in the financial markets by reducing the leverage used in the repo markets).

• Recognizing distortions as they develop in the broader economy (fiscal deficits, trade imbalances, structural state budget deficits) and forcing policy bodies to anticipate the problems that may result.

• Encouraging international coordination as much as possible – not only so companies compete on a level playing field but also because crises don’t stop at national borders.

“These are just some of the ways a systemic regulator could help fix the flaws in our regulatory framework and create a system that continually adapts and improves itself.

“We support an enhanced resolution authority — and the elimination of too big to fail

“Even if we achieve the primary goal of regulating financial firms to prevent them from failing, we still have to get government out of the business of rescuing poorly managed firms. All firms should be allowed to fail no matter how big or interconnected they are to other firms. That’s why we at JPMorgan Chase have argued for an enhanced resolution authority that would let regulators wind down failing firms in a controlled way that minimizes damage to the economy and will never cost the taxpayer anything. Fixing the “too big to fail” problem alone would go a long way toward solving many of the issues at the heart of the crisis. Just giving regulators this authority, in and of itself, would reduce the likelihood of failure as managements and boards would recognize there is no safety net. Think of this enhanced resolution as “specialized bankruptcy” for financial companies. The principles of such a system would be as follows:

• A failure should be based on a company’s inability to finance itself.

• The regulator (or specialized bankruptcy court) should be able to terminate managements and boards.

• Shareholders should be wiped out when a bank fails – just like in a bankruptcy.

• The regulator could operate the company both to minimize damage to the company and to protect the resolution fund.

• The regulator could liquidate assets or sell parts of the company as it sees fit.

• Unsecured creditors should recover money only after everyone else is paid – like in a bankruptcy. (In fact, the resolution authority should keep a significant amount of the recovery to pay for its efforts and to fund future resolutions.) • In essence, secured creditors should be treated like they are treated in a bankruptcy. • The resolution fund should be paid for by the financial industry (like the FDIC is today).

• All institutions under this regime should live with the exact same rules.

• Regulators should make sure that companies have enough equity and unsecured debt to prevent the resolution fund from ever running out of money. To give an example, while Lehman had $26 billion in equity, it also had $128 billion in unsecured debt. A resolution regulator, in my opinion, would clearly have been able to let Lehman meet its obligations, wind it down and/or sell it off and still have plenty of money left over to return some money to the unsecured creditors. Had this been done wisely, the economy would have been better off.

• If a firm fails, there should be enough clarity about the financial, legal and tax structures of that firm to allow regulators, cooperating across international boundaries, to wind it down in a controlled manner – what some refer to as living wills.

• While there is no argument about who should pay for the resolution (i.e., banks), there are some technical issues about how it should be funded. The resolution regulator does need to be able to fund these companies while they are being wound down, and there are plenty of appropriate ways to accomplish this.

“Once it is established that any firm can fail, firms of all sizes and shapes should be allowed to thrive. It is wrong to assume that big firms inherently are risky. Banks shouldn’t be big for the sake of being big, but scale can create value for shareholders and for consumers who are beneficiaries of better products that are delivered more quickly and less expensively. These benefits extend beyond individuals to include businesses that are bank clients, particularly those that are global in scale and reach, and the economy as a whole.

“Many banks’ capabilities, size and diversity enabled them to withstand the crisis and emerge from it as stronger firms. This strength, in turn, made it possible for many firms to acquire weaker firms at the government’s request and help to alleviate potential damage to the economy.

“Closing comments on regulation

“While we support the general principles behind enhanced regulation of derivatives, securitizations and enhanced consumer protections, we do not support each and every part of what is being recommended. The devil is in the details, and it is critical that the reforms actually provide the important safeguards without unnecessarily disrupting the health of the overall financial system.

“We also believe there are some serious ideas that need attention if the system is to be made more fail-safe:

• Repo markets could be better structured, monitored and controlled.

• Loan reserving could be made far less pro-cyclical.

• Securitization markets could be fixed so that both originators and distributors have skin in the game.

• A system could be put into place to prevent a “run” on money market funds.

• The ability to buy shareholder or creditor voting rights without owning and being exposed to the risks of owning the underlying securities should be extremely limited. Investors should not have the ability to vote the capital securities actually owned if the investors are voting for the failure of the company and stand to gain more on their short positions than on their long positions.

• Finally, we support strong controls on so-called naked short selling.

“During the past year’s discussion among regulators and legislators, many other ideas have been proposed or recommended – from the Volcker Rule to new bank taxes to changes in Basel capital. These ideas are all in varying stages of development and are too undefined to comment on here. What we would urge our regulators and legislators to do is proceed with clarity and purpose and avoid broadly penalizing all firms alike – regardless of whether they were reckless or prudent.”

Part One: An overview of JPMorgan Chase's Operations.
Part Two: Jamie's views on banker's bonuses and TARP.
Part Four: Industry observers’ views about Jamie.

 

Commentary on Jamie Dimon's views (Part Four)

Jamie Dimon’s letter to JPMorgan Chase’s shareholders created quite a storm of commentary amongst various industry observers, not all of it complementary.

Tom Brown of Bankstocks.com says that the letter is: "outstanding. The letter isn’t just a wrap-up of how Morgan did last year (although, as is typical, Jamie’s candid on the topic)—it’s also a worthwhile meditation on how and why financial crisis happened, and what sort of changes need to be made to prevent another one. This is just the sort of letter, that is to say, that a lot of us hoped Warren Buffett might write this year, but did not. As far as that goes, it may be the best shareholder letter I’ve ever read, from any CEO, ever."

The Wall Street Journal notes that Dimon also focuses upon succession planning: "Ladies and Gentlemen, place your bets. Who will replace the chief of JP Morgan Chase & Co?  In his annual letter to shareholders, CEO Jamie Dimon says his number one priority this year is to find his successor."

Meanwhile, one of the more interesting takes on the letter is Simon Johnson's over at Baseline Scenario:

There are two kinds of bankers to fear.  The first is incompetent and runs a big bank.  This includes such people as Chuck Prince (formerly of Citigroup) and Ken Lewis (Bank of America).  These people run their banks onto the rocks – and end up costing the taxpayer a great deal of money.  But, on the other hand, you can see them coming and, if we ever get the politics of bank regulation straightened out again, work hard to contain the problems they present.

The second type of banker is much more dangerous.  This person understands how to control risk within a massive organization, manage political relationships across the political spectrum, and generate the right kind of public relations.  When all is said and done, this banker runs a big bank and – here’s the danger – makes it even bigger.

Jamie Dimon is by far the most dangerous American banker of this or any other recent generation.

That may be a bit extreme, but Jamie Dimon is by far the most powerful American banker of this generation.  More so than even Lloyd Blankfiend, and Barack Obama and most of his admin linger upon his every utterance, as do the markets.

So my own view is that Jamie Dimon is a man to take seriously.  Very seriously.

And that's why I've posted most of his letter here, as I'm taking note of his comments very seriously.

Part One: An overview of JPMorgan Chase's Operations.
Part Two: Jamie's views on banker's bonuses and TARP.
Part Three: Jamie's views on regulatory reform.