Jamie Dimon likes to write grandiose letters to shareholders. Unfortunately, the financial media sees fit to treat them seriously. And his minders manage to save him from himself. Right after the crisis, Dimon's annual missive contained an section praising the heroics of his staff, comparing them at length to the soldiers at Iowa Jima. Dimon was persuaded to get rid of that bit only because his outside PR firm threatened to quit.
This year's letter, as recapped by the Financial Times, is every bit as exaggerated, although less obviously so to the outsider. The theme this year is why too big to fail banks like his need to be left alone by meanie regulators and rabid politicians.
Customers Allegedly Need One-Stop Investment Banking and Commercial Banking Services
Mr. Dimon set out the benefits of structures spanning corporate and investment banking, arguing that they allow big banks such as JPMorgan to perform "mission-critical services . . . that regional and community banks simply cannot do."
Since when? Commercial banking services (commercial loans and revolving credit, cash management, foreign exchange) are sold to treasurers and assistant treasurers of banks. Investment banking services (public bond and stock offerings, mergers) are sold to chief financial officers and CEOs. Both commercial and investment banks deal in derivatives (plain vanilla ones like swaps to supposedly lower funding costs, more complex ones for tax and accounting gaming). And as we've argued, the more complex ones are negative value added from a societal perspective, so any arguments that rely on the importance of complex products that integrate derivatives with more traditional products should be taken with a fistful of salt.
Moreover, most large and large-ish commercial corporations like to play horses for courses in their selection of financial firms. They don't like to rely on one major firm, and if they are multinationals, they want to hire a local bank in countries that are important to them because the local bank will have better local intel than a foreign bank. Even if the big foreign bank gets a few stars from the domestic market, people in that country know their long-term career prospects and job security are higher at a local player.
Lots of Finance Is Good for the US
The US financial services industry does not conform to simple narratives. It is a complex ecosystem that depends on diverse business models coexisting because there is no other way to effectively serve America's vast array of customers and clients.
False again. Numerous studies have found that larger financial sectors are negatively correlated with growth rates. The sort of "complex ecosystems" for finance that Dimon touts as a virtue is virtuous only as far as the people in his industry are concerned. One of the most devastating findings came in a recent IMF paper. From a 2015 post:
But the recent IMF paper, Rethinking Financial Deepening: Stability and Growth in Emerging Markets, is particularly deadly. Even though it focused on the impact of financial development on growth in emerging markets, its authors clearly viewed the findings as germane to advanced economies. Their conclusion was that the growth benefits of financial deepening were positive only up to a certain point, and after that point, increased depth became a drag. But what is most surprising about the IMF paper is that the growth benefit of more complex and extensive banking systems topped out at a comparatively low level of size and sophistication. We've embedded the paper at the end of this post and strongly urge you to read it in full.
The contribution of the IMF paper is that the authors developed a new index to do a comprehensive job of capturing financial activity. Previous work had tended to look either at the size and sophistication of financial institutions, or the depth and complexity of financial markets. The new index incorporates both aspects of financial activity, as well as incorporating access. The writers concede that their measure is still imperfect, but is an improvement over other approaches. They also stress that they are well aware of the issue of establishing that the relationship between the size and complexity of the financial sector is causal, and not a mere correlation…
The authors have a more sophisticated and nuanced assessment than "Having a financial sector that is more developed than Poland's is a bad idea." From the paper:
There is no one particular point of "too much finance" that holds for all countries at all times.The shape and the location of the bell may differ across countries depending on country characteristics including income levels, institutions, and regulatory and supervisory quality. In other words, a country to the right of the average "too much finance" range may still be at its optimum if it has above average quality of regulations and supervision; conversely, a country to the left of the range with weak institutions may have reached its maximum already.
This implies that countries like the US, UK, and Japan before its crisis, went pedal to the metal in the wrong direction by deregulating institutions and markets at the same time. That policy shift, in combination with overt and covert subsidies, fostered explosive growth in products and trading volumes, particularly is the least regulated sectors.
The Chinese Are Coming!
You cannot make this up:
I do not want any American to look back in 20 years and try to figure out how and why America's banks lost the leadership position in financial services. If not us, it will be someone else and likely a Chinese bank.
It used to be that people like Dimon would brandish the threat of European universal banks as ready to invade the US we didn't support our home grown institutions. Having advised more than a few foreign banks operating here, their US operations were virtually without exception sub-scale and with accordingly lower profits than similar-in-balance-sheet sized US institutions. But Europe and European banks are such obvious basket cases that even normally very provincial Beltway denizens have heard about their distress, so Dimon can't use them to scaremonger any more. So Dimon plays the Yellow Peril card instead.
Why is this nonsense? First, it took world-class commercial banks like the then Citibank and JP Morgan well over 15 years of hard slogging to establish a serious beachhead in the investment banking game. The biggest obstacle was cultural incompatibility. Commercial banking has staff with very narrow responsibilities, with highly routinized, repetitive tasks, lots of controls, and hierarchical structures with top managers having thousands of people under their supervision. Historically, investments banks had very flat hierarchies, and were extremely freewheeling, but could do so because the top managers (who were partners) supervised small units, of business in which they were deeply expert and actively involved, and ween't even managers in the banking sense. They weren't administrators (save at the very top of the firms) but were running their own books of business.
The Japanese, which actually at least had very large commercial banks in the 1980s that had established operations in major economies around the world, were only able to follow the Japanese footprint and for the most part either participated in low-end commodity businesses where the size of their balance sheets and low return requirements were a plus, and also did get business with Western firms that had or were seeking to establish operations in Japan. The Chinese are decades behind in the internationalization of their banks where the Japanese were as of the mid 1980s. And do you think the Chinese would fare any better than the Japanese in hiring and retaining top Western "talent" long enough to get skill transfer?
And that's before you get to the reserve currency issue. The US banks have a huge natural advantage with the dollar as the reserve currency, and that is not going away any time soon. As much as China hungers for the status that goes with that, it does not want the attendant costs of running ongoing current account deficits, which is tantamount to exporting jobs. That's anathema given how important high employment levels and wage growth are to political legitimacy in China.
The Fed Is Mean and Wrong Too
Mr Dimon took special aim at the US Federal Reserve's stress test, the Comprehensive Capital Analysis and Review , which has become the regulator's primary tool for keeping the banks in check.
Mr Dimon noted that last year's test, the fourth of a now-annual series, was "extremely severe" on credit risk, imagining losses for JPMorgan well in excess of anything seen during the global financial crisis of 2008-09, and on a par with the Great Depression of the 1930s.
As unlikely as the Fed's Armageddon scenarios may be, Mr Dimon noted that JPMorgan, alone, has enough resources to absorb the entirety of the losses assumed by CCAR.
Dimon is still apparently peeved that the Fed put limits on JP Morgan dividends and share buybacks in 2015, deeming the bank to need to strengthen its capital levels.
Dimon conveniently omits that the reason he and his peers didn't suffer a Great Depression level wipeout was that central banks and national treasuries rose into the rescue. And spare me the "fortress balance sheet" myth. JP Morgan was about a $2 trillion bank attached to a $75 trillion derivatives clearing operation. Morgan Stanley and Goldman would have failed were it not for the AIG money laundering operation and other emergency measures. If Morgan Stanley and Goldman had failed, JP Morgan was next in line.
And he completely sidesteps the real issue. The cost of the last crisis was so great that there isn't any justification for allowing banks to operate as private entities. The cost periodic crises impose on society at large are so great that the banks can't begin to pay for the costs. Andrew Haldane of the Bank of England did the quick and dirty math in 2010:
….these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers "astronomical" would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. "Economical" might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
Yves here. So a banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive. Even though we have described its activities as looting (as in paying themselves so much that they bankrupt the business), the wider consequences are vastly worse than in textbook looting.
At the time, critics contended that his output loss estimate of one times global GDP was unreasonably high. It now looks about right. And Haldane pointed out in the same paper that the classic economic analysis of whether to tax an activity that imposed costs on bystanders (called externalities) or prohibit the activity entirely depended on the level of private gain versus public cost. Where the public costs clearly outweigh the private gain, as Haldane's calculation clearly demonstrates, prohibition is the right answer. Thus putting banks out of the too big to fail business is a completely orthodox remedy, despite the continuing protests of executives like Dimon and economists willing to fall in with the banking party line.
Do read the comments on this Financial Times article. It's gratifying to see that even people in the banking industry aren't buying what Dimon is selling.