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Two Billion Dollar Tip of Banking Iceberg

Tuesday, 15 May 2012 11:12 By Paul Jay, Real News Network | Video Interview

Gerald Epstein: J.P. Morgan debacle shows systemic risk unchanged; breaking up big banks, reform Fed and public banking urgently required.

TRANSCRIPT

Paul Jay, Senior Editor, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington.

As we've discussed many times on The Real News Network, no serious financial reform has yet to be enacted in the United States. The Dodd–Frank bill has been eviscerated. It depended very much on the issue of regulation, and the agencies that are supposed to regulate are being underfinanced, and the regulations are being lobbied to nothingness. The latest debacle now is JPMorgan Chase has apparently lost at least $2 billion—I stress at least, 'cause it's still not fully known, the scope of this, and it's not known how far and wide this practice and this debacle goes throughout the industry.

Now joining us to discuss this, JPMorgan's latest case, is Gerry Epstein. Gerry is codirector of the PERI institute in Amherst, Massachusetts. He's also coeditor of a new volume that will be coming out this fall on political economy and the financial crisis. Thanks for joining us, Gerry.

Prof. Gerald Epstein, PERI, UMass Amherst: Thank you, Paul.

Jay: So what do we know so far about the facts of this case?

Epstein: Well, what we know is that there was an office of—supposed to be a risk management and investment office in London, a branch of JPMorgan Chase that was undertaking some bets that was moving markets, became very risky. As of a month or so ago, we knew that there was a trader there that used to—they were calling the London Well or Voldemort because he was taking such huge bets he was moving the markets, and that those bets have now turned sour and still have not been played out and could be losing at least $2 billion, and some people have estimated up to $4 billion.

Jay: Now, these bets are in these what they call dark markets, derivatives markets?

Epstein: That's right. This was a very complex set of bets, first designed, supposedly, to hedge some investments they had made in corporate bonds. But then the bank started writing some credit default swaps protection on these. Those are the same instruments that were at the core of the financial meltdown we had in 2008. And this office was becoming a profit center for the bank, rather than a center to hedge risk, and it was clearly a proprietary trade on the part of this office.

Jay: And what were they—they were betting, what, that these corporate bonds would go up, that the value of the bonds would go up?

Epstein: That's right. Essentially it was a bet that things were getting better, things were turning around, these big corporate names like General Electric and Ford and other corporate names, their profits would improve. And the hedge funds on the other side began to smell blood. They began to see that their bets were too big and that they couldn't—JPMorgan Chase couldn't unwind these bets without actually dropping the prices even further. So these hedge funds started betting against them, and these hedge funds won.

Jay: So we're back in casino capitalism. I shouldn't say back, 'cause we've actually never been out of it. And that is the story, isn't it? We've never been out of casino capitalism, in spite of the Obama administration and others suggesting there has been financial regulation. So what is the state of this?

Epstein: That's right, it's casino capitalism, plus it's being paid for by low-interest loans from—almost zero interest loans from the Federal Reserve. And so these banks can borrow money at almost zero percent, and instead of investing the money in the real economy, they're taking these wildly speculative bets. Jamie Dimon, the head of JPMorgan Chase who's supposedly this great risk manager, in fact was turning a blind eye to these big, extremely risky bets while at the same time lobbying very heavily against financial reform, against the Volcker rule, against controls of derivatives. The bank bank paid over $7 million last year on lobbying fees to gut these rules. He was the point man for Wall Street fighting against Dodd–Frank.

Jay: And I think it's important to note that Dimon is also a member of the New York Fed, alongside most of the leading CEO bankers on Wall Street, and the New York Fed is also supposed to be the one that oversees the bankers, which is kind of ridiculous. And some people have called for Dimon to resign from the Fed, which I guess is a good thing, but it doesn't structurally change anything.

Epstein: Well, it is an outrage that the Dodd–Frank Act put so much of the power back in the hands of the Fed, along with this financial—the FSOC group of regulators, to really look at these large banks and to try to reduce their risk, while at the same time among their major advisers are the banks themselves. So, yes, Elizabeth Warren and others have called for Jamie Dimon to resign. But structurally, as you suggest, what we need to do is really insulate the regulators from these bankers.

Jay: So what is the state, then, of the Volcker rule? The Volcker rule, as originally proposed, would it have prevented this? And the Volcker rule, as what's left of it, does it actually allow this?

Epstein: Well, that's a good question. I think most—since we don't really know precisely the details of the trade, it's a little hard to answer that question with any degree of precision. But most people think that the original and—certainly the original intention of the Volcker rule was to stop all of his proprietary trading. There could be hedging, but it had to be risk-reducing hedging. As Marcus Stanley of the Americans for Financial Reform put it in his blog piece, this was clearly risk-increasing hedging. Hedging is not supposed to be a profit center. It's supposed to offset potential losses elsewhere. But they were seeing these kinds of bets as a profit center.

Jay: So let me just quickly, for people—.

Epstein: Let me just say one other thing, which is that, however, as the rules have been eviscerated, as you put it, over time, with the lobbying of the banks, the current rule as it seems like it would be put in place perhaps might have allowed this kind of trading, because the rule is so vague. It allows so-called portfolio hedging, which means that the bank can try to offset any kind of risk with some kind of hedges someplace else. But there are no perfect hedges.

Jay: And if there's no transparency, who knows if they're really offsetting or just betting?

Epstein: Correct. And since they don't have to really report even now precisely what they were doing, there's no transparency at all.

Jay: So just quickly for people that are not following this as much as we do, proprietary trading is when a bank takes its own money and it goes out and makes a bet, rather than just becoming a middleman between two other players that want to bet against each other. So they're putting the bank's assets at risk. Right?

Epstein: That's right. So whenever the banks own assets or risk, when they end up holding the bag, as they do in this case, that's a form of proprietary trading, because on the upside they're the ones who would make the profits. And the basic idea of the Volcker rule was that since these banks have access to the government safety net (if they fail, then the government supposedly has to bail them out, and they can borrow from the Federal Reserve), they should not put taxpayer money at risk for their own risky trades. That's the basic idea behind the Volcker rule.

Jay: Right. And the original rule now has been so watered down that it's not going to be meaningful, it seems. Okay. Now let's go another step in this. The political power of finance is such that it seems like no serious law or regulation can simply reform them or control them. So there's been various calls about what to do about that, and one of them is a new piece of legislation that was just introduced called the SAFE Banking Act. So what's that about?

Epstein: So the SAFE Banking Act was introduced last week by Sherrod Brown, Democrat of Ohio, and it's similar to a bill that he and Ted Kaufman of Delaware had proposed during the period of the creation of the Dodd–Frank Act. And this idea was to actually break up the banks, to get rid of banks that are too big to fail, because after all, as my colleague Jim Crotty put it, these banks have structural blackmail, they're so big. If they threaten to go under because of such risky bets, the government feels like they have to bail them out. So the basic idea is to actually break up the banks, make them smaller. So the Sherrod Brown safer reform act of 2012 puts a very strict limit on the leverage that banks can have, 10 percent, and also limits how big the bank liabilities can be relative to the size of the economy. It's a very good idea. It's actually a fairly modest proposal the way it's written now. It hasn't gotten much attention yet, but because of the JPMorgan debacle, I think it's going to get more attention, and it really should be supported.

Jay: And it would seem to me completely naive to think that if JPMorgan Chase is allowing such risks, that all the other big banks aren't doing exactly the same thing. If there's profit to be made there, you know, the banking sector, big finance sector is not going to allow one bank to do it and the others not jump on it. So this problem is we're back to the same level of systemic risk in all likelihood, are we not?

Epstein: Yeah. I mean, if the financial crisis and the reforms that were supposed to have occurred did one thing, it should have shed light on these financial markets, it should have created transparency, so we wouldn't be in a situation where we don't know the risks that all these banks have. This leads to enormous uncertainty in the financial markets and could possibly lead to bank runs again and financial meltdowns as we had before. Who knows? But we don't have the transparency that we should have gotten.

And part of the problem is that President Obama really has not made this a top priority. The Frontline documentary on the financial crisis showed that when he had a lot of leverage over the banks, he didn't do anything with it, presumably because he was trying to get financial support from the banks. Well, the banks are giving their financial support mostly to Mitt Romney. So now we have the worst of both worlds for Obama. He not only did not get the financial support from the banks, but he didn't regulate the banks. And this is the situation we have found ourselves in.

Jay: So, then, what does that mean for the rest of us, in terms of what we should be imagining, envisioning, demanding? Some people—and we've discussed this before, that, you know, if you can't really get effective regulation passed, does there not need to be some campaign for public banking to actually create an alternative banking system to break this blackmail?

Epstein: Yes. Two things. One, break up the banks so that if they fail, then that's their problem and it won't be so much our problem. So the Sherrod Brown kind of legislation, perhaps legislation even stronger than that. And two, the strong promotion of what some of us call finance without financiers, that is, public banks—go to the Demos website. They have a lot of information on state banks and other public banks, cooperative banks. The Occupy Wall Street is proposing we—completely reforming the financial system with public banks. This is really where we have to go, along with breaking up the banks that we have.

Jay: Thanks for joining us, Gerry.

Epstein: Thank you.

Jay: And thank you for joining us on The Real News Network.

This piece was reprinted by Truthout with permission or license. It may not be reproduced in any form without permission or license from the source.

Paul Jay

Paul Jay is CEO and Senior Editor of The Real News Network. As Senior Editor of TRNN Paul has overseen the production of over 4,500 news stories and is the Host of our news analysis programming. As Executive Producer of CBC Newsworld's independent flagship debate show counterSpin he produced over 2,000 shows during its 10 yrs on air. He is an award-winning documentary filmmaker with over 20 films under his belt and was founding Chair of Hot Docs!, the Canadian International Documentary Film Festival (now the largest in North America).


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Two Billion Dollar Tip of Banking Iceberg

Tuesday, 15 May 2012 11:12 By Paul Jay, Real News Network | Video Interview

Gerald Epstein: J.P. Morgan debacle shows systemic risk unchanged; breaking up big banks, reform Fed and public banking urgently required.

TRANSCRIPT

Paul Jay, Senior Editor, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington.

As we've discussed many times on The Real News Network, no serious financial reform has yet to be enacted in the United States. The Dodd–Frank bill has been eviscerated. It depended very much on the issue of regulation, and the agencies that are supposed to regulate are being underfinanced, and the regulations are being lobbied to nothingness. The latest debacle now is JPMorgan Chase has apparently lost at least $2 billion—I stress at least, 'cause it's still not fully known, the scope of this, and it's not known how far and wide this practice and this debacle goes throughout the industry.

Now joining us to discuss this, JPMorgan's latest case, is Gerry Epstein. Gerry is codirector of the PERI institute in Amherst, Massachusetts. He's also coeditor of a new volume that will be coming out this fall on political economy and the financial crisis. Thanks for joining us, Gerry.

Prof. Gerald Epstein, PERI, UMass Amherst: Thank you, Paul.

Jay: So what do we know so far about the facts of this case?

Epstein: Well, what we know is that there was an office of—supposed to be a risk management and investment office in London, a branch of JPMorgan Chase that was undertaking some bets that was moving markets, became very risky. As of a month or so ago, we knew that there was a trader there that used to—they were calling the London Well or Voldemort because he was taking such huge bets he was moving the markets, and that those bets have now turned sour and still have not been played out and could be losing at least $2 billion, and some people have estimated up to $4 billion.

Jay: Now, these bets are in these what they call dark markets, derivatives markets?

Epstein: That's right. This was a very complex set of bets, first designed, supposedly, to hedge some investments they had made in corporate bonds. But then the bank started writing some credit default swaps protection on these. Those are the same instruments that were at the core of the financial meltdown we had in 2008. And this office was becoming a profit center for the bank, rather than a center to hedge risk, and it was clearly a proprietary trade on the part of this office.

Jay: And what were they—they were betting, what, that these corporate bonds would go up, that the value of the bonds would go up?

Epstein: That's right. Essentially it was a bet that things were getting better, things were turning around, these big corporate names like General Electric and Ford and other corporate names, their profits would improve. And the hedge funds on the other side began to smell blood. They began to see that their bets were too big and that they couldn't—JPMorgan Chase couldn't unwind these bets without actually dropping the prices even further. So these hedge funds started betting against them, and these hedge funds won.

Jay: So we're back in casino capitalism. I shouldn't say back, 'cause we've actually never been out of it. And that is the story, isn't it? We've never been out of casino capitalism, in spite of the Obama administration and others suggesting there has been financial regulation. So what is the state of this?

Epstein: That's right, it's casino capitalism, plus it's being paid for by low-interest loans from—almost zero interest loans from the Federal Reserve. And so these banks can borrow money at almost zero percent, and instead of investing the money in the real economy, they're taking these wildly speculative bets. Jamie Dimon, the head of JPMorgan Chase who's supposedly this great risk manager, in fact was turning a blind eye to these big, extremely risky bets while at the same time lobbying very heavily against financial reform, against the Volcker rule, against controls of derivatives. The bank bank paid over $7 million last year on lobbying fees to gut these rules. He was the point man for Wall Street fighting against Dodd–Frank.

Jay: And I think it's important to note that Dimon is also a member of the New York Fed, alongside most of the leading CEO bankers on Wall Street, and the New York Fed is also supposed to be the one that oversees the bankers, which is kind of ridiculous. And some people have called for Dimon to resign from the Fed, which I guess is a good thing, but it doesn't structurally change anything.

Epstein: Well, it is an outrage that the Dodd–Frank Act put so much of the power back in the hands of the Fed, along with this financial—the FSOC group of regulators, to really look at these large banks and to try to reduce their risk, while at the same time among their major advisers are the banks themselves. So, yes, Elizabeth Warren and others have called for Jamie Dimon to resign. But structurally, as you suggest, what we need to do is really insulate the regulators from these bankers.

Jay: So what is the state, then, of the Volcker rule? The Volcker rule, as originally proposed, would it have prevented this? And the Volcker rule, as what's left of it, does it actually allow this?

Epstein: Well, that's a good question. I think most—since we don't really know precisely the details of the trade, it's a little hard to answer that question with any degree of precision. But most people think that the original and—certainly the original intention of the Volcker rule was to stop all of his proprietary trading. There could be hedging, but it had to be risk-reducing hedging. As Marcus Stanley of the Americans for Financial Reform put it in his blog piece, this was clearly risk-increasing hedging. Hedging is not supposed to be a profit center. It's supposed to offset potential losses elsewhere. But they were seeing these kinds of bets as a profit center.

Jay: So let me just quickly, for people—.

Epstein: Let me just say one other thing, which is that, however, as the rules have been eviscerated, as you put it, over time, with the lobbying of the banks, the current rule as it seems like it would be put in place perhaps might have allowed this kind of trading, because the rule is so vague. It allows so-called portfolio hedging, which means that the bank can try to offset any kind of risk with some kind of hedges someplace else. But there are no perfect hedges.

Jay: And if there's no transparency, who knows if they're really offsetting or just betting?

Epstein: Correct. And since they don't have to really report even now precisely what they were doing, there's no transparency at all.

Jay: So just quickly for people that are not following this as much as we do, proprietary trading is when a bank takes its own money and it goes out and makes a bet, rather than just becoming a middleman between two other players that want to bet against each other. So they're putting the bank's assets at risk. Right?

Epstein: That's right. So whenever the banks own assets or risk, when they end up holding the bag, as they do in this case, that's a form of proprietary trading, because on the upside they're the ones who would make the profits. And the basic idea of the Volcker rule was that since these banks have access to the government safety net (if they fail, then the government supposedly has to bail them out, and they can borrow from the Federal Reserve), they should not put taxpayer money at risk for their own risky trades. That's the basic idea behind the Volcker rule.

Jay: Right. And the original rule now has been so watered down that it's not going to be meaningful, it seems. Okay. Now let's go another step in this. The political power of finance is such that it seems like no serious law or regulation can simply reform them or control them. So there's been various calls about what to do about that, and one of them is a new piece of legislation that was just introduced called the SAFE Banking Act. So what's that about?

Epstein: So the SAFE Banking Act was introduced last week by Sherrod Brown, Democrat of Ohio, and it's similar to a bill that he and Ted Kaufman of Delaware had proposed during the period of the creation of the Dodd–Frank Act. And this idea was to actually break up the banks, to get rid of banks that are too big to fail, because after all, as my colleague Jim Crotty put it, these banks have structural blackmail, they're so big. If they threaten to go under because of such risky bets, the government feels like they have to bail them out. So the basic idea is to actually break up the banks, make them smaller. So the Sherrod Brown safer reform act of 2012 puts a very strict limit on the leverage that banks can have, 10 percent, and also limits how big the bank liabilities can be relative to the size of the economy. It's a very good idea. It's actually a fairly modest proposal the way it's written now. It hasn't gotten much attention yet, but because of the JPMorgan debacle, I think it's going to get more attention, and it really should be supported.

Jay: And it would seem to me completely naive to think that if JPMorgan Chase is allowing such risks, that all the other big banks aren't doing exactly the same thing. If there's profit to be made there, you know, the banking sector, big finance sector is not going to allow one bank to do it and the others not jump on it. So this problem is we're back to the same level of systemic risk in all likelihood, are we not?

Epstein: Yeah. I mean, if the financial crisis and the reforms that were supposed to have occurred did one thing, it should have shed light on these financial markets, it should have created transparency, so we wouldn't be in a situation where we don't know the risks that all these banks have. This leads to enormous uncertainty in the financial markets and could possibly lead to bank runs again and financial meltdowns as we had before. Who knows? But we don't have the transparency that we should have gotten.

And part of the problem is that President Obama really has not made this a top priority. The Frontline documentary on the financial crisis showed that when he had a lot of leverage over the banks, he didn't do anything with it, presumably because he was trying to get financial support from the banks. Well, the banks are giving their financial support mostly to Mitt Romney. So now we have the worst of both worlds for Obama. He not only did not get the financial support from the banks, but he didn't regulate the banks. And this is the situation we have found ourselves in.

Jay: So, then, what does that mean for the rest of us, in terms of what we should be imagining, envisioning, demanding? Some people—and we've discussed this before, that, you know, if you can't really get effective regulation passed, does there not need to be some campaign for public banking to actually create an alternative banking system to break this blackmail?

Epstein: Yes. Two things. One, break up the banks so that if they fail, then that's their problem and it won't be so much our problem. So the Sherrod Brown kind of legislation, perhaps legislation even stronger than that. And two, the strong promotion of what some of us call finance without financiers, that is, public banks—go to the Demos website. They have a lot of information on state banks and other public banks, cooperative banks. The Occupy Wall Street is proposing we—completely reforming the financial system with public banks. This is really where we have to go, along with breaking up the banks that we have.

Jay: Thanks for joining us, Gerry.

Epstein: Thank you.

Jay: And thank you for joining us on The Real News Network.

This piece was reprinted by Truthout with permission or license. It may not be reproduced in any form without permission or license from the source.

Paul Jay

Paul Jay is CEO and Senior Editor of The Real News Network. As Senior Editor of TRNN Paul has overseen the production of over 4,500 news stories and is the Host of our news analysis programming. As Executive Producer of CBC Newsworld's independent flagship debate show counterSpin he produced over 2,000 shows during its 10 yrs on air. He is an award-winning documentary filmmaker with over 20 films under his belt and was founding Chair of Hot Docs!, the Canadian International Documentary Film Festival (now the largest in North America).


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