The Unbiased Eye

A scientist's commentary on events and culture

The Incredible Gloom After a Long Night of Gambling

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Gambling is a weird thrill. You’re not into it unless you play until you lose. When you step back, it’s dumb and self-destructive, but as long as you’re in the game, it’s exciting.

My acquaintance with gambling isn’t much. I played in regular poker games a couple times over the years, I’ve been to the race track a couple of times and I once went to Atlantic City. The results were always the same: Total loss.

Jamie Dimon

Jamie Dimon of JP Morgan Chase

I thought about that when reading about the $2 billion trading loss at JP Morgan Chase and trying to figure out what happened. The big guy at the bank, Jamie Dimon, a $23 million-a-year man, set up a conference call with Wall Street analysts to explain. Anyone can listen to it.

The bank was gambling, but it wasn’t anything like anything I’d do. Dimon readily admitted that the bank did something stupid. He didn’t go into detail, but he said the $2 billion loss might grow by a few more billions in the next two quarters, as the bank tries to extract itself from its risky bets. Dimon pointed out that the loss was not large enough to wipe out the bank’s profit, and he proceeded to promise that the bank would not do “something stupid” while it clears away these gambles from the bank’s books.

Granted that I’m not in command of accounting and Wall Street jargon when I listen to this kind of thing, but a lot of that sounds like what they call hand waving in my own field: When a learned professor can’t or won’t explain something difficult or embarrassing, he slams down the chalk, waves his hands and declares, “The rest is obvious.”

Dimon steadfastly refused to go into specifics. The news media is often of no help at all. A lot of the writing is along the lines of an ABC News report that says: “This gets back to the topic no one wants to talk about, and possibly no one understands. Synthetic derivatives – Credit Default Swaps.” The article says the amount of money in the derivatives market amounts to $700 trillion — more than all the money in the world. The author says, “No one we have spoken to over the years has explained how this is possible.”

Ina Drew

Ina Drew, JP Morgan Chase

When I worked for newspapers, no one in the newsroom ever seemed to know how to figure out percentages. That didn’t mean no one in the world knew how to do it. Someone can explain it in all the gory details.

Since the meltdown in 2008, I’ve tried to educate myself, and I think I understand what these credit default swaps are, and what the huge numbers stand for. They are side bets, lots of them, not directly connected to concrete investments, but to the fate of the value of those investments. They behave like insurance. In the JP Morgan Chase case, the bank was selling insurance that groups of loans wouldn’t go bad — i.e. default.

Since the odds of failure for some big collection of loans, packaged by Wall Street and sold to investors, are low, the person who holds the loans and collects the interest can buy insurance for a relatively small percentage of total value. In the current case, The Wall Street Journal reported that bond holders could protect $10 million of bonds representing corporate debt for a year for $112,000, or a little over 1%. JP Morgan was selling this insurance aggressively, collecting these 1% fees where they could. It was easy money. The bond holders paid a little for peace of mind — another way of saying it was that they hedged the bets they made by buying the original $10 million bonds.

People refer to these maneuvers as casino capitalism. It’s not a good analogy. If you walk into a casino with $112,000, you could lose it all on the roulette wheel, but no more. A casino pays out around 80% of everything bet, and no more. In the JP Morgan case, the bank is the casino and for every $112,000 bet, the payout could be $10 million. That could make short work of the bank’s capital, and lead to a total collapse. What’s worse, if a casino fails, its investors lose; if a bank fails, the whole country loses.

The point of regulating banks is to prevent this outrageously risky calculation by the institutions that lie at the heart of the global economy. Dimon says there’s no need for regulation. He admits doing something stupid, but promises never to do another stupid thing again. Not he or any of the people working for him. I wouldn’t pay someone $23 million a year, let him lose $2 billion and then say, “Whoops! I’ll never do that again.”

Here’s this man, not elected by anyone, not accountable to anyone, playing with our fate. The big banks hold the fate of the economy in their hands. Just four years after a tidal wave of speculation just like this deal by these giant, unregulated banks nearly sank the economy, they got caught doing exactly the same thing. In arguing against government regulation, Dimon hold up the Dimon principle. Huh?

Financial reporters are now writing that Ina Drew, the chief of the JP Morgan department that lost this money, and her entire London crew would be fired. This group controlled $350 billion in bank assets. She earned $14 millon in total compensation last year, according to reports. Pretty good for a fall guy.

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Written by theunbiasedeye

May 13, 2012 at 11:49 pm

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