JP Morgan Chase recently lost an estimated $2 billion in 45 minutes of trading. The company was involved in risky, complex trades that had the potential for tremendous losses. Yet as long as they were winning on those risky bets and making profits, executives ignored the red flags and continued to gamble (Silver-Greenberg, J. and Schwartz, N.D., 2012).
The main assumption was the same as any gambler, that losses would be easily covered by their winnings. This proved to be at least partially true, as mere days later the company posted a quarterly dividend of 30 cents per share (JPMorgan Chase & Co., 2012), as well as CEO Jamie Dimon receiving 91% of the shareholder vote to remain in position and be granted a $23 million compensation package (Associated Press, 2012); it should be noted, however, that a good portion of those votes had been cast prior to the announcement of the loss.
The misguided assumptions, however, were that these ongoing risks would be acceptable to shareholders and the law. The 2008 financial crisis remains fresh in most peoples’ memories, and this has led to a renewed cry for tighter banking regulations (Wagner, D., 2012). Ina R. Drew, the company’s Chief Investment Officer, would surely not have made the decision to not only approve but encourage such risks had she foreseen that it would lead to her forced resignation. Nor would such risks been undertaken had the threat of investigation by The FBI, the Federal Reserve, the Securities and Exchange Commission and regulators in Britain been taken seriously (Serrano, R.A. and Puzzanghera, J., 2012) .
Since 1929, the world has known that finance has as much to do with public perception as it does with economic reality. Losses lead to a lack of confidence in specific firms like JPMorgan Chase, as well as in the overall market. People don’t invest. People sell off existing investments, causing prices to plummet. People withdraw their money from banks. This sort of panic leads to a downward spiral. By looking over historical data, one can get a sense of how large a loss can be borne, by a firm or the market, before people get an idea that it’s too much. If the company has lost only $1 billion, not two, would anyone blink? Half a billion? There much be a trigger point. What if the company lost $2 billion over 45 days, rather than 45 minutes? Would a slower decline have felt less dramatic, and thus sparked a less dramatic response or even been chalked up to business as usual?
Another test is to look at what past regulation of the market looked like, and what what proposed legislation would do to the way trades are conducted, and see if such things could or would happen under those rules. Right now, an executive can say that they’re playing by the current rules and everything they do is legal, but if people aren’t comfortable with those rules it doesn’t matter. By sticking to stricter guidelines, it is easier to convince shareholders, potential investors, and regulators that such a huge loss in such a short time was simply a blip, a fluke, an uncommon occurrence, rather than the inevitable result of risky practices. That would lead to greater confidence in the firm and the market, and greater stability over the long haul. Leaders in the banking industry have to learn to manage perceptions as well as numbers.
Silver-Greenberg, J. and Schwartz, N.D. (2012) Red Flags Said to Go Unheeded by Bosses at JPMorgan Retrieved from http://dealbook.nytimes.com/2012/05/14/warnings-said-to-go-unheeded-by-chase-bosses/
JPMorgan Chase & Co. (2012) JPMorgan Chase Declares Common Stock Dividend. Retrieved from http://www.marketwatch.com/story/jpmorgan-chase-declares-common-stock-dividend-2012-05-15
Associated Press (2012) JPMorgan Chase CEO Jamie Dimon wins votes on pay, chairmanship despite $2B loss Retrieved from http://www.freep.com/article/20120515/NEWS07/120515034/JPMorgan-Chase-shareholders-Jamie-Dimon-bonus-pay
Wagner, D. (2012) How will JPMorgan’s $2B loss affect banking rules? Retrieved from http://www.boston.com/news/nation/articles/2012/05/15/how_will_jpmorgans_2b_loss_affect_banking_rules/
Serrano, R.A. and Puzzanghera, J. (2012)
FBI opens inquiry into JPMorgan Chase $2 billion trading loss. Retrieved from http://www.latimes.com/business/money/la-fi-mo-jpmorgan-fbi-inquiry-20120515,0,672725.story