The $2 billion and counting that JPMorgan Chase's chief investment office recently lost in London has turned the spotlight on CEO Jamie Dimon's seat on the board of the Federal Reserve Bank of New York, better known as the New York Fed. Dimon is due to testify on Capitol Hill starting on June 13, and things could get ugly.
It's about time Dimon felt the heat over his board seat. As one of 12 regional reserve banks that make up the Federal Reserve, the New York Fed's responsibilities include regulating big Wall Street banks like JPMorgan and Goldman Sachs. If Dimon sitting on the organization's board sounds like a conflict of interest to you, you're right: Nearly four years after the implosion of Lehman Brothers triggered a global economic meltdown, the fox is still guarding the henhouse.
JPMorgan's trading loss has already prompted many calls for Dimon's ouster from the Fed board. Treasury Secretary Timothy Geithner, who previously headed the New York Fed, conceded in mid-May that Dimon had a "perception problem," and Senate Democrats have explicitly called on the JPMorgan chief to step down from the board. In late May, Esther George, the president of the Kansas City Fed, made the same point more obliquely, noting that "when an individual no longer meets these [high] standards, the director resigns voluntarily to allow someone who does meet the criteria to serve."
I couldn't agree with George more. At the same time, her suggestion brings up a larger point: Why stop at Dimon? The entire system by which Wall Street banks are regulated needs to change, and urgently.
On June 13 and 19, Dimon will testify in front of the Senate Banking Committee and the House Financial Services Committee and be asked to explain his losses. It won't be easy. Many details of the loss-generating credit trades that JPMorgan -- the largest bank in the United States by assets -- engaged in remain unknown. And for good reason: The more information becomes public, the harder it will be for JPMorgan to unwind the deal. (Why? Because if you know which contracts the bank must dump, it's easy to wait for the price of the contracts to drop, thus adding to JPMorgan's losses.)
From the few snippets of information that have become available since the trading loss was first reported in May, it is clear that the bank's chief investment office bought so many contracts in certain credit indices that it was distorting the market. (Credit index here is shorthand for credit-default-swap index, the opaque and under-regulated "insurance policies" blamed by many for the 2008 financial crisis.) Credit-default swaps (CDSs) do not require that the owner of the derivative contract actually stand to lose from a credit default. When CDSs lack such an insurable interest they are considered "naked" -- the financial market's equivalent to buying insurance on your neighbor's house.
Although JPMorgan's risk positions remain obscure, one particular credit index seems to have been at the heart of the $2 billion loss: the Markit CDX.NA.IG.9. In less than a few months, the bank's position in the index almost doubled from under $80 billion to a whopping $145 billion, which makes one wonder where regulators were in all of this. The Depository Trust Company, a data warehouse, keeps information on 99 percent of all CDS trades all of which is accessible by the bank's regulators. Each and every regulator could easily have looked up who was moving the market and made further inquiries.