Normally we see the gory details only after a firm collapses, like Enron or Lehman, when vultures tear open its guts to fight over shriveled assets that had appeared fat and healthy on paper, and some of them had been written up repeatedly to create—which our accounting system encourages us to do—paper income.
Other outfits get bailed out. JPMorgan among them. A distinction made behind closed doors. They still have hollowed-out balance sheets … and the certainty, if they’re large enough, that the Fed and the Treasury, or central banks and government agencies around the world, will prop them up at a moment’s notice. Confidence is required to keep the scheme going. Once confidence fades, the scheme collapses, and central banks have to print trillions and hand them to the industry so that confidence will reassert itself, and so that the scheme can be driven to the next level. And yet, it’s all about prosaic accounting.
Accounting rules allow the use of estimates to value many assets. And estimates can be written up. If a trader or an executive imagines that an asset has increased in value, he’ll set in motion a chain reaction that will cause the company to make the adjustments, increasing the value of the asset with one entry and increasing by the same amount an income account. It’s all good. Asset value goes up, profit goes up. Trader bonus goes up. Manager bonus goes up. CEO bonus goes up. Investors froth at the mouth. Earnings per share beat analysts’ expectations. A money machine. Everyone is happy. Even regulators, their banks being strong and profitable. Halleluiah.
Until it blows up. So, the revelation that the “London whale”—as JPMorgan trader Bruno Iksil was known due to his enormous positions—had been prodded by his boss to jack up the valuations of his trades comes as no surprise. But this time, the system got snared and exposed live. Iksil had been trading credit-default swaps in amounts so huge that they were budging the index. He lived in Paris and commuted to his office in London, on the Eurostar presumably. What is it with these French guys that are accused of gouging deep holes into the balance sheets of their mega banks?
Before him, there was Jérôme Kerviel who became famous in 2008 as the junior trader who’d lost $6 billion at French mega-bank Société Générale. Accused of a litany of shenanigans, he was condemned to five years in the hoosegow, though he claimed he was innocent and was being scapegoated. He just couldn’t prove it. Until now. And he’s fighting back.
It has been quite a ride for JPMorgan. At first, it was a loss of $2 billion, a “tempest in a teapot,” as CEO Jamie Dimon said. Then more truth seeped out, and it was suddenly $5.8 billion. And now it looks like it might spiral past $7 billion. Citing unnamed sources, the Wall Street Journal reported on the internal investigation that reviewed emails and voice communications. And these people were doing what nearly everyone is doing, nudging up asset values. With a host of beneficial side effects: increase capital ratios, boost income, goose bonuses.
The internal investigators determined that credit-trading chief Javier Martin-Artajo, who was working at the Chief Investment Office (CIO), had pushed Iksil to jack up the values of his trades—not just once, but repeatedly. And Iksil complied. Normally, this would have been no big deal, and future losses could have been swept under the complex rug of the mega bank. They tried. The called it $2 billion and a tempest in a teapot. No big deal really, just some hedging, all by the book. “The CIO balances our risks,” said CFO Doug Braunstein back when the scandal broke. It was about “protecting the balance sheet.” But it turned out to be too big to be swept under the rug.
There will be some housecleaning. And leaks to the Wall Street Journal to make clear to the world that this was a one-time event that won’t repeat itself, the handy-work of a couple of guys—who, through their lawyers, have denied any wrongdoing. New procedures would nip this sort of thing in the bud. These leaks and assorted dog-and-pony shows are part of the campaign to re-inflate the bubble of confidence without which the financial markets—and the valuations of stocks, bonds, and other instruments—would take a big hit.