JPMorgan Chase chief Jamie Dimon’s admission last week that the bank blew $2 billion — maybe mor
e — on a “terrible egregious” trading mistake isn’t just a warning that President Obama hasn’t fixed finance. It’s also one that Gotham remains dangerously dependent on a business that’s still one desperate day away from catastrophe. Next year’s mayoral candidates need to be wise to the risk — and plan accordingly.
The bank’s blunder shouldn’t have been a surprise. In the decade before the 2008 financial crisis, Wall Street doubled its annual profits — to $20.9 billion — by making massive bets.
As Wall Street regroups, the industry’s remaining shareholders won’t hear of lower profits. Because shareholders of firms like Lehman Brothers took big losses in 2008, they want even bigger profits now. The week before JPMorgan’s loss, the chiefs of all the big banks announced so-so earnings and promised shareholders that profits would rise — somehow.
But how? The economy isn’t so great — so such staid business lines as providing advice to companies are slow. Bankers need to do something — so they take bigger gambles.
A 2-week-old report from SNL Financial, analyzing banks, highlights the problem. Last quarter, JPMorgan saw its revenues from more old-fashioned businesses drop by 23 percent compared to the same time last year — and that’s unacceptable to shareholders.
JPMorgan lessened the blow because revenue from other activities, including the far more risky trading business, fell by only half that figure.
Such figures explain why Dimon looked the other way while some folk in London took a trading shot. The bank’s London office created a financial instrument — a kind of “insurance” — that other financial firms could buy to protect against the possibility that companies would default on debt.
JPMorgan figured that if it could create enough of the stuff, it could control the market — and reap the profits. But some other folks were smarter than its traders.
Dimon said that the bank was trying to reduce its risk, not raise it. But banks are already vulnerable to the risk that companies will default on their debt. They lend money, remember? Taking on more such risk — in fact, creating it — hardly constitutes prudence.
Nor can the bank easily fix the mistake. Now that the product exists, JPMorgan can’t simply conjure it away. The bank may have to create some other instrument, which could carry new problems.
It’s not as easy as selling a money-losing stock. It’s like a trip with Alice in Wonderland.
What JPMorgan did still makes sense, however. The company wanted to make a profit on this trade, and maybe if its traders were just a bit cleverer and more secretive about what they were doing, so others couldn’t so aggressively bet against them, they would have. If Dimon was announcing a $2 billion gain, nobody would ask questions. Shareholders would be thrilled, and regulators wouldn’t know better. That’s capitalism.
New York needs to plan for this rational “insanity,” however. As Wall Street struggles not to shrink, it will make more Hail Mary passes — sometimes winning, sometimes losing.
That means New York’s next mayor can expect even wilder swings in tax revenue — one year, too much; the next year, not nearly enough.
It takes enormous discipline to run a budget in such an environment. What if, one spring, revenues come in higher than expected because the Alice-in-Wonderland bets are working out and the bankers are in good moods?
Will the next mayor stash the money — or will he or she give it to the “advocates” who will want everything from retroactive raises for city unions to more after-school programs?
And despite Wall Street’s best efforts, we’re likely to have more lean years than salad days.
The next mayor already faces a $3.5 billion deficit — one that could quickly double if he or she makes promises to give years’ worth of retroactive pay raises in return for union support. (Mayor Bloomberg hasn’t given out raises since shortly after Lehman collapsed.)
New York’s would-be mayors could avoid that bad trade now, by standing together and saying that they agree that the city can’t afford retroactive raises, so let’s get it off the table.
Dimon would love such an easy fix for his problems.
But New York pols have the same problem that Wall Street execs have: They can’t help themselves, and they’re not sure they want to.
Nicole Gelinas is contributing editor to the Manhattan Institute’s City Journal.
@nicolegelinas