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Wall Street Rivals Fret About Tougher Regulation, Possible Credit Downgrades
J.P. Morgan Chase & Co.'s (JPM) trading debacle is causing employees to worry it will unfairly tarnish their reputations, while deepening concerns at rival financial firms about tougher regulations and potential rating downgrades.
On Friday, J.P. Morgan sent a memo to employees with advice on how to respond to questions from clients and customers about the mess in the New York company's Chief Investment Office. One strategy, according to a person who saw the memo: Stress the company's strong financial position. The bank has issued similar notes to employees at other critical times, such as at the height of the mortgage meltdown.
Nevertheless, investment bankers at J.P. Morgan are particularly unhappy about last week's disclosure, partly because some clients might mistakenly think the losses occurred in the investment-banking unit, people familiar with the matter said. J.P. Morgan's investment-banking operations and Chief Investment Office operate separately.
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In addition, some investment bankers "are incredibly frustrated" because senior executives from the unit are being relied on to help fix the mess, one person familiar with the matter said.
Executives at other Wall Street firms are privately expressing concern that J.P. Morgan's problems could cause their firms trouble, too. Even before Thursday's announcement, financial firms were on the defensive for trying to dilute new rules that aim to limit such proprietary trading. Big firms already are overhauling their operations in advance of such rules, but now they are likely to face even more pointed questions from lawmakers, investors and analysts.
Another worry: The mess might give more ammunition to Moody's Investors Service, the credit-rating firm that is weighing widespread downgrades that could force some banks to post billions of dollars in additional collateral.
The deepening turmoil overshadowed the normal competitive delight that bankers typically express when a rival gets into trouble. J.P. Morgan has been one of the strongest banks through the financial crisis, generating fury and jealousy from bankers at other firms hobbled by the crisis.
That is the case at Goldman Sachs Group Inc., one of J.P. Morgan's most powerful rivals. Goldman employees have long described Chief Executive James Dimon as untouchable, comparing his blunt and aggressive approach with that of Goldman CEO Lloyd Blankfein, who has irked lawmakers and stoked populist ire with his long and complex explanations of trading and his often obtuse sense of humor.
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"No one is happy; no one is gleeful," said one official at a rival bank, adding that J.P. Morgan's trading loss had come "at the worst possible time."
J.P. Morgan's troubles are in its Chief Investment Office, a small group that manages the bank's money with the strategy of making a return that exceeds the firm's cost of capital.
Over the weekend, rival banks scurried to explain why they believe a similar trading loss couldn't happen at their firm. Some companies pointed to moves already taken to reduce risk and sell off volatile and opaque assets such as derivatives on credit indexes.
Citigroup Inc. (C) has a centralized office that reports to its treasurer to hedge liability risks for the New York bank but doesn't have a single group that handles the big macroeconomic bet that backfired on J.P. Morgan. But the bank, led by CEO Vikram Pandit, is unwinding the small amount of macro hedging it does, such as buying protection against a double-dip U.S. recession, people familiar with the situation said.
In a statement, Citigroup "has a small amount of straight-forward economic hedges managed at the corporate center to mitigate our credit exposure, principally relating to consumer loans." About half of that total is in cash, with most of the rest in U.S. Treasury bonds and other conservative investments.
At Morgan Stanley (MS), the portfolio most similar to J.P. Morgan's investment office is a $32 billion "available for sale" portfolio. The portfolio primarily consists of easily traded U.S. Treasury and government agency securities. It doesn't hold any derivatives instruments, a person familiar with Morgan Stanley's operations said.
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Goldman Sachs has no similar unit to the one at J.P. Morgan that suffered the loss.
This type of activity, where banks manage their assets and liabilities, is largely exempt from the new restrictions, known as the Volcker rule, as it is currently understood, said some Wall Street executives.
The new rule is slated to take effect this summer, although details of trading activities that would be exempt still are being worked out. In response to the trading loss at J.P. Morgan, some lawmakers have vowed to redouble their efforts to narrow the exemption.
The J.P. Morgan loss also is refocusing attention on proprietary trading, which has been under attack from lawmakers. Goldman and Citigroup already have unwound their proprietary-trading desks, while Morgan Stanley still has one proprietary-trading operation, a quantitative desk called Process-Driven Trading. Morgan Stanley has announced plans to dispose of that trading desk by year end.
Goldman is pulling out its own money from the hedge funds run by the firm's asset-management unit. Some of that activity would likely be prohibited under the Volcker rule.
Goldman still manages a portfolio of debt investments run by a unit called the Special Situations Group, but that group's investments wouldn't run afoul of the Volcker rule because they are lending commitments, people familiar with the portfolio have said.
—Suzanne Kapner contributed to this article.
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