Sound Lending Practices in One Simple Sentence

It never, ever ends, does it?

Our company, J.P. Morgan Chase, employs more than 220,000 people, serves well over 100 million customers, lends hundreds of millions of dollars each day and has operations in nearly 100 countries. And if some unforeseen circumstance should put this firm at risk of collapse, I believe we should be allowed to fail. As Treasury Secretary Timothy Geithner recently put it, "No financial system can operate efficiently if financial institutions and investors assume that government will protect them from the consequences of failure." The term "too big to fail" must be excised from our vocabulary.

But ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense. The goal should be a regulatory system that allows financial institutions to meet the needs of individual and institutional customers while ensuring that even the biggest bank can be allowed to fail in a way that does not put taxpayers or the broader economy at risk.

The solution is very simple, but you will notice that Jamie doesn't bring it up. That's because he finds it unacceptable.

What's that solution?

Prohibit as a matter of Federal Law, and enforce it vigorously under pain of immediately dissolution, THE LENDING OF MONEY UNSECURED THAT EXCEEDS THE FIRM'S CAPITAL.

This is in fact the only way you can both end "too big to fail" and not constrain size or influence.

It is also the definition of sound lending.

It is also how lending was done prior to the banksters corrupting the government and literally usurping the sovereign credit of The United States.

As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company's failure to another and to the broader economy.

A requirement that you hold one dollar of actual capital for each dollar of unsecured obligation you have, marked to market nightly, absolutely prevents this risk.

That actual excess capital can be lost but there can be no systemic bleed-through as your capital then backs your bets in each and every instance.

While the strategy of artificial limits may sound simple, it would undermine the goals of economic stability, job creation and consumer service that lawmakers are trying to promote. Let's be clear: Banks should not be big for the sake of being big. Moreover, regardless of a company's size, it must be well managed. As we've seen in many industries, companies that grow for the sake of growth or that expand into areas outside their core business strategy often stumble. On the other hand, companies that build scale for the benefit of their customers and shareholders more often succeed over time.

Then prove it by putting your own capital at risk in each and every unsecured lending transaction. For each loan you write where the collateral is worth less than the outstanding amount of the loan, at any point in time, hold one dollar of your own capital as security against that loan's default and the bleed-through effects on the economy.

And it's not just multinational corporations that rely on such a large scale. J.P. Morgan Chase and others supply capital to states and municipalities as well as to firms of all sizes. Smaller banks play a vital role in our nation's economy, too -- but a fragmented banking system cannot always provide the level of service, breadth of products and speed of execution that clients often need. Capping the size of American banks won't eliminate the needs of big businesses; it will force them to turn to foreign banks that won't face the same restrictions.

Yes, and JP Morgan/Chase will allegedly bribe states and municipalities (aka Jefferson County Alabama) to "obtain" that business and earn a 400% profit beyond the market rate too. Yes, I know, you didn't admit guilt in the "settlement", but you did pay $75 million and forfeit another half-billion+ in termination fees. Is it "usual and customary" for your company to pay nearly three quarters of a billion dollars in forfeits and fines when you did nothing wrong? Our states and municipalities would be far better off without your firm's "services."

Global economic growth requires the services of big financial firms. It also requires that big financial firms be allowed to fail.

ONE DOLLAR OF CAPITAL FOR EACH DOLLAR OF UNSECURED LENDING, MARKED TO MARKET NIGHTLY.

A one-sentence Bill that, were it to become law, would instantly end "too big to fail" and yet let you grow as large as you'd like - provided you are gambling with your own money and not the sovereign credit of The United States.

Comments

[mzobian:]

Some good thinking there, but bank lending is unfortunately not as simple as that rule. (I wish it were.) Experienced bankers will raise two problems with it immediately: 1) collateral values themselves are not always dependable (see our recent mortgage crisis), and 2) unsecured loans often depend on guarantors in lieu of collateral, the value of that guarantee often being even less certain than the value of any collateral.

Instead of trying to simplify capital requirements into a sound bite, we should just make them more robust. Some sensible ideas, already being considered in Congress: raise minimum capital levels (say, 8% Tier 1/RWA, up from the current 5%) AND Tier 1 and Tier 2 capital must be "contingent", ie, readily convertible to common equity, when capital levels fall below the minimums. A futher idea is to hold "too big to fail" companies to higher minimums, the rationale being that they represent a higher unexpected risk and thus need additional capital to cover it. Defining T.B.T.F. is a whole other topic, but it can be done rationally and fairly.

Nov 13 06:55 PM

[derryl:]

I like Karl's idea. It immediately separates taxpayer backstopped gambling from good old fashioned banking by putting the banker's own skin on the line. If JPM really is prepared to accept its own failure then it should be prepared to lose its own capital on every unsecured loan it makes. This restores the incentive for TBTF bankers to take a realistic look at their potential losses on loans, rather than merely seeing all the potential upside as they do now. If big business needs big banks to lend big bucks, then all parties should be prepared to lose their money, like us small fry do, if our plans go awry.

Nov 13 08:22 PM

[fizzicyst:]

Failed to mention derivatives, CDSs, trading for own account in investment bank side of business, and the like. How much capital do you require for those kinds of risks ?

Nov 13 11:31 PM

[john s. gordon:]

author is proposing the end of go-go banking (and good riddance).
the gamblers will now have to go elsewhere to gamble.
suggest las vegas.
> jack

Nov 14 10:03 AM

[User 494952:]

Thank you very much for a real idea. Interesting points but I wonder if they will work without being gamed and the blind eye of DC. Some here seem to think themselves witty and brilliant but don't seem to have a clue or present a real rebuttal. Again thanks. Tired of the BullShit


On Nov 13 06:55 PM mzobian wrote:

> Some good thinking there, but bank lending is unfortunately not as
> simple as that rule. (I wish it were.) Experienced bankers will raise
> two problems with it immediately: 1) collateral values themselves
> are not always dependable (see our recent mortgage crisis), and 2)
> unsecured loans often depend on guarantors in lieu of collateral,
> the value of that guarantee often being even less certain than the
> value of any collateral.
>
> Instead of trying to simplify capital requirements into a sound bite,
> we should just make them more robust. Some sensible ideas, already
> being considered in Congress: raise minimum capital levels (say,
> 8% Tier 1/RWA, up from the current 5%) AND Tier 1 and Tier 2 capital
> must be "contingent", ie, readily convertible to common equity, when
> capital levels fall below the minimums. A futher idea is to hold
> "too big to fail" companies to higher minimums, the rationale being
> that they represent a higher unexpected risk and thus need additional
> capital to cover it. Defining T.B.T.F. is a whole other topic, but
> it can be done rationally and fairly.

Nov 14 10:24 AM

[FB5000:]

Truly. You are an idiot.

Why don't we burn all the paper money and repalce it with gold coins while we are at it.

You would radically reduce the amount of credit, gut the economy, drive up interest rates. Small and mid market borrowoers would die on the vine. Unemployment would rise, recovery snuffed out. The banking sector would be crushed too.

I have said it before and you only just underline it every time. Explaining anything to you is like trying to teach my dog to play chess.

Go back to your cave.

Nov 14 02:27 PM

[Andrew Butter:]

Karl you are right and you are wrong

Sure lending more money than the collateral that is put up is simply gambling - banks shouldn't be allowed to gamble.

But the valuation of the collateral needs top be done properly and if you knew anything about valuation you would know that mark to market is a useless way to do a valuation that encourages banks to lend more than the collateral will be worth in the event that the loan defaults.

That's why International Valuation Standards was written over ten years and finally published in 2000, and why it is accepted by every valuation institute in the world.

And that's why bankers, banking regulators, and auditors refuse to use it,

IVS stipulates that the person doing the valuation should determine if the market is in disequilibrium or not.

If it's not the mark to market is accepatble.

If it is then that fact must be flagged, and "other than market value" should be used.

Example in 2003 it was obvious to anyone who knows about valuation that house prices were in a bubble and the market was in disequilibrium.

Yet banks used "mark to market" to value assets.

In fact when banks came to liquidate those assets (because the loans defaulted), they were not worth enough to cover the loan.

That's how mark to market does not protect and that is the ruse that banks used to "gamble".

Why not say

ONE DOLLAR OF CAPITAL FOR EACH DOLLAR OF UNSECURED LENDING, VALUED STRICTLY IN ACCORDANCE WITH INTERNATIONAL VALUATION STANDARDS.

Nov 14 03:33 PM

[TeresaE:]

You do realize if they raise the capitalization limits the results will either be MORE printed/government money and/or 50% credit card rates and ZERO business credit lines including all that exist today?

Congress is plotting our demise and is useless in regulating anything, especially those that keep their war chests and pockets lined so well.


On Nov 13 06:55 PM mzobian wrote:

> Some good thinking there, but bank lending is unfortunately not as
> simple as that rule. (I wish it were.) Experienced bankers will raise
> two problems with it immediately: 1) collateral values themselves
> are not always dependable (see our recent mortgage crisis), and 2)
> unsecured loans often depend on guarantors in lieu of collateral,
> the value of that guarantee often being even less certain than the
> value of any collateral.
>
> Instead of trying to simplify capital requirements into a sound bite,
> we should just make them more robust. Some sensible ideas, already
> being considered in Congress: raise minimum capital levels (say,
> 8% Tier 1/RWA, up from the current 5%) AND Tier 1 and Tier 2 capital
> must be "contingent", ie, readily convertible to common equity, when
> capital levels fall below the minimums. A futher idea is to hold
> "too big to fail" companies to higher minimums, the rationale being
> that they represent a higher unexpected risk and thus need additional
> capital to cover it. Defining T.B.T.F. is a whole other topic, but
> it can be done rationally and fairly.

Nov 14 04:18 PM

[TeresaE:]

Don't forget Detroit, Ohio, Atlantic City and dozens of riverboats and Native American casinos around the country.

After all, our states' treasuries need the cash too!


On Nov 14 10:03 AM john s. gordon wrote:

> author is proposing the end of go-go banking (and good riddance).
>
> the gamblers will now have to go elsewhere to gamble.
> suggest las vegas.

Nov 14 04:20 PM

[wcinvest:]

I would advise different solutions so that the country still has enough lending to have a reasonable economy. Nevertheless, lending standards do need to get tougher as a part of official government policy and not simply from weeding out the bad actors from them failing/being bought out by stronger financial institutions.

Some things that should get done.
1) At least 10% down before *anyone* can buy a house. Have most homes require at least 20% down. 10% down should be reserved for folks in special circumstances such as the military.
2) Mandate that banks and states to only offer recourse home loans. Canada is doing much better in part since they have recourse loans. Yes, if someone turns in their keys, the banks should be able to go after their future wages for the next 10 years or so and all of their current assets(jewelry, stocks, bonds, clothing) beyond 25k. They should even be allowed to go after parts of their 401k accounts if that account has more then let's say 500k in it. This is needed to fight speculation and have folks realize that society is not going to pay for their gamble that home prices will constantly increase more then inflation. The banks were not the biggest winners from the housing boom, it really was the speculators that got out in time and sold their homes to the next round of speculators. Laws must be put in place to discourage speculating on homes.
3) Real Estate agents/mortgage brokers/consumers/bank... who lie in the process of someone buying a home should go to jail and lose their licenses to operate in the industry.
4) Interest only/no documentation home loans should be outlawed. All arm loans should require at least 25% down
5) Downpayments on second homes should be at a minimum 25%. A third home should require 30% down. A fourth home should require 35% down. I know of several speculators that on 125k salaries levered up and bought 6 or 7 homes. Some of them got out in time; others didn't. But government policy should make sure that useless speculation like this is minimized since it's not in the national interest to have booms and busts in the housing sector.
6) Banks should be allowed to be involved with trading but the capital requirements for that side of the business should be fairly draconian and those employees should be subject to clawbacks.
7) The government is doing a fairly well balanced approach to cleaning up credit cards and checking accounts... Credit cards are a necessary evil since many businesses have started off from this sort of unsecured lending. Yes, many other have failed as well.


The solution to this problem is fairly simple and doesn't have to be draconian.


The US could learn a lot from Canada and other countries that didn't suffer major problems.

The poster who pointed out that some sort of independent agency should determine if the US is in equilibrium or not... I didn't know *when* it would blow up but it was obvious to me that the housing market and dotcom markets would blow up.

One thing the US government could do is implement a "trading tax" to end a good deal of speculation in the markets. The markets should be about efficiently allocating capital and not a bunch of short term bets. This would have the added benefit of actually making it easier to spot fraud. If not many people are left doing short term trades then it is even easier to identify insider trading and market manipulation.

Nov 14 05:36 PM

[Leonard C.T...:]

I like your comments. I have a web site that you might be interested in taking a look at. economysflaw.wordpress... Read Alternative Economic Stimulus Plan to start with. I think you will enjoy it. Please make a comment or e-mail me


On Nov 14 05:36 PM wcinvest wrote:

> I would advise different solutions so that the country still has
> enough lending to have a reasonable economy. Nevertheless, lending
> standards do need to get tougher as a part of official government
> policy and not simply from weeding out the bad actors from them failing/being
> bought out by stronger financial institutions.
>
> Some things that should get done.
> 1) At least 10% down before *anyone* can buy a house. Have most homes
> require at least 20% down. 10% down should be reserved for folks
> in special circumstances such as the military.
> 2) Mandate that banks and states to only offer recourse home loans.
> Canada is doing much better in part since they have recourse loans.
> Yes, if someone turns in their keys, the banks should be able to
> go after their future wages for the next 10 years or so and all of
> their current assets(jewelry, stocks, bonds, clothing) beyond 25k.
> They should even be allowed to go after parts of their 401k accounts
> if that account has more then let's say 500k in it. This is needed
> to fight speculation and have folks realize that society is not going
> to pay for their gamble that home prices will constantly increase
> more then inflation. The banks were not the biggest winners from
> the housing boom, it really was the speculators that got out in time
> and sold their homes to the next round of speculators. Laws must
> be put in place to discourage speculating on homes.
> 3) Real Estate agents/mortgage brokers/consumers/bank... who lie
> in the process of someone buying a home should go to jail and lose
> their licenses to operate in the industry.
> 4) Interest only/no documentation home loans should be outlawed.
> All arm loans should require at least 25% down
> 5) Downpayments on second homes should be at a minimum 25%. A third
> home should require 30% down. A fourth home should require 35% down.
> I know of several speculators that on 125k salaries levered up and
> bought 6 or 7 homes. Some of them got out in time; others didn't.
> But government policy should make sure that useless speculation like
> this is minimized since it's not in the national interest to have
> booms and busts in the housing sector.
> 6) Banks should be allowed to be involved with trading but the capital
> requirements for that side of the business should be fairly draconian
> and those employees should be subject to clawbacks.
> 7) The government is doing a fairly well balanced approach to cleaning
> up credit cards and checking accounts... Credit cards are a necessary
> evil since many businesses have started off from this sort of unsecured
> lending. Yes, many other have failed as well.
>
>
> The solution to this problem is fairly simple and doesn't have to
> be draconian.
>
>
> The US could learn a lot from Canada and other countries that didn't
> suffer major problems.
>
> The poster who pointed out that some sort of independent agency should
> determine if the US is in equilibrium or not... I didn't know *when*
> it would blow up but it was obvious to me that the housing market
> and dotcom markets would blow up.
>
> One thing the US government could do is implement a "trading tax"
> to end a good deal of speculation in the markets. The markets should
> be about efficiently allocating capital and not a bunch of short
> term bets. This would have the added benefit of actually making it
> easier to spot fraud. If not many people are left doing short term
> trades then it is even easier to identify insider trading and market
> manipulation.

Nov 15 12:51 AM

[Mark Anthony:]

Karl:

You are absolutely WRONG.

have you ever run a bank? If not how do you know what is sound lending practices and what isnot? Neither would the government know. So why would it be appropriate for the government to dictate what is sound lending? When does government intervention ever do any thing good to free market economy?

You must have the illusion that there could be banks that would never collapse. Such a thing does not exist. A bank that could never fail, never existed and never will. All bank businesses are inheritly risky, the question is only how big a risk there is.

I can assure you that any bank that operates at the principle as you suggested, would be closed three decades earlier than the banks that does NOT follow your suggestion. Because they simply will NOT be competitive. When a business is not competitive, it fails and goes out of business.

Lending, is inheritantly risky, there is always a certain possibility that you can not get your money back. A bank that does not lend a single penny, is absolurely safe, but such bank will be promptly closed on the first day it opens for business, because it could not generate revenue.

A bank operates on the principle of trying to maximize its revenue and maximize its attraction to both depositors and borrowers, while minimize the risks.

I think we should leave it up to the banks themselves to calculate the risks. But at the same time, there should NEVER be any government bailout of any bank failure, big or small. This is basic free market principle: You calculate your risks and you take your own risks. If you make money, it's yours, but if you lose, don't count on the public to bail you out.

As a matter of fact, I think having a FDIC is a bad idea as well. Because of the existance of FDIC, depositors are more careless about the safety of their money, because there will be some one to bail them out if the bank fails. If we do NOT have a FDIC, the depositors would scrutinize the security of their banks more closely, and they will try to diversify their riskmore. And so there will be less panic of a few banks fail.

Depositors need to understand that if they deposit money in a bank, there is a certain amount of risk that they may lose the money.This is a risk they must pay, to get paid interest. If you do not want the risk, there is always this home grown bank called your pillow bank.

If we abolish the FDIC, replacing it could be a public equivalent of pillow bank. There needs to be a central bank which accepts cash deposits. Such deposit shall receive no interest, ever, and no check shall ever be allowed to be drawn. The only withdraw is cash withdraw. As it pays no interest, it is equivalent to your pillow bank, and hence will NOT compete with privately run banks which pays interests but also bares risks.

Nov 16 04:28 AM