The Current Situation
Looking at J.P Morgan's current situation, it is almost possible to forget that the bank's brand was once synonymous with prudence and fiscal conservatism. Though capable of taking risks, founder John Morgan was a near-perfect example of rationality.
Under Jamie Dimon, J.P Morgan (JPM) is now facing a completely different reputation. For years, J.P Morgan allegedly sold questionable mortgage-backed securities to an unsuspecting public, helping undermine the global economy in the process.
Now, yet another embarrassing scandal is winding its way through the public's consciousness. Reportedly, J.P Morgan has just ironed out another settlement to avoid criminal charges from the United States Department of Justice. This time, J.P Morgan stands accused of failing to speak out upon discovering alarming facts about Bernie Madoff's history-making pyramid scheme.
To avoid criminal prosecution for this lapse, JPM has reached a deal to pay $2 billion to the Department of Justice and other regulators. Since Madoff banked with JPM, the bank may have had all of the information it needed to ascertain Bernie's true motives.
JPM's History with Madoff Securities
At one time, Madoff was known as one of the nation's most successful investors and wealth managers. Under his stewardship, Madoff Securities became the sixth-largest market maker on Wall Street. Today, Madoff is the most notorious white-collar criminal in history. In 2009, Madoff was sentenced to over a century in prison for bilking investors out of billions of dollars.
Apparently, JPM had questions about Madoff Securities long before Bernie's arrest. JPM staffers should have raised these concerns with federal regulators by filling out a form known as a suspicious activity report. Leaked emails between JPM staffers show that the organization had plenty of suspicions about the fundamentals of Madoff's operation. Instead of taking responsible action, JPM chose to quietly reduce its involvement in Madoff's Ponzi scheme. From October 2008 until Madoff's momentous arrest, JPM reduced its exposure by over $300 million. Though the facts of this disengagement are undeniable, it still isn't clear if JPM analysts realized Madoff's fund was a truly criminal enterprise. Publicly, there is no "smoking gun" for the Department of Justice to bring an unstoppable case against JPM. However, Dimon's willingness to pay $2 billion to make the issue go away is telling.
Criticism of Jamie Dimon
At this point, J.P Morgan has paid several huge fines to settle civil and criminal investigations; indeed JPM has faced so many recent controversies that it is sometimes difficult to keep track of them all. J.P Morgan's CEO, Jamie Dimon is at the center of a virtual firestorm of criticism. It remains to be seen whether Dimon will ever regain his status as an example of sterling leadership and whether he can maintain his highly paid job in 2014.
Too Little, To Late for Regulations?
Most assuredly, the U.S government will tout JPM's new fine as a testament to federal vigilance. However, it is arguable that these measures are coming too little, too late. After over a decade of lax enforcement, regulators have encouraged Wall Street to develop a culture of impunity and lawlessness. While multi-billion dollar fines might seem massive to ordinary people, they aren't large enough to truly discourage the largest banks from taking irresponsible actions. Many wonder if the threat of jail is the only incentive that can keep Wall Street honest. As long as it is cheaper to pay the occasional fine than change, ethically challenged financiers will continue their questionable practices.
In the 1990s and early 2000s, financial deregulation was the order of the day in the U.S banking sector. Purportedly, these changes were meant to make financial institutions more flexible and competitive. Today, the mainstream consensus holds that deregulation was rolled out too quickly and without proper oversight. Until these gaps in regulatory oversight are corrected, the public will stay wary of fully engaging with investment markets. Ultimately, proper oversight is the best way to promote greater economic freedom and development.
The Next Step
Bernie Madoff, Jamie Dimon and their ilk do not represent the true potential of American capitalism. At their best, investment banks and hedge funds help ordinary people by driving the modern economy forward. JPM's latest fine is a good first step towards holding out-of-control banks responsible for their actions. If and when regulators take decisive action against white collar crime, the U.S population will finally feel confident enough to fully engage with the investment economy.
What Should Investors Do
Investors should continue to take some profits in the mega banks like JPM, our Bank of America (BAC) and Citigroup (C) and reallocate the money to banks like U.S. Bancorp (USB) which Goldman Sachs recently added to their conviction list, PNC Financial (PNC) and Berkshire Bank (BHLB) which we have recently rated as our top banking pick for 2014. See recent article here.
These financial institutions have good management, don't have the legacy issues of the mega banks and they pay their shareholders a solid and fair dividend.
Investors also need to consider that mega banks have not always performed well during periods of rising rates which could continue to occur in 2014.