What have we learned from the JPMorgan (NYSE:JPM) "London Whale" implosion, which has threatened America’s largest bank and could lead to another credit crisis?
Well, the most important thing we've discovered is that it is certain to happen all over again unless Wall Street abruptly changes its compensation practices.
According to the New York Times description of the risky trade in an articled authored by Azam Ahmed, the London Whale received a $40 million bonus for placing the risky bet, which at one point was profitable. After it declined and resulted in at least a $2 billion to $3 billion loss to JPMorgan, the London Whale exited and swam away with his $40 million. There were no consequences to him. Indeed, the investment community should expect him to resurface at some point at another brokerage firm or, more likely, an unregulated hedge fund.
Interestingly, the other side of the trade was a hedge fund manager named Boaz Weinstein who has made tens of millions for his firm by taking the opposite side of the London Whale's risky bet. But where did Boaz come from?
He was previously at Deutsche Bank where his own risky trade resulted in almost a $2 billion loss to the bank and contributed largely to the financial crisis. But don’t worry about Boaz, folks. He exited Deutsche Bank with a hefty $100 million-plus in bonuses and went to, you guessed it, an unregulated hedge fund.
Lest we forget, Joseph Cassano of AIG made over $100 million selling credit default swaps (CDS) on all the risky banks, including Lehman Brothers, which resulted in a collapse of the world's largest insurance company. AIG was eventually bailed out with hundreds of billions of dollars of taxpayer money. Again, there’s no need to worry about Cassano, as he is sitting on his pile of cash.
So the moral of the story is that Wall Street traders who take huge bets with company money (and eventually taxpayer money) will keep doing it over and over again because the compensation system encourages them to do so.
Interestingly enough, some of Wall Street's own are actually concerned about out-of-control pay. In a column from the New York Times earlier this week, Joe Nocera cited a recent article by Wall Street veteran Sallie Krawcheck in the Harvard Business review that links a bank's risk profile to "market oriented ideas that would almost surely pare back the complexity of risk posed by banks," Nocera explains.
"My favorite is her first one: Top bank executives and senior management should be paid in bonds as well as stocks -- and in the same percentage as the bank's risk profile," Nocera says. "Thus, as [Krawcheck] envisions it, a bank that had a dollar of debt for every dollar of equity would pay its chief executive half in debt and half in stock. But if the bank was accumulating, say, $30 of debt for every $1 of equity, the executive's pay would also be skewed 30 to 1 in favor of debt. One would be hard pressed to imagine a more surefire way to focus a banker’s mind on making sure the bank could pay back that debt."
Let's hope such ideas take hold because this ridiculous merry-go-round of Wall Street compensation must stop. If it doesn't, if the banking industry's greed is not curtailed, the American investor and tax payer will continue to suffer.
Disclosure: Zamansky & Associates are securities attorneys representing investors in federal and state litigation and arbitration against financial institutions, including JPMorgan.