I attended a dinner party a while back. After the prerequisite number of cocktails, the conversation turned to politics. It was an interesting conversation, since the group was about roughly divided by liberal Occupy sympathizers and hardcore conservatives. The week's topic du jour was CEO pay, a topic that had been all over the news. Vikram Pandit of Citigroup (NYSE:C) got $15M. Brian Moynihan, CEO of Bank of America (NYSE:BAC), received $7.4M. Lloyd Blankfein of Goldman Sachs (NYSE:GS) scored $12.4 million.
One of the more liberal men started down the usual train of "Wall Street fat cat" arguments, bemoaning the CEOs' multimillion dollar pay packages as undeserved. The right wingers jumped in, pointing out that in comparison to the banks' overall profit margins, CEO pay is actually a miniscule percentage.
While I mostly tried to distance myself from the shouting match, I did offer my two cents: effective management is critical to the success of any company, and especially in today's challenging financial environment, I believe that securing strong management teams is a worthwhile investment. Furthermore, executive compensation can be rejected by shareholders if they so desire, a fact recently highlighted in the Aubrey McClendon/Chesapeake (NYSE:CHK) scandal. So as a general rule, I don't have a problem with multimillion dollar executive compensation packages.
But after recent developments, I'm wondering if the banker with the biggest paycheck really deserved it.
(Mis)Management: How Much Can We Lose?
A year-end review by Forbes ranked JPMorgan's financial health middle of the pack -- 48th out the the 100 largest US banks. But for investors following the financial sector, there are other considerations to keep in mind as well: namely, how well is the company managed? As we saw in 2008, finances can go from "fine" to "awful" in the blink of an eye. We hoped that banks had at the very least learned some lessons from the crash.
The UBS rogue trader scandal seemed like a wakeup call, to me anyway. In true armchair CEO fashion, I said that it should be a general matter of business policy that individual traders shouldn't be able to make outsized bets endangering the entire bank's finances. I figured that management at other banks would take note of the situation and make sure a similar situation didn't unfold under their noses.
Well, it did. Excessive risk-taking is not over, says Reuters. For the three people in America who live under a rock and didn't hear, JPMorgan suffered a $2 billion trading loss on oversized bets placed by a trader appropriately nicknamed "the Whale." Management of the trades, which were supposed to be a hedging strategy, were described as the following by CEO Jamie Dimon:
This was a unique thing we did. Obviously it had a lot of problems. It was a bad strategy. It became more complex, it was poorly managed.
Dimon also rattled off a few factors that caused the loss:
- bad judgment
It's no surprise that the SEC is investigating.
A loss of $2B would be concerning enough, except that it really wasn't just a loss of $2B. The loss is quickly ballooning -- current estimates are $7 to $8B. While the bank can obviously recover from a $8B loss, what it might not be able to recover from is catastrophic mismanagement. Janet Tavakoli, a derivatives expert in the consulting industry, had this to say about the situation at JPMorgan:
The real issue here is lack of oversight, reasonable standards and risk control for which Dimon is answerable. It's not about these particular trades.
The truth is that JPMorgan had little to no idea about what was going on. This isn't a situation where the bank just made a bad bet -- it's a situation where management just wasn't paying enough attention. As stated by Thomas Curry, Comptroller of the Currency:
We believe the issue was inadequate risk management within the (bank's) chief investment office. We're focusing on gaps, and looking to see if similar gaps exist in other parts of the bank.
Obviously, the results of this investigation have huge implications to JPMorgan shareholders. I can live with a company in any industry making the occasional mistake, as long as it isn't so large that their overall business is threatened. Even the great Warren Buffett makes mistakes. But those mistakes are the results of bad judgment calls -- not a systemic failure, which is what happened at JPMorgan.
Conclusion: Management Concerns Cloud JPMorgan
Strong management is especially important in the financial industry, and it's clear that JPMorgan does not have that, even in light of Dimon's testimony before Congress. Until the investigations conclude and reveal exactly how large and prevalent these "gaps" in risk management are, I'm keeping my money well away from JPMorgan. Please note that this view is by no means an attack on Jamie Dimon -- I think he is taking appropriate steps to resolve the issues, but I'm just not sure at this point if those steps will be enough.
JPMorgan's stock price may have survived the financial crisis better than other banks, but with the depth and breadth of mismanagement problems as of yet unknown, I don't see JPM as a buy. I believe better long-term opportunities can be found in other companies with strong management -- for example, Bank of America, which I've written about previously. Another good option is Wells Fargo (NYSE:WFC).
Disclosure: I am long (BAC).