May 14 2012

JP Morgan: why the Whale was in London

Posted by: Nick Shaxson in: Thoughts

What a surprise – the trading unit that just blew a $13 billion hole in JP Morgan had been parked offshore, away from the scrutiny and reach of US regulators, to . . . . the City of London. No reader of Treasure Islands will be surprised at that.

The trading unit that destroyed AIG and left US taxpayers on the hook for generations was based, not coincidentally, in London.  The MF Global disaster was London-centred. On a related theme, there’s the London rehypothecation scandal, which potentially dwarfs those. Naked Capitalism, another widely read financial blog, had this to say last December:

“Banks operated in London to get around the US restriction; then rehypothecation was a massive factor in the complexity of the Lehman bankruptcy, which dragged lots ($15-$45Bn, depending on how the bankruptcy plays out) of hedge funds’ rehypothecated assets into the mess; surviving hedge funds toned down their agreements to London rehypo, in a rush.”

One of the few commentators who has taken notice of the London black hole is the widely followed blog Zero Hedge. He had this to say yesterday in the wake of the JP Morgan calamity:

“Anyone who worked in finance in the decade before Glass-Steagall was repealed knows that prior to Gramm-Leach-Bliley the megabanks just took their hyper-leveraged activities offshore (primarily to London where no such regulations existed).

The big problem (at least in my mind) with Glass-Steagall is that it didn’t prevent the financial-industrial complex from gaining the power to loophole and lobby Glass-Steagall out of existence, and incorporate a new regime of hyper-leverage, convoluted shadow banking intermediation, and a multi-quadrillion-dollar derivatives web (and more importantly a taxpayer-funded safety net for when it all goes wrong: heads I win, tails you lose).

My emphasis added. This so closely mirrors the line taken by Treasure Islands, that I wonder if he has read it. The only thing I’d add is that all these London-epicentred calamities we keep reading about are not just a phenomenon that precede the repeal of Glass-Steagall. And guess what? When Glass-Steagall was repealed, ‘competition’ from light-touch London (and potentially others) was cited as the key reason it needed to be repealed! Here is the influential Senator Charles E. Schumer, at the time:

”If we don’t pass this bill, we could find London or Frankfurt or years down the road Shanghai becoming the financial capital of the world,” said Senator Charles E. Schumer, Democrat of New York. ”There are many reasons for this bill, but first and foremost is to ensure that U.S. financial firms remain competitive.”

There will be more of these London-based black holes. The question is: when will the world’s media properly start to take note of this financial black hole, parked roughly at the geographical centre of a circle following Britain’s M25 motorway?

We need to find out more about the precise reasons why that JP Morgan unit was in London, and not elsewhere, and I hope that journalists, somewhere, will start digging properly. In the meantime, read my earlier posts about the London loophole, and weep.

Light-touch London: the Banksters’ financial centre of choice.

Fortunately, it seems that the incoming Dodd-Frank legislation in the U.S. will aim to limit the damage from London, as the Wall St. Journal reports:

“Dodd-Frank gives derivatives regulators jurisdiction over anything that affects the U.S. economy. Banks have fought hard against this provision of Dodd-Frank because it could put them at a disadvantage to foreign banks, but after American International Group (AIG) used its London desk to make infamously risky bets before the financial crisis, it’s unlikely that this provision will get tossed.”

That sounds promising. But it will be extremely leaky. And how many other countries will put in place similar version of this defence against offshore erosion? And there is this kind of stuff to worry about, too:

Levin said Dimon had argued for the repeal of Dodd-Frank and is also against regulation of derivatives and greater oversight of overseas outposts like London. “All three of those positions have been dramatically proven to be wrong,” said Levin.

“There are people who want to go further than this. We have a candidate for president who wants to wipe out the whole law. Romney wants to create not just a loophole, he would repeal Dodd-Frank, which would remove the possibility that we would get a cop on Wall Street.”

(That’s the same Senator Levin who spoke about Treasure Islands, so clearly he’s read it.)

3 comments so far

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Arbolioto 5th May, 2012 9.44 am

Absolutely awesome article and one of the big reasons we are where we are now. But on Saturday May 12 City of London police violently dislodged an Occupy protest outside the Bank of England precisely making the same point. They are well protected, these pirate bankers.

Nick Shaxson 5th May, 2012 7.01 am

i missed the news of that protest – is there a link on this?

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