In this research we give a brief overview of JP Morgan Chase. We evaluate and discuss JP Morgan Chase baking practice that contributed to the firm requiring funds from the TARP program and the bank’s contribution to the 2007-2009 financial crisis. We look at JP Morgan Chase banking practices prior the financial crisis. We discuss JP Morgan TARP assistance and the ramifications of the firm receiving TARP funds, as well as the actions the firm implemented to prevent the company getting into future financial crisis. We evaluate and discuss the size and scale of the TARP program, and make historical comparisons with the Resolution Trust Corp. (RTC), which was used to abate the savings and loan (S;L) crisis of the late 1980s and early 1990s; the Home Owners Loan Corporation (HOLC), which was established during the Great Depression. We discuss the pros and cons of TARP program. We evaluate and discuss whether classifying banks as “Too Big to Failure” would lead to excessive risk taking by the banks. We evaluate and discuss Dodd- Frank Regulatory Reform Bill that was passed in 2009, with the intent of cleaning up the consequences of the past decade’s financial sector decline, its impact on JP Morgan Chase bank, and whether the law would prevent future banking crisis. We end with a brief summary of our evaluation and discussion, together with our conclusions.
Research Methodology and Data Collection
Identify the method(s) that will be used to collect the data for the topics and how that data will be evaluated.
In this research we use both qualitative and quantitative method to collect data and information on JP Morgan Chase and the Troubled Asset Relief Program (TARP), from reliable sources such as JP Morgan’s annual reports, government publications; Securities and Exchange Commission (SEC) filed financial statements, and other reliable sources. We qualitatively analyze the data and use it to evaluate and discuss the topics contained in our introduction. We evaluate JPMorgan quantitative data by analyzing; JP Morgan financial Statements and qualitative data by evaluating and discussing the company’s banking practices and their deviation from the normal banking practices leading their contribution to the 2007-2009 financial crisis.
JP Morgan Chase Company Overview
JPMorgan Chase & Co. is a financial holding company, which provides financial and investment banking services. The company was founded in 1998 in New York, NY. It offers a broad array of investment banking products and services locally in the US and internationally in all capital markets. These services and products include among others; advising on corporate strategy and structure; capital raising in equity and debt markets; sophisticated risk management; market making in cash securities and derivative instruments; and prime brokerage and research. It also offers investment banking, financial services for consumers, small business and commercial banking, financial transaction processing, asset management and private equity. JP Morgan with its head office in the US has operations in Canada, Europe, Asia, Latin America , the Caribbean, Meddle East and Africa, Australia and New Zealand. By February 2016 JP Morgan Chase market share by total deposits and total assets in the stood at 10.29% compared to Bank of America at 10.73% and 14.04% compared to Bank of America at 10.50% respectively in the US. Major competitors in the US include among others; Wells Fargo Bank, Bank of America, Citibank, U.S. Bank. The top five institutions, including JPMorgan make up nearly half (46.8%) of the total bank assets in the US. (Comoreanu, 2017). Internationally JP Morgan major competitors include among others; Industrial and Commercial Bank of China, HCBC Holding PLC, Royal Bank of Canada. To name a few. (Morningstar, 2018). JP Morgan operates through the following four segments: Consumer and Community Banking; Corporate and Investment Bank; Commercial Banking; and Asset & Wealth Management.
1. The Consumer and Community Banking segment; serves consumers and businesses through personal service and through its branches, automated teller machine, online, mobile, and telephone banking. The segment is subdivided into : Consumer and Business Banking, Mortgage Banking and Card, Merchant Services and Auto Card. These banking subdivisions offer deposit, investment and lending services, cash management and payment solutions. Mortgage Banking Services; mortgages and home equity loans; and credit card services, payment processing services, and student loans services.
2. The Corporate and Investment Bank segment; offers a myriad of investment banking services, such as; market-making, prime brokerage, and treasury and securities products and services to a global client base of corporations, investors, financial institutions, government and municipal entities.
3. The Commercial Banking segment: provides industry knowledge, local expertise and dedicated service to United States and its multinational clients, including corporations, municipalities, financial institutions, and non profit entities. These services include among others; providing real estate investors and owners financing needs, financial solutions, lending, treasury services, investment banking, and asset management to meet its client’s domestic and international financial needs.
4. The Asset ; Wealth Management segment; offers asset and wealth management services which include among other; equities, fixed income, alternatives, and money market funds.
JP Morgan Chase and the 2008 Financial Crisis
Top brains within JP Morgan engineered many of the financial products such as credit derivative, which almost brought down the financial system in 2008. Credit derivatives are a type of insurance that allows lenders to off load risks of default on the loans they have made. Even though JP Morgan did not invent credit derivatives, it was the first to “industrialize” them; mass producing derivative deals which could cover large numbers of loans at once (SourceWatch, 2017). The purpose behind credit derivatives was to enable JP Morgan to circumvent regulatory capital requirements, (SourceWatch, 2017).
In 1986, the Feds chaired by Alan Greenspan, a former director of JP Morgan; suggested credit derivatives would allow banks to lower capital requirements. Credit derivatives pair those who want to take on risks, with those who want to be hedged against it. JP Morgan successfully convinced regulators that it could use credit derivatives to shift risk associated with the loans it made. Therefore, it did not need to set aside capital to cover losses in the event that borrowers defaulted. With credit derivatives, JP Morgan not only succeeded in shifting risks off its own books, but created a rapidly expanding market which raked in billions in fees for financial institutions. (SourceWatch, 2017).
Industry observers view post 2008 financial crisis was without derivatives, the total losses from the spike in subprime mortgage defaults would have been relatively small and easily contained. Instead, derivatives multiplied the losses from subprime mortgage loans, through side bets based on credit default swaps (SourceWatch, 2017). Also contributing to the financial crisis were more credit default swaps, based on defaults by banks and insurance companies themselves. These magnified losses on the subprime side bets.
JP Morgan in 2998 with a loan facilitated by the Feds, acquired Bear Stearns and later Washington Mutual both of which were at the verge of collapse and receivership respectively. Bear Stearns then the fifth-largest U.S. investment bank had been heavily involved in the business of packaging and reselling subprime mortgage-backed securities. Washington Mutual had been heavily involved in retail mortgage lending. (Irwin.2013). JP Morgan intensified securitization of the subprime mortgages when it took over the above two banks. Post financial crisis period, the largest U.S. bank JP Morgan admitted to, authorities that it had regularly and knowingly sold mortgage backed securities to investors that should have never been sold. (Irwin.2013). The company was ordered to pay a fine. The risky and bad banking practices by US largest bank JP Morgan, contributed to inflating the housing bubble. This as we earlier mentioned was compounded by lenders making bad mortgages and selling them to investors who thought they were relatively safe. When the loans started turning bad, investors lost faith in the banking system, and a housing crisis turned into a financial crisis. (Dayen. 2017).
We believe that the escalation in the buying and selling securities backed with subprime mortgages by JP Morgan spread to other banks that joined in cashing in on bad mortgages inflaming the housing bubble. However despite JP Morgan’s bad banking practices and taking on excessive risks when dealing with subprime mortgages as we earlier alluded to, and while other banks with similar risk taking were driven into financial distress during the financial crisis, JP Morgan Chase financial position at the start of the 2008 financial crisis was sound with what the company referred to as a ‘Fortress Balance sheet’. According to its Chief Executive at the time, the bank did not need any bailout from the government during the 2008 financial crisis. However the company claims that it was requested by the government to access the TARP program funding which it accepted. JP Morgan post 2008 financial crisis identified major risks that would affect the bank and put in-house place risk management framework and governance structure that would provide oversight, assess and manage among others credit risk, market risk, and liquidity to name a few. (Arwin G. et all.2014 ).
JP Morgan acceptance of TARP funding upon request from the government was not without ramifications. As a result of taking TARP funds, JP Morgan was required to provide the Treasury with non-voting preferred stock (which pays quarterly dividends at an annual yield of 5% for the first three years and 9% afterwards) and ten-year life warrants for the common stock (which allowed the purchase of common stock for an amount equal to 15% of the preferred equity infusion. (REF). The bank was subjected to greater scrutiny by the government in its operations in. Also in addition, JP Morgan like other TARP participants was subject to among others, compensation restrictions. Some of these were outlined at program inception in October 2008, and included; limited tax deductibility of compensation for senior executives to $500,000, ;requirements for bonus claw-backs, and limited golden parachute payments; requirements for comprehensive reporting and record keeping relating to compliance, as well as stiffer penalties for non compliance; Stricter, Merger and Acquisition requirements, to name a few. (Willey. 2009).
Description of the Troubled Asset Relief Program (TARP)
In October 2008 US Congress passed the Emergency Economic Stabilization Act (EESA). This ushered in the Troubled Asset Relief Program (TARP), one of the largest government intervention in order to address the 2008 financial crisis. Compared to the Savings and Loan crisis of the late 1980s and early 1990s the 2008 financial crisis was larger in scale. The combined assets of just two firms, Lehman Brothers and Washington Mutual, $946 billion, exceeds the assets targeted during the S&L crisis. (C.J. van Aardt & G.P. Naidoo (2010). The TARP program was aimed at bringing financial stability to the financial system by injecting $700 billion into the purchasing bank’s “troubled assets” thereby stabilizing banking organizations balance sheets, prevent losses and enable the banks to resume lending again. But instead of purchasing “troubled assets,” the Treasury was authorized under the Capital Purchase Program (CPP) of TARP to invest up to $250 billion of the $700 billion bailout provision in the preferred equity of the nine large involuntary participating selected financial institutions in order to beef up their capital ratios.JP Morgan was one of the nine selected banks. TARP also injected capital of $204.9 billion into 709 banking organizations which were perceived to be viable and healthy. (Marcia Clemmitt (2010). The banking organizations were required to fulfill requirements set out under the TARP program. These included among others; staff compensation restrictions.
Many banks were selected and those that qualified benefited from TARP. However the program also had the downside. We identify below are the pros and cons of the TARP program:
1. Focusing total bailout package on financial sector ensured a focused approach to dealing with toxic assets and ensuring financial institution survival.
2. Bailing out struggling financial institutions ensured continuity in the financial sector.
3. Buying up toxic assets meant removing assets that would potentially have negatively impact on financial stability and be sold later when the crisis is over.
4. Using taxpayer money to bailout the banks was more fitting as government being the custodian of the fiscal stability demonstrated its commitment to financial sector stability.
5. The program succeeded in mitigating Monetary and financial risks by stabilizing the financial sector and enhancing investor confidence in the US economy.
6. The program succeeded in mitigating macroeconomic risks by preventing a run on US banks and by mitigating against many banking clients being hard hit by banks becoming insolvent.
7. The program succeeded in mitigating credit risks by purchasing inferior assets, thereby ‘standing in’ for large amounts of bad debt in the United States.
8. The program succeeded in mitigating emerging market risks by mitigating some of the effects of a struggling US financial system on emerging economies.
9. Government, by intervening in the economy assumed its responsibility as a stabilizing agent in the economy.
1. Increased fiscal deficit, inflation, and interest rate spread and government debt.
2. Lowered general economic stimulus value.
3. Skewed competitiveness in the financial sector; market dominance by large institutions.
4. Good money was being used to buy out toxic assets, the value of which will probably only increase marginally.
5. Such money could have been spent more optimally to the benefit of taxpayers.
6. Government actions worked to distort market dynamics, which over the long term would give rise to lower levels of economic growth and development. (C.J. van Aardt ; G.P. Naidoo (2010).
U.S. banks, on average, have grown increasingly larger over time, while the total number of banks has declined. In 2011, the five largest banks held 48 percent of total system assets. Four banks had total assets in excess of $1 trillion, and the largest commercial bank—JPMorgan Chase Bank—had $1.8 trillion of assets, equal to 14 percent of the total assets of all U.S. commercial banks. (Wheelock, 2012). The government policies that have left these banks including JP Morgan to grow to the extent where they become classified as too big to fail (TBTF) and the preferential treatment given to them to mitigate systemic risk, pose serious risks to the financial system and potential catastrophic consequences for the broader economy. TBTF has the downside, known as moral hazard. Moral hazard is explained as the tendency for insurance to encourage risk-taking and, thereby, make an insurance payout more likely( Wheelock, 2012).. One example of this is a government guarantee that protects a bank’s creditors from loss enables the bank to borrow on more favorable terms and operate with greater leverage and, thereby, have a greater chance of failing than would be the case without the government backstop. Federal deposit insurance provides a good example of a guarantee that can encourage greater risk-taking. However, coverage limits, risk-based insurance premiums, minimum capital requirements and government supervision all discourage or prevent excessive risk-taking. Treating a bank as TBTF extends unlimited protection to all of the bank’s creditors, not just depositors, which gives the bank a funding advantage and more incentive to take on risk than other banks have. ( Wheelock, 2012).
After the passage of EESA, Congress later passed the Dodd-Frank Regulatory Reform Bill which officially became law in July 2010. We evaluate and discuss below the impact of Dodd-Frank on JP Morgan and whether the law will help prevent future banking crisis.
The Dodd-Frank Regulatory Reform Bill
The 2008 financial crisis began in December 2007 and went on up to 2009. In September 2008, financial meltdown worsened when Lehman Brothers the US fourth largest investment bank collapsed and was followed by plummeting of the Stocks. This sent shockwaves in all the US financial system and the economy as a whole prompting the government to step in and sort out the mess by passing EESA famously known as TARP in 2008, which we alluded to earlier in our discussion. This was later followed by passage of The Dodd-Frank Act which officially became law in July 2010. The Dodd Frank Act primary objectives were to promote financial stability of the US by improving accountability and transparency in the financial system.(History.com, 2018). Dodd –Frank Act put in place among others, the following:
1. Banks are required to come up with plans for a quick shutdown if they approach bankruptcy or run out of money.
2. Financial institutions to increase their reserve to mitigate for potential future slumps.
3. Banks with more than $50 billion of assets to take an annual “stress test,” by the Federal Reserve, to determine if the institution could survive a financial crisis.
4. The Financial Stability Oversight Council (FSOC) to identify potential risks that affect the financial industry and keeps large banks in check.
5. The Consumer Financial Protection Bureau (CFPB) to protect consumers from the corrupt business practices of banks. This agency works with bank regulators to stop risky lending and other practices that could hurt American consumers. It also oversees credit and debit agencies as well as certain payday and consumer loans.
6. The Office of Credit Ratings to ensure that agencies provide reliable credit ratings to those they evaluate.
7. A whistle-blowing provision law to encourage reporting of information about violations to the government for a financial reward. (History.com, 2018).
In addition to the above, Dodd-Frank Act, there was a provision known as the Volcker Rule, named after Paul Volcker former chairman of the Federal Reserve. This Rule forbids banks from investing with their own accounts and owning or sponsoring proprietary trading or Hedge funds for their own profit, with some exceptions. (History.com, 2018). While Dodd-Frank Act puts in place checks and balances aimed at ensuring; stability. transparency and accountability in the financial system as whole, and seem to have worked well in achieving it intended purpose of improving financial stability in the financial sector, there remains more room for improvement as opponents claim that the financial system over regulated.
Impact of Dodd- Frank act on JP Morgan Chase
Our analysis of Dodd- frank Act provisions leads us to a few conclusions about the impact of this law on JP Morgan and indeed on the financial system as whole. Dodd-Frank law has improved JP Morgan’s financial stability without seriously harming efficiency. These provisions require higher capital requirements. JP Morgan compliance with this law is likely to puts the bank in a better position to deal with future financial crisis. Increasing capital is not free, but it is worth the cost in the contribution it makes by improving the stability of JP Morgan and the financial system as a whole. However increased cost of increased capital reduces JP Morgan’s profitability. The Single Point of Entry (SPOE) approach under Dodd-Frank successfully minimizes uncertainty about which firms could expect to be rescued in case of financial distress. By putting in place clear procedures for resolving failed institutions, the SPOE strategy removes a major source of risk for JP Morgan and the financial sector as a whole. (Baily et al. 2017). The lack of authority to place the holding company of an insured depository institution or any other nonbank financial entity into FDIC receivership served as a major source of instability during the 2008 crisis. Regulators lacked an important tool to resolve these entities in an orderly manner and help stem contagious panics and runs that can result from such failures. Dodd-Frank took several steps to address the need for a formal procedure to deal with the failure of systemically important financial institutions in the future. (Baily et al. 2017).
Dodd-Frank requires annual stress tests for all systemically important financial institutions; banks such as JP Morgan. These tests have proved valuable to both banks and regulators, but are also complex and costly. Further, flawed assumptions can cause stress tests to fail to predict important gaps and problems in the same way that flawed assumptions about risk can lead to inaccurate risk-weighting of assets. (Baily et al. 2017). Dodd Frank legitimizes the entire concept of too big to fail in a strange way. The bigger banks will now assume that if they get into trouble, there will be some kind of government back-stop. This almost certainly distorts their incentive to become more self-reliant and could eventually lead to failure to prevent JP Morgan and indeed other banks of the same size from triggering a financial crisis in future. (Carducci. 2013). Also regulation alone may not prevent another financial crisis. (Zhai Z., 2017).
Section VI: Summary and conclusion(s). The discussion should provide a brief summary of the previous sections, and the conclusions you have reached.
The 2008 financial crisis can be attributed in part to bad predatory banking practices arising out of greedy and unethical conduct by US largest banking organizations including JP Morgan Chase. Our research reveals that JP Morgan Chase has been identified as one of the large banking organizations that contributed to the 2008 financial meltdown. The company’s top brains engineered and industrialized on a large scale financial instruments called derivatives , which almost brought down the financial system in 2008. Credit derivatives are a type of insurance that allows lenders to off load risks of default on the loans they have made.(Ref). Bad banking practices identified with JP Morgan Chase spread to many banking organizations in their quest to cash in on subprime mortgages triggering the 2008 financial crisis. The government moved in during the crisis to save the financial sector from total collapse by passage of the Emergency Economic Stabilization Act (EESA) in October 2008. This ushered in the Troubled Asset Relief Program (TARP), one of the largest government interventions in order to address the 2008 financial crisis. Compared to the Savings and Loan crisis of the late 1980s and early 1990s, the 2008 financial crisis was larger in scale. Selected banks perceived to be healthy and viable received TARP funds to keep them afloat. JP Morgan Chase though it did not need TAFP assistance received TARP funds upon request from the government. TARP funding came with strings as it placed strict requirements by participating banks amounting to increased costs and reducing profitability. This also affected JP Morgan Chase profitability. TARP program had both its upside of saving the financial sector from total meltdown and downside of increasing fiscal deficit to name a few. However TARP achieved its intended aim of stabilizing the financial system.
The government later passed the Dodd- Frank Act which became law in 2010. The primary objectives were to promote financial stability of the US by improving accountability and transparency in the financial system.(History.com, 2018). This law strengthened oversight and put in place requirements for financial institutions to increase their reserves to mitigate for potential future slumps. High capital requirements increased costs and reduced profitability of banks including JP Morgan Chase. However the law has improved stability transparency and accountability in JP Morgan Chase and indeed all financial organizations. Dodd Frank legitimizes the entire concept of too big to fail and as such, the bigger banks such as JP Morgan will now assume that if they get into trouble, there will be some kind of government back-stop. This almost removes the incentive for JP Morgan to become more self-reliant and could eventually lead to JP Morgan and indeed other banks of the same size to trigger a financial crisis in future. (Carducci.2013). Wee must also mention here that financial regulations such as Dodd-Frank alone may not prevent another financial crisis in future. (Zhai Z., 2017).
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