Jamie Dimon (pg. 3)
One goal of the reviews is to make sure that each card, or any other product, is profitable on its own and not being subsidized by other products. Says Mandelbaum: "Jamie wants all corporate costs, from legal to marketing, allocated to all the businesses in relation to how much they use them, to ensure that the businesses are truly profitable after all the overhead expenses."
The Dimon team has two hallmarks that reflect the boss's thinking: First, as the EMRs show, they mine every part of the business for detailed information - especially data that point to trouble - then share it at warp speed throughout the corporation. The team is just as focused on exchanging information from retail to investment banking to asset management as it is about selling products across divisions. Second, if the data show that a business is really far riskier than it looks, get out - no matter how lucrative it appears. The team's ultimate strength is its willingness to shun products its competitors crave, even if that means sacrificing short-term profits. "In the crisis, everyone was trying to grow in products we didn't want to grow in," says Dimon. "So we let them have it."
That philosophy helped J.P. Morgan avoid big losses in structured investment vehicles. SIVs are pools of mortgages, credit card loans, and other debt created by banks but not carried on their books. Before Dimon's arrival, Winters and Black completely avoided SIVs. One reason: The high cost of the credit default swaps - the financial instruments used to insure against SIV losses - told them that SIVs were too risky (a warning sign other investors ignored). Black and Winters also worried that in a credit crunch J.P. Morgan would have to take the SIVs' assets onto its own books. "We knew that our name was on it, so that in a crisis, the SIVs would become J.P. Morgan's problem," says Winters.
But when J.P. Morgan bought Bank One in 2004, it found itself in possession of an $8 billion SIV that Bank One had created. Black and Winters insisted on selling it. Dimon initially challenged them, arguing that SIVs were a favorite with the bank's clients. But Winters and Black convinced him that the modest fees from SIVs weren't worth the risk. The SIV was sold. It was a prescient move: Citigroup has had to take $58 billion worth of SIVs back on its books; HSBC has taken back $35 billion. J.P. Morgan's SIV exposure: zero.
Shedding the Bank One SIV was just a warmup. Even more important was J.P. Morgan's decision to shun subprime CDOs - vehicles that sell bonds backed by pools of subprime mortgage-backed securities. J.P. Morgan has long ranked among the biggest buyers of auto and credit card loans, which it turned into asset-backed securities. But even in 2005, J.P. Morgan remained a small player in the hottest business on Wall Street, securitizing mortgages. Dimon wanted to build a far bigger franchise, chiefly by securitizing the loans made by the bank itself through its Chase Home Lending division.
By 2006, J.P. Morgan was growing substantially in securitizing mortgages and dabbling in subprime CDOs. Many of J.P. Morgan's traders and capital markets executives were urging investment banking chiefs Winters and Black to ramp up the subprime production, a business that was generating billions in fees for other Wall Street firms. "Given our position in securitizations, it would have been a natural for us," says Winters.
But Dimon soon began to see reasons to pull back. One red flag came from the mortgage servicing business, the branch that sends out statements, handles escrow, and collects payments on $800 billion in home loans, its own and others'. During a regular monthly business review for the retail bank in October 2006, the chief of servicing said that late payments on subprime loans were rising at an alarming rate. The data showed that loans originated by competitors like First Franklin and American Home were performing three times worse than J.P. Morgan's subprime mortgages. "We concluded that underwriting standards were deteriorating across the industry," says Dimon.
In the investment bank, Winters and Black were discovering more reasons to be cautious. CDOs issue a range of bonds, from supposedly safe AAA-rated ones with relatively low yields to lower-rated ones with higher yields. Winters and Black saw that hedge funds, insurance companies, and other customers were clamoring for the high-yielding CDO paper and were less interested in the other stuff. That meant banks like Merrill and Citi were forced to hold billions of dollars of the AAA paper on their books.
What's wrong with that? Doesn't an AAA rating mean the securities are safe? Not necessarily. In 2006, AAA-rated CDO bonds yielded only two percentage points more than supersafe Treasury bills. So the market seemed to be saying that the bonds were solid. But Black and Winters concluded otherwise. Their yardstick, once again, was credit default swaps - insurance against bond failures. By late 2006 the cost of default swaps on subprime CDOs had jumped sharply. Winters and Black saw that once they bought credit default swaps to hedge the AAA CDO paper J.P. Morgan would have to hold, the fees from creating CDOs would vanish. "We saw no profit, and lots of risk, in holding subprime paper on our balance sheet," says Winters.
The combined weight of that data triggered Dimon's call to King in Africa. "It was Jamie who saw all the pieces," says Winters. In late 2006, J.P. Morgan started slashing its holdings of subprime debt. It sold more than $12 billion in subprime mortgages that it had originated. Its trading desks dumped the loans on their books and mostly stopped making markets in subprime paper for customers. The alarm spread to the private bank that manages money for wealthy clients. "We connected with the other lines of business," says Mary Erdoes, who heads the private bank. "We encouraged our clients to sell their CDOs. We concluded we weren't getting paid for the risk." J.P. Morgan's corporate treasury under Ina Drew even starting hedging, betting that credit spreads would widen. Over the next year those hedges reportedly yielded gains of hundreds of millions of dollars.