Jamie Dimon (pg. 4)
Dimon's stance was radical: He was skirting the biggest growth business on Wall Street. "Our employees wanted to know why we were being so conservative," says Black. "We lost a lot of structured credit people to hedge funds." J.P. Morgan also lost ground to competitors. It sank from third to sixth in fixed-income underwriting from 2005 to 2007, and the main reason was its refusal to play in subprime CDOs, which its rivals were gorging on. "We'd get the quarterly reports from our competitors and see that they'd added $100 billion to their balance sheets," says Dimon. "And they were hardly adding any capital, so it looked like their investments were almost risk-free." But in the end, of course, the decision to shun subprime made Dimon a hero.
No team is perfect, of course, and there are a few big blemishes on J.P. Morgan's record. In 2007 bankers in a unit that makes short-term secured loans to blue-chip corporations bought a $2 billion subprime CDO as an investment. Somehow the arrangement escaped the notice of the risk management brass. The CDO lost half its value, hitting J.P. Morgan with a $1 billion pretax write-down in the third quarter and sending Dimon on another manic crusade to tighten risk management. "I was livid, and so were Winters and Black," says Dimon. "It was $1 billion we didn't even know about! The people responsible aren't here anymore." (The bank was also embarrassed in April 2007 when it emerged that a half-owned British joint venture, J.P. Morgan Cazenove, was working on an LBO of J.P. Morgan client Dow Chemical without the knowledge or approval of Dow's CEO or board. See "Inside Job" on fortune.com).
And while J.P. Morgan largely dodged the subprime bullet, it stumbled in two other areas: loans for LBOs and home loans in its consumer bank. During the LBO frenzy it lost its normal discipline, funding dubious deals. Through June, J.P. Morgan had written off around $3 billion in leveraged loans on such deals as Chrysler and HD Supply. The misadventure in home loans illustrates that Dimon's guiding principle - take risks only when you are well paid for doing so - is far from foolproof. By mid-2007 the subprime debacle had hammered the market for all mortgage securitizations. As a result, many banks stopped making jumbo mortgages - ones too big to be backed by Fannie Mae or Freddie Mac. Dimon saw what seemed like a rich opportunity. "Spreads on jumbos were getting very attractive," he says, "so we thought we'd make a lot of money in that market." The strategy may have been correct, but the timing was off. Housing prices dropped far more than J.P. Morgan had anticipated. "We were too early," says Dimon. "We could have done it later and saved $500 million in losses."
Today's conventional wisdom holds that financial behemoths like Citigroup are simply too big and complex to manage. That view implies a dim future, given that in the current environment, the big will only get bigger, through an inevitable wave of consolidation. But the success of Dimon and his crew seems to refute the "too big to manage" hypothesis, and in any case, Dimon doesn't buy the whole concept. "In every business, some huge companies are successful and others aren't," he says. To Dimon the rich flow of information from different corners of the bank, like the signal from servicing that warned him about subprime, is a major advantage. "We have a gold mine of knowledge, but you have to manage it well," he says, "so every one of our businesses benefits from it." Other successful models will emerge, but for now Dimon has the best game plan - and don't forget, the best team to go with it.