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from Felix Salmon:

Chart of the day: JP Morgan’s excess deposits

Many thanks to Ben Walsh for putting this chart together for me. What you're seeing is JP Morgan's excess deposits -- the size of the bank's deposit base, minus the amount of its loans -- both in absolute terms and as a ratio. Either way, it's going up and to the right.

JP Morgan clearly has a certain amount of control over the amount of deposits it takes in. What you're looking at here isn't entirely a flight-to-quality trade: JP Morgan's total deposits actually fell in the two years following the financial crisis. They were just over $1 trillion at the end of 2008, they dropped to $940 billion at the end of 2009, and then they fell again to $930 billion at the end of 2010.

But then, in 2011, they shot straight back up -- and now they're at a record high of $1.13 trillion, with JP Morgan having failed to lend out more than $400 billion of that amount. That's a record not only in absolute terms but also in relative terms: for every dollar that JP Morgan has on deposit, it has managed to lend out just 64 cents.

To put it another way, JP Morgan has $9,900 on deposit per US household -- and of that, $3,600 per US household is "excess deposits" which are mostly being farmed off to London rather than being invested in helping US individuals and businesses grow.

The ostensible purpose of JP Morgan's Chief Investment Office is to take the bank's excess deposits and invest them in a way which manages to hedge the rest of the bank's exposures. But if you're spending 57 cents on hedging operations for every dollar you're making in original loans, which is the case here, then something's clearly very wrong. JP Morgan's loan book isn't that risky, or difficult to hedge. And if it is, JP Morgan needs some new loan officers.

The real story here, of course, has nothing to do with the difficulty of hedging JP Morgan's loan exposures. Rather, the hotshot CIO traders in London were managing to get a higher return on their "hedging" operations than the loan officers were getting on their bread-and-butter loans. And so Jamie Dimon started taking in all the deposits he could find, and sending them straight to London, where they could be "hedged" to the tune of billions of dollars a year in profits.

from Felix Salmon:

Why JP Morgan’s CIO found it so easy to make money

You want proof that JP Morgan was -- is -- using its Chief Investment Office to gamble with taxpayer-backstopped funds?

The CIO unit also had a lower cost of capital than other parts of the bank, an artificial advantage that gave it an incentive to take more risk and behave in a less disciplined way, people familiar with the unit said.

“It was very large, but was never very transparent, and it wasn’t clear that they had an appropriate funding cost,” said the source with direct knowledge of the CIO.

In any unit of any bank, one of the key drivers of profit and loss is the internal cost of funds. If you're paying 1% for your funds and earning 3%, then you can claim profits of the difference, 2%. But if your cost of funds is increased to 2%, then your profit is halved at a stroke. For someone like Ina Drew, who was charged with turning hedges into profitable trades, the easiest way to do that would always have been to simply get Jamie Dimon to decrease the CIO's cost of funds.

And at JP Morgan, just like at any other bank, the cheapest cost of funds is always deposits. JP Morgan has hundreds of billions of dollars in excess deposits just because it's too big to fail, and has an implicit government backstop. It's bonkers that it should then be able to take the resulting ultra-low cost of funds, and turn it into eight-figure bonuses to people like Drew, all for taking that money and playing on derivatives indices in London.

As John Macaskill points out, the CIO, by its own faulty measurements, had for the past two quarters more money at risk than JP Morgan's entire investment bank -- and that was with a more lenient risk measurement and with a lower cost of capital. In reality, the CIO's risk levels were vastly greater than those at the investment bank, as we discovered after the blow-up.

If JP Morgan wants the CIO to be taking that kind of risk, it has to significantly increase the CIO's internal cost of funds. The CIO is at heart a hedge fund (it's designed to put on hedges), and JP Morgan should extend it billions on the same kind of terms that it would extend money to top prime-brokerage clients. The CIO's secret weapon, all these years, has been its artificially low cost of funds. If that number were more realistic, maybe JP Morgan wouldn't have ended up parking such an insanely enormous amount of money there.

from Felix Salmon:

How Europe’s banking crises threaten the eurozone

The size of the run on Greek banks is not at all clear: while it seems that something on the order of €1 billion has left the banks of late, it's less obvious whether that was over the course of one day, three days, or two weeks. The big picture, though, is unambiguous:

What you're seeing here is Greece down to its last €165 billion or so in deposits, and at the margin the rate of decrease is probably accelerating, despite the fact that most sensible Greeks will have already stashed their hard-earned euros safely outside the country a long time ago. I don't know what the minimum amount is that Greeks need on deposit just to serve their near-term liquidity requirements, but we're not there yet: Greece's total population is only 11 million. So there's a long way further this number can fall -- especially since the Greek banking system isn't receiving the support it needs from the ECB.

The more realistic constraint is simply that many Greeks lack the education and sophistication and language skills needed to move their money out of the country. This, for instance, is telling:

A 60-year-old textiles store owner who gave his name only as Nasos said he had transferred 10,000 euros over the phone to a bank in fellow euro zone state Cyprus on Tuesday afternoon.

If Greece exits the euro, there's no doubt that there will be a massive banking crisis in Cyprus -- it's pretty much the least safe haven conceivable for someone looking to move their money from Greece. The only reason to move money to Cyprus rather than, say, Luxembourg is that they speak Greek there, and the logistics of moving money to Cyprus are easier than the logistics of moving money to any other country.

Meanwhile, in the rest of the eurozone periphery, foreigners are already pulling their deposits from Italian banks, while the Spanish banking system is only getting increasingly precarious:

from Breakingviews:

Dodd-Frank opponents return to the drawing board

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

JPMorgan has given financial reformers at least two billion reasons to insist on more aggressive oversight of the banking industry. In the wake of last week’s trading loss, presidential contender Mitt Romney and other Republicans will have to rethink their rhetoric around gutting the Dodd-Frank Act and, more specifically, its Volcker Rule provision. Voters may no longer believe that big banks can manage their own risks, which leaves making banks smaller the alternative to tighter regulation.

Jamie Dimon reiterated over the weekend that JPMorgan’s loss at its chief investment office came from mistakes made hedging its loan portfolio. The trading led to more - not less - risk. But portfolio hedging isn’t the sort of activity limited by the Volcker Rule, which is meant to prevent banks from betting with capital secured by customer deposits. Still, that hedging went awry. While the bank’s capital can handle the hit, the episode has critics rightly complaining that even a bank as seemingly bullet-proof as JPMorgan is too complex to manage its own risk.

And that presents a political problem. Dimon has been outspoken about the flaws of Dodd-Frank, and Republicans have largely nodded in agreement. Presidential hopeful Mitt Romney has promised to repeal much of the 2010 law if elected. This episode shatters that strategy. The GOP shift may already have begun. On Friday, Senator Bob Corker called for a hearing to learn more about JPMorgan’s loss and what such mistakes mean for taxpayers. As recently as February, he was pushing to weaken the Volcker Rule.

Republicans will need to come up with a strategy to end too big to fail without increasing the government’s footprint in finance. If embracing Dodd-Frank is not an option, do not be surprised to see many in the party adopt a more radical idea, and one embraced by Dallas Fed President Richard Fisher: breaking up the banks.

from Felix Salmon:

Jamie Dimon’s failure

Ina Drew -- the JP Morgan executive who famously "loves crises" -- is out; it seems the buck for the $2 billion trading loss in her unit has stopped with her. And slowly, a few shapes are beginning to emerge from the fog of what exactly happened here.

For one thing, it's becoming increasingly obvious that Drew got paid her eight-figure salary in return for being able to pull off a very neat trick: turning hedging operations into a profit center.

Drew's Chief Investment Office quadrupled in size between 2006 and 2011, reaching $356 billion in total, and it's easy to see how that happened. On the one hand, it was incredibly profitable, with the London team alone, which oversaw some $200 billion, making $5 billion of profit in 2010, more than 25% of JP Morgan's net income for the year. At the same time JP Morgan accumulated enormous new deposits in the wake of the financial crisis, both by acquiring banks and by attracting big new clients wanting the safety of a too-big-to-fail bank. Historically, JP Morgan has served big corporations by lending them money, but nowadays, as the cash balances on corporate balance sheets get ever more enormous, the main thing these companies want from JP Morgan is a simple checking account -- one where they can be sure that their money is safe.

With lots of deposits coming in, and little corporate demand for loans, it was easy for all that money to find its way to the Chief Investment Office, which could take any amount of liabilities (deposits are liabilities, for a bank) and turn them into assets generating billions of dollars in profits.

But the CIO does much more than just provide profits for JP Morgan. In contrast to the bank's lending book, the CIO is nimble. Loans, as a rule, have to be held to maturity: that's the essence of relationship banking. Investments, by contrast, can be sold at any time. Of course, an investment which can be sold at any time has another name: it's a trade. Thus did the CIO become home to big traders, making huge bets and huge bonuses.

In the past couple of years, of course, that raised its own set of problems: how could this group of traders possibly be Volcker-compliant? The answer lay in Drew's love of crises: her incredibly valuable ability to prevent losses and even make profits when the world is falling apart. In that sense, the CIO was one big hedge, and in a narrower sense the CIO was the go-to office whenever JP Morgan saw a risk which needed hedging.

Mark Dow has an intriguing thesis this morning:

from Felix Salmon:

JP Morgan: When basis trades blow up

I'm not sure if it was the biggest quarterly loss of all time, but Merrill Lynch's $16 billion loss in the fourth quarter of 2008 certainly ranks very high up there in the annals of investment-bank blowups. It happened after the bank had already been taken over by Bank of America, and it was in the middle of the financial crisis, so it didn't get nearly the amount of attention it deserved. But it was not simply a case of assets plunging in value. Instead, it was, in very large part, a basis trade blowup.

The basis trade is an arbitrage, basically. There are two different ways the market measures credit risk: by looking at credit spreads -- the yield on a certain issuer's bonds, relative to the risk-free rate -- or by looking at CDS spreads, which are basically the same thing but set in the derivatives market rather than the cash bond market. Most of the time, CDS spreads and cash spreads are tightly coupled. But sometimes they're not. And at Merrill, a huge part of that $16 billion loss was reportedly due to a bad basis bet: the basis on many credits became very large and very negative during the financial crisis.

This time around, the basis-trade disaster has happened at JP Morgan, where the famous London Whale seems to have contrived to lose $2 billion on what was meant to be a hedging operation. And once again, although the details are still very murky, the culprit seems to be the CDS-cash basis.

I've been meaning to write a post about the CDS-cash basis for a few days now, which is why I happen to have this chart handy, showing the basis for various European banks as of Tuesday May 8.

These are very big numbers, for very big banks: UBS is at 75bp, Deutsche is at 83bp, Natixis is at 116bp, and IKB is at a whopping 392bp. And this is just the banks -- other corporates have seen similar price action. The cost of protection has gone up sharply, while the cash bonds are still trading at very low spreads.

Bruno Iksil, the London Whale, had a massive long position on corporate CDS in general, and the CDX.NA.IG.9 index in particular. He was selling protection, betting that credit spreads would go down, rather than up. The position was meant to be a hedge, although it's a bit unclear how JP Morgan could have some massive short position in corporate debt that it was hedging against. In any case, CDS spreads went up -- and credit spreads, in the cash market, didn't.

from David Rohde:

Break up the big banks

UPDATE: JPMorgan's surprise announcement late Thursday of a $2 billion trading loss - and the drop in stocks it sparked - is yet another sign of the need for reform.

The numbers are startling. HSBC, the world’s fifth-largest bank, failed to review thousands of internal anti-money-laundering alerts, according to a Reuters investigation published last week.

The bank did not file legally required “suspicious activity reports” to U.S. law enforcement officials. It hired "gullible, poorly trained, and otherwise incompetent personnel" to run its anti-money-laundering effort. Each year, hundreds of billions of dollars flowed through the bank without being properly monitored.

HSBC is not alone. Last month, U.S. regulators accused Citigroup of having major lapses in its anti-money-laundering systems as well. Under an agreement with the Comptroller of the Currency, the agency that regulates national U.S. banks, Citigroup agreed to improve its monitoring operations, but did not pay a monetary penalty or admit any wrongdoing.

For critics of mega-banks, the reports are the latest sign of big banks’ ability to defy regulation, engage in dubious business practices and face few consequences.

In a British court last month, a former Nigerian governor pleaded guilty to pilfering $79 million from state coffers, funneling it offshore and buying six properties in the U.S. and UK. The banks he used to move the illicit money? HSBC, Citibank, Barclays and Schroders.

"Banks get hauled up by the regulators for failing to follow the law, promise to reform, and yet a few years down the line they're caught doing the same thing,” said Robert Palmer of the anti-corruption group Global Witness. “I think for this to change we need strong penalties for when the banks get things wrong, and in the worst cases, jail time for individual bankers."

from MacroScope:

Is that a bailout in your pocket?

There was an awkward moment of tension at the Milken Global Conference in Los Angeles, when a buysider on one panel asked a Wall Street banker whether he had pocketed taxpayers' bailout cash.

The tit-for-tat began when several panelists at the "Outlook for M&A" session began griping about the U.S. government's tax policy, which they said dissuades corporations from bringing overseas profits back home because of punitive taxes.

The panelists – including James Casey, co-head of global debt capital markets for JP Morgan, Anthony Armstrong, an investment banker at Credit Suisse, and Raymond McGuire, global head of corporate and investment banking at Citigroup – predicted that the M&A market might get a big boost if the U.S. were to offer a tax holiday of sorts for repatriated profits.

They also suggested such a move could be a boon for hiring and economic growth: Tilman Fertitta, a panelist who is chairman and CEO of the consumer products company Landry's, said he would certainly feel the incentive to do more deals and invest more at home if he could bring back his overseas profits without being taxed. He even wondered why Mitt Romney and Barack Obama hadn't made such a proposal a key point in their election campaigning.

But just before the executives could launch into a profit repatriation samba, another panelist stopped the music.

Maria Boyazny, CEO of distressed debt investing firm MB Global Partners, pointed out that previous government actions that were supposedly intended to spur the economy had only saved Too Big To Fail banks and bolstered the financial industry's fortunes. ("No offense to anybody on the panel," she said in that but-I'm-going-to-offend-you-anyway tone.)

In the intervening time, she said, corporate America has only gotten richer by cutting jobs and hoarding capital. She then wondered aloud where all the $700 billion in bailout money and trillions of dollars in Federal Reserve stimulus programs had actually gone.

from Felix Salmon:

What does the Walmex corruption scandal mean for Banco Walmart?

David Barstow's explosive 7,600-word investigation of corruption at Wal-Mart is required reading this weekend. I'm not going to attempt to summarize the whole thing, but basically Eduardo Castro-Wright, currently Wal-Mart's vice-chairman, oversaw a culture of bribery when he was CEO of Walmex. And when a key player in that bribery scheme blew the whistle, Walmart in Bentonville buried the investigation, and didn't report anything to the authorities in either Mexico or the US.

All of this looks like a slam-dunk case under Foreign Corrupt Practices Act, and I'm quite sure that multiple extremely senior heads are going to roll in the wake of this NYT exposé. As always in such cases, the crime was bad; the cover-up was worse.

One name, however, is conspicuous by its absence in Barstow's report: Banco Wal-Mart, the huge bank which is a wholly-owned subsidiary of Walmex. It's a serious player in the Mexican banking industry -- it opened its millionth account over a year ago -- and thanks to a quirk of international banking-regulation protocols, it lacks a lot of the regulation that its competitors have.

Banks like Banco Wal-Mart which are subsidiaries of foreign corporations are meant to be regulated by the bank regulators in the parent's country. But because regulators in the US have consistently refused to allow Wal-Mart to become a bank here, bank regulators in the US don't regulate Wal-Mart at all -- let alone its Mexican subsidiary. (There is a Wal-Mart-branded prepaid debit card, but that's run by Green Dot, not Wal-Mart.)

Barstow's report shows that corruption is marbled throughout Walmart's international operations, not only in Mexico but also in Asia, where reports of bribery were coming in to Bentonville HQ at the rate of five per month just from Asia alone. There's nothing in the NYT which suggests that Banco Wal-mart was doing anything suspect at all -- but at the same time, all parts of Castro-Wright's empire should be under suspicion now, given the kind of illegal activity which peaked under his leadership. And Banco Wal-mart was one of the jewels in Castro-Wright's crown.

All US corporations are held to high standards under the FCPA, but banks are even more important, given the way in which they're regularly used by criminals for money laundering. After reading the NYT this weekend, I have no faith at all that Wal-mart has done an effective job of ensuring that Banco Walmart is corruption-free. And given its regulatory status, I also have no faith at all that if there were corruption at the bank, its regulators would have found it.

If I were the Mexican banking authorities, then, I'd start asking some very pointed questions indeed in the wake of this news -- and I might even start thinking about revoking Banco Walmart's license entirely. Certainly there's no indication at all that Wal-Mart cares about stamping out corruption in Mexico -- quite the opposite. And if a foreign-owned bank is operating in your country, you want to be sure that its parent is particularly assiduous in such matters.

from The Great Debate:

Good riddance to the tax refund loan

There are the Liberty Tax guys dancing at strip malls in Statue of Liberty costumes. The "FA$T CA$H" banners plastered on storefronts. And in a cult classic of advertising, all over the South there were those ridiculous Mo’ Money Taxes commercials in which buffoonish Southerners bumble through financial crises. Each one ends with advice on how to avoid a similar mess: “Just come on down to Mo’ Money!”

All of these campy promos are actually selling costly loans against your own money, but they have in fact generated lots of easy cash – for the lender, if not the borrower.

Refund anticipation loans, as they are called, have been risk-free business for most of the past decade. Lenders offer roughly 10-day advances of tax refunds, for which they charge exorbitant subprime fees. More than 12 million taxpayers got anticipation loans in their peak year, in 2004, according to the National Consumer Law Center. IRS data shows that over 90 percent of people who applied in 2010 were low-income.

Don't be fooled, though, refund anticipation loans are no fringe market. Throughout the so-called boom years, the same banks that sit at the center of our high-end economy spread this fraud-ridden industry throughout its bottom tier. Take for instance Mo' Money, which has faced several fraud probes. Until 2010, its storefronts were actually agents of JPMorgan Chase. The bank backed roughly 13,000 independent preparers in this business.

But as of Apr. 30, no banks will remain in the refund loan market. They’ve been driven out by a combination of watchdog advocacy and renewed regulatory oversight – and as a result, an industry that strips hundreds of millions of dollars a year from low-income taxpayers is now in rapid decline. In 2010, when the largest banks pulled out, the industry’s take in loan fees plummeted to $338 million, down nearly 60 percent from just three years prior and nearly three-quarters from its peak.

There’s a crucial lesson for regulators and lawmakers in this change of fortune.

Refund anticipation loans are part of a pack of predatory financial products that feed off low-income communities, and in particular black neighborhoods that have long struggled for access to fair credit. All of those products saw impressive growth before the crash, in large part because banks helped scale them up. Now, financial players at all levels are looking for new twists on the old idea: risk-free money at the expense of the working poor.