JP Morgan’s depositors needn’t worry about its gambles

September 24, 2012
Bill Cohan declares, today, that the money JP Morgan lost in its infamous "London Whale" trades actually belonged to depositors. He's wrong about that.

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Bill Cohan declares, today, that the money JP Morgan lost in its infamous “London Whale” trades actually belonged to depositors. He’s wrong about that.

Here’s Cohan’s argument:

To my mind, the money that Iksil lost was depositors’ money. Iksil worked for the CIO, where depositors’ money is invested until it is lent out. The trade lost almost $6 billion in cash, which we know is real because hedge funds such as Saba Capital, run by wunderkind Boaz Weinstein, and Blue Mountain Capital staked out the other side of Iksil’s trade and made a fortune. How could there be any confusion that the money Iksil lost came from the bank’s depositors?

This is just silly. If you deposit money at a bank, you’re lending that money to the bank. Bank deposits count as liabilities on the bank’s balance sheet: they’re money that the bank owes to its depositors. And like all other debt, bank deposits are a contractual arrangement: the bank borrows your money — and agrees to repay it — on certain terms. Often, those terms include an effective call option: the depositor can ask for her money back at any time.

Once money is borrowed, the borrower can do with it as she wishes. If JP Morgan borrows money from depositors and then gambles it in London, then any profits it makes on those gambles are profits of JP Morgan — and any losses it makes on those gambles are losses of JP Morgan. The bank’s obligations to depositors are unchanged.

I believe that JP Morgan shouldn’t be allowed to gamble its excess deposits in London like this, and in that sense I’m not that far removed from Cohan: it does matter where the bank is getting its billions. JP Morgan has lots of excess deposits just because it’s too big to fail and is therefore a place where most companies and rich individuals want to deposit their money: they know the bank is safe and that they’ll be able to get it back whenever they want it.

But just because the money came from depositors doesn’t mean that it belongs to depositors. Depositors have no particular claim to that money in particular; they have their own place in the pecking order when it comes to seniority, but there’s no pool of JP Morgan funds that depositors have some kind of privileged access to. So long as JP Morgan remains solvent, the money belongs to JP Morgan, and depositors just have claims on the bank.

Cohan then says that depositors only avoided losing money because JP Morgan was lucky enough to avoid a bank run. But again that’s silly: if depositors did end up losing money because of a bank run (and I doubt they would, but that’s a separate issue), then the cause would be the bank run, not some losses in London. Banks are always at risk of a run, and there’s no reason at all to believe that the London Whale losses changed that probability at all.

Cohan also says, unhelpfully, that “taking money out of depositors’ accounts is exactly what banks do”. But of course this isn’t true at all. A bank account is just that — an accounting of how much money the bank owes the depositor (or, if it’s in negative territory, how much money the customer owes the bank). The bank can take money out of depositors’ accounts by charging that depositor those fast-rising fees. When that happens, the amount of money the bank owes the depositor goes down. But it can’t take money out of depositors’ accounts by lending that money to someone else, or even by gambling it in London, since those activities don’t have any effect on the amount the bank owes the depositor.

If you borrow money from a bank, you owe that money back to the bank however well or badly you invest it. The same is true of the money that the bank borrows from you. Cohan is trying to gin up controversy where there is none: his headline reads “Exactly Whose Money Did the London Whale Lose?”, and he simply refuses to accept the simple fact — patiently explained to him by JP Morgan spokesman Joe Evangelisti — that the answer is “JP Morgan shareholders'”. Instead, he goes all faux-naive:

Evangelisti said depositors lost nothing and, in fact, the CIO account has an embedded $10 billion unrealized gain. This leaves me feeling a little like the casino executive in “Ocean’s Eleven” who, upon realizing the casino’s vault had just been robbed of close to $163 million, incredulously asks Andy Garcia’s casino-owner character: “I don’t understand. What happened to all that money?”

This really isn’t hard to understand. The CIO account is huge — on the order of $360 billion. It goes up, and it goes down. When it goes up, JP Morgan treats those gains as profits for the benefit of shareholders. When it goes down, the losses are borne by the shareholders as well. Overall, the account has gone up, but during a few fateful quarters it went down, and as a result shareholders lost money in those quarters. No one’s denying that there were losses. But it’s just not true to say that depositors suffered any losses, because they didn’t.

The United States has a two-tier system of deposit insurance. There’s the formal insurance provided by the FDIC, which covers deposits up to $250,000. And then there’s the informal too-big-to-fail insurance: the fact that JP Morgan is so big that the government would always step in before any of its depositors had to suffer losses. This system has served America well. And there’s really no good reason to scare people into thinking that their money is being gambled away in London, when in reality it’s perfectly safe. It’s the shareholders, not the depositors, who need to keep an eye on such things.


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