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| Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks |
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The deal was almost identical to the Abacus trade that prompted a reputational risk management crisis at Goldman Sachs last year, after the SEC alleged that the bank had misled investors by failing to disclose the role played by hedge fund Paulson in selecting assets for a portfolio that it would then short.
Rather than suffer an existential crisis, JPMorgan was able to portray the June settlement as a regulatory road bump, and it received plaudits from some analysts and investors for negotiating a lower settlement than the $550 million Goldman paid to make Abacus go away.
This leaves one of the central financial crisis myths largely intact: the notion that JPMorgan avoided the excesses of the mortgage boom and related structured credit market abuses because of the wisdom of its senior managers.
JPMorgan certainly steered clear of some hazards as it charted a path through the credit boom. It avoided use of the structured investment vehicles that wrecked rivals such as Citigroup, for example. JPMorgan’s investment banking co-head Bill Winters shut down a SIV that the bank inherited when it bought Bank One in 2004, in the merger designed to bring on board Winters’ eventual nemesis, Jamie Dimon, current chief executive of JPMorgan.
Winters then avoided the temptation to set up new SIVs as the credit markets grew ever frothier. But JPMorgan was up to its neck in the market for structuring synthetic credit portfolio trades, as would be expected from the biggest derivatives dealer in the world.
The $1.1 billion Squared CDO 2007-1 deal that prompted JPMorgan’s settlement with the SEC in June showcased the disdain shown towards investors by many dealers at the tail end of the credit boom, and also the difficulties that regulators face in making subsequent charges stick to the individuals who structured trades.
Michael Llodra, head of ABS CDOs at JPMorgan at the time, did not face any charges, despite receiving a Wells notice that he was under investigation, for example. Magnetar did not make direct representations to the CDO investors, so it is unlikely to face any future sanction. And GSC, the nominal collateral manager for the portfolio, has gone bust. That left the SEC pursuing only a rather lame case against Edward Steffelin, the GSC managing director who signed off on the portfolio selection, on the grounds that he approved a misleading section of the CDO pitch book describing GSC’s role in portfolio section and allowed Magnetar to select assets while simultaneously discussing a job with the hedge fund.
Although the SEC might be having trouble making cases stick against the bankers who structured complex credit deals, its suits should still be required reading for investors. Lessons about the cynicism of the sell side are always valuable, after all.
Unfortunately, one of the main conclusions reached by the sell side from the recent SEC suits could well be that a limited email trail and a strict embargo on colourful language in written communications can be enough to limit the impact of investigations.
JPMorgan might take comfort in the relatively minor effect of its settlement with the SEC over the Squared CDO, but its senior managers will be well aware that other potential reputational risks remain. Chief among these is the threat of fallout from its longstanding relations with Bernie Madoff. A ruling against JPMorgan in the Madoff case – even a harshly worded preliminary judgment allowing a case to go ahead – could finally crack the bank’s image of invulnerability.
