My Amazon Review of Nicholas Sargen's "JPMorgan's Fall and Revival: How the Wave of Consolidation Changed America's Premier Bank"

 

A Reflection on the House of Morgan

 

Nick Sargen, longtime Wall Street economist and a friend and former colleague, has written a personal memoir of his working at JPMorgan, a history of the financial markets from 1978-2005 and a too endearing recent history of JP Morgan and the strategic issues it faced in the late 20^th century.* To me it is a misnomer to call JPMorgan “America’s premier bank,” in that as of yearend 1976 Morgan, with $28 billion in assets was the fifth largest bank holding company with roughly one-third the assets of Bank of America and standing behind Citicorp, Chase Manhattan, and Manufacturers Hanover. Simply put JPMorgan’s past was brighter than its future.

 

Sargen arrives at Morgan in early 1978 with an economics Ph.D. from Stanford after a stint at the Federal Reserve Bank of San Francisco where he specialized in international economics. He is thrust into a rapidly inflating global economy and the world of sovereign lending to Asia and Latin America and is taken under the wing of the banks lead international economist, the highly respected Rimmer De Vries. In the early 1980’s Morgan had a virtual murderers row of economists that included Dick Berner (later Morgan Stanley’s chief economist), Bill Dudley (later Goldman Sachs’ chief economist and later President of the NY Fed), and Steven Roach (later Morgan Stanley’s chief economist). It was quite the intellectual hothouse.

 

By 1982 the American banking system and JPMorgan found themselves facing the imminent default of a host of Latin American countries as their scheme to recycle petro-dollars went awry. For all practical purposes the banks were insolvent. Sargen whose early warning system at the San Francisco Fed signaled the crisis, was not heeded at Morgan and elsewhere as the lure of high spreads dazzled the commercial banker of that day. To me, of all banks, Morgan should have stayed away given its experience with the Dawes Plan of the 1920s which recycled German reparations payments. Morgan partner Tommy Lamont was in up to his eyeballs with German loans. Of course, that all came crashing down when the New York call money market sucked money in from all over the world and the Fed’s 1929 tightening brought that episode to an ignominious end. The Volcker tightening of 1979-82 had the same effect. Simply put, Morgan should have known better.

 

Sargen describes a very insular and elite coat and tie “WASP” culture that only hired from the best of schools. There is no way Morgan would have hired me as a Jewish street kid from Queens with a UCLA finance Ph.D.  Although it was somewhat of a culture shock when Sargen was lured away from Morgan to the rough and tumble shirt-sleeve culture of Salomon Brothers. Sargen arrived in 1984 and I arrived there two years later. There Sargen learned the power of Salomon’s trading floor and he was shocked to see the firm’s chairman John Gutfreund sitting at open desk right on the floor. A far cry from JPMorgan. While there Sargen witnessed the collapse of the dollar, the 1987 stock market crash and the Brady Plan for Latin debt and Salomon’s infamous treasury scandal. By 1991 he was looking for greener pastures and ended up running money for Prudential and then in 1995 he returned to Morgan to be the chief strategist for its Private Bank. All the while he keeps up with the fits and starts problems facing Morgan as it enters investment banking.

 

Sargen rightly notes that Morgan’s strategic dilemma was that its core strength of banking for America’s top corporations was being disintermediated by the Wall Street investment banks who picked off its clients by offering better terms and conditions via the short-term commercial paper and long-term capital markets. Morgan under the leadership of Lew Preston and Dennis Weatherstone understood the problem and began to build an investment bank skirting around the requirements of the Glass Steagall Act that limited commercial banks from underwriting securities. They were successful to a degree, but at great cost. According to Sargen, Morgan’s biggest strategic mistake was not buying State Street Bank in 1990 when it had the chance.

 

With the late 1990’s bull market in full swing Morgan is left behind. All the action is in the new economy, while Morgan is wedded to the old economy. Its stock lags and of a sudden Morgan becomes takeover bait. Sargen cites an interesting vignette when Morgan invites twenty something TheGlobe.com CEO to address their annual managing directors meeting. Krizelman addresses the crowd in jeans and a tie-dyed T-shirt. The game was over, and Chase Manhattan Bank would soon acquire Morgan. However, the culture class was enormous with Chase and Morgan people hating each other’s guts. It would only settle down after JPMorgan Chase would acquire Bank One bringing with it a star banker named Jamie Dimon. It would be Dimon who restores the franchise to its past glory, but in a completely unrecognizable incarnation. Sargen would be long gone by then.

 

Because I am a finance and history geek and was involved in many of the big events discussed in the book, I thoroughly enjoyed reading Nick’s account. However, I am not so sure about the general reader. It would have helped if either there was more discussion about all the Morgan executives named in the book, or alternatively dropping a host of names. It was confusing at times. Further it would have helped to have annual data on Morgan’s profitability metrics and stock price. Nevertheless, from my biased perspective it is well worth the read.

 

*-I received the book from Sargen.

For the full Amazon URL see: A Reflection on the House of Morgan (amazon.com)

 

My Amazon Review of Mervyn King's "The End of Alchemy: Money, Banking and the Future of the Global Economy"

Fixing the Banks

Mervyn King, the former governor of The Bank of England, has written a very readable book on the interaction of money and banking on the global economy. He offers his insights as a practical banker and a serious economist for the way forward from the financial crisis of 2007-09 that we are still reeling from.

Although he discusses a host of topics relating to how people make decisions in practice compared to how economic theory suggests they behave, the problems of the fixed exchange rate regime within the European Union, and the difficulties of making policy within a framework of competing nations; I will focus on two issues that he raised.

The first is his suggested reform for the banking system. His reform is a modified “Chicago Plan” of the 1930s which called for 100% reserves. Under that regime bank deposits would be matched with cash and short term government securities. Hence no risk and no potential for bank runs. In contrast the current system is based on fractional reserves where banks hold a small portion of their deposits in reserves and lend out the balance. This process is King’s alchemy where short   maturity deposits are transformed into long term assets. In the jargon of economists this process is called “maturity transformation.” 

This system is inherently unstable because the cash is not there to pay off depositors if they want all of their money at once. To deal with this contradiction the central bank acts as a lender of last resort to meet the demands of anxious depositors. This gives rise to the issue of “too big to fail.” King’s compromise is to turn the central bank into a “pawnbroker for all seasons.” Under his proposed system banks must hold sufficient reserves, liquid assets and discounted long term assets to meet all deposit and short term borrowing liabilities. The discounted assets would be valued at a “normal times” value with an appropriate “hair-cut”  to allow for risk and those asset could be pawned at the central bank should the need arise. Any lending above this threshold would have to be funded by additional equity and long term liabilities. Thus depositors would feel secure that their money be there when they needed it.

All this is fine and good, except there would be very little incentive for banks to make risky loans. Why is that bad? It is bad because new businesses, new ideas and new construction have to be funded if the economy is going to achieve the growth that most of us desire. To undertake King’s reforms we would need new institutions to undertake those risks. King is silent on this question.

The other issue that King raises that I would like to discuss is that the universal answer to all financial crises is to throw central bank money at it. We have been doing this for nine years. The problem that King rightly raises is that if the problem is structural rather than liquidity, throwing money at the crisis will delay solving the structural imbalances. To King’s mind central bankers in this environment may set interest rates too high to permit growth, but too low to allow for a structural adjustment.

The issue in the West is that savings are too low, while in the East consumption is too low. For example in order for the U.S. to cure its chronic trade deficit the savings rate has to rise and consumption has to fall, while China’s huge trade surplus has to be cured by higher consumption and lower savings. Politically asking people to reduce consumption is a hard sell so the easy way out is to keep interest rates low that works to keep consumption up.

All told Mervyn King has written an important book that will play a significant role in the ongoing debates over banking reform and monetary policy. He also offers a well done primer on current thinking on monetary policy that is accessible to the lay reader.

For the full Amazon URL see:
https://www.amazon.com/review/R2QKZ627F6QZRL/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Charles Calomiris' and Stephen Haber's "Fragile by Design: The Political Origins of Banking Crises and Scarce Credit"

Banking in a Political Context

According to Professors Calomoris and Haber banking does not exist in a political vacuum. In fact banks are product of a bargain between political coalitions and bankers; a social contract, if you will. In a very long book, too long in my opinion, the authors delve into the history of the banking systems of the United States, the United Kingdom, Canada, Brazil and Mexico and the political coalitions that underpin them.

Calomoris is a self-described Hamiltonian; he likes large banks with extensive branching systems. He credits Canada where a bank bargain between the political elites enabled a crisis free banking system. In contrast the United States with its agrarian populist combining with local banks created a crisis ridden small unit banking system. That system ended when a new coalition of mega-banks and urban activists enabled the creation of the banking system we have today. Simply put in exchange for supporting mega-mergers, banks channeled trillions of dollars into urban mortgages, some of which being of dubious quality. One thing that comes through is that lending on illiquid real estate lurks behind most of the banking crises experienced in the U.S. and U.K.

The political context rests on the fact that politicians need banks to fund government debt, support favored activities and to make it easy to finance government though an inflation tax. Brazil and Mexico are prime examples of using inflation to fund the government. In the United States banks and government sponsored agencies exist to fund housing programs off the budget.

This is more a history book than an economics book. Nevertheless it is very important for economists to understand the milieu their models are operating in.

The full Amazon URL is:

http://www.amazon.com/review/R2PL4PN97RNSVP

In the Dow Jones Newswire, "Ex-Tarp Chief: Proposals Should Consider Broad Risk

JANUARY 22, 2010, 4:35 P.M. ET
UPDATE: Ex-TARP Chief: Proposals Should Consider Broad Risk

(Adds post-speech comments from Lambright in fourth paragraph.)
By Marshall Eckblad
Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--The former chief investment officer of the U.S. government's Troubled Asset Relief Program said Friday proposals for overhauling the U.S. financial system should focus on limiting broad risks at institutions large and small.
Risk "could arise from lots of small institutions," said Jim Lambright, who left the TARP program last summer, at a financial services conference hosted by the Australian Consulate in New York.
President Barack Obama said in a speech Thursday he is committed to limiting the investment activities and risk levels of the nation's banks, and he also signaled the biggest banks could be forced to shrink.
Lambright didn't address any specific proposals in his speech. He said after the speech that he was challenging the audience to ask "where risks might migrate to other parts of the system."
Lambright was an appointee in the Bush administration under then-Treasury Secretary Henry Paulson, but stayed on to work for the Obama administration.
David Shulman, a former executive at Lehman Brothers and now an economist at the UCLA Anderson Forecast, told Dow Jones Newswires on Thursday that any regulatory overhaul should include capital requirements for bigger hedge funds to prevent banks from being exposed to risk at less regulated firms.
-By Marshall Eckblad, Dow Jones Newswires; 212-416-2156; marshall.eckblad@dowjones.com

Source:http://online.wsj.com/article/BT-CO-20100122-712290.html?mod=WSJ_latestheadlines