JP Morgan's Beached Whale

What the fallout from JP Morgan's 'whale trade' tells us about the new financial system.

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Jamie Dimon, CEO of JPMorgan Chase, testifies before the House Financial Services Committee on Capitol Hill in Washington, on Tuesday, June 19, 2012.

Last week, JP Morgan Chase settled with regulators in both the United States and United Kingdom over massive losses suffered in the 2012 "London Whale" trading fiasco. Chase, America's largest bank, fessed up to wrongdoing and agreed to pay a stiff $920 million fine. As part of the agreement, regulators agreed not to pursue further charges against Chase's top brass.

Thus ends the biggest financial hiccup since Wall Street nearly tanked in 2008. The story begins in April of 2012, when Bruno Iksil, an obscure trader in the big bank's London unit, got caught in a series of outsized derivatives trades that went bad. Fellow traders dubbed Iksil the "London Whale" for the monstrous size of his bad bets. Chase CEO Jamie Dimon was initially dismissive, calling the burgeoning scandal a "tempest in a teapot."

Iksil escaped prosecution by cooperating with authorities. But two former employees in the London branch weren't so lucky and are being prosecuted for falsifying books and regulatory filings in an effort to cover up the trader's disastrous positions.

"The defendants deliberately and repeatedly lied about the fair value of assets on JPMorgan's books in order to cover up massive losses that mounted up month after month," Preet Bharara, the U.S. Attorney for the Southern District of New York, said when announcing the charges. "Those lies misled investors, regulators and the public, and they constituted federal crimes."

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The final impact on Chase's bottom line for the rogue bets? More than $7 billion.

That's a lot of money, even for a charter member of the "too big to fail" fraternity. But while a loss to the balance sheet of that magnitude would prove fatal to most companies, Chase quickly recovered. After the news of the scandal broke, Chase saw its stock fall from around $45 a share in April 2012 down to $31 in June. But by the end of 2012, the stock regained all the ground it lost and has moved higher since, and the bank recently announced a 21 percent increase in its dividend.

So what does the London Whale episode tell us about the new regulatory framework set up to prevent a recurrence of the 2008 financial crash? Did the system succeed or fail?

On one hand, Dimon has led the construction of a financial behemoth capable of swallowing a multi-billion loss and resulting multi-million dollar fine. The system didn't buckle, the market didn't panic, there was no run on the bank and no bailouts were needed. That's very good. For better or worse, that's what lawmakers and pundits of all political stripes have clamored for since after the 2008 Lehman catastrophe, bailouts and the Dodd-Frank response.

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And yet: It's equally true that Dimon presided over a mega-bank with lax internal risk and accounting controls, and, perhaps most important, a culture of excessive risk-taking in pursuit of outsized gains. All that allowed middling-level employees to make and cover up positions that cost the big bank big bucks while also breaking the law.

It's unrealistic to expect the CEO of a company that employs more than 250,000 people worldwide and has a market cap of almost $200 billion to know what is going on with every employee in every nook and cranny of his bank. The buck, nonetheless, stops in the CEO's executive suite.

In today's climate of heightened regulatory scrutiny and outright public hostility to Wall Street, it behooves a bank CEO like Dimon to have a firmer grasp on the most problematic kinds of trading. One place that a "too big to fail" bank can't afford any missteps is in the derivatives market. Even the legendary investor Warren Buffet calls derivatives "financial weapons of mass destruction." Iksil used credit default swaps – the very instrument which sunk insurance giant AIG during the crisis – to execute his $100 billion bet on corporate grade bonds.

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Such complex hedging instruments are especially fragile threads in the global financial web. As such, they are squarely in the crosshairs of lawmakers and regulators who are showing zero tolerance for any flare-ups of the old financial buccaneering. It's not surprising that the Securities and Exchange Commission, which typically settles for levying steep penalties on errant banks, in this case forced Chase to make a public admission of wrongdoing.

What does all this ultimately mean for megabank CEOs? When it comes to holding Dimon accountable for the London Whale scandal, Chase has sent decidedly mixed messages. Its boards of directors cut Dimon's stratospheric pay in half – to $11.5 million from $23 million – but let him keep both titles: chairman of the board and CEO.

Critics of the big banks are deeply frustrated by what they see as regulatory wrist-slapping and an unwillingness by authorities to bring criminal charges against corporate leaders. Nonetheless, the post-crash financial regulatory system may benefit from the London Whale debacle. The bottom line is that a handful of bank employees broke the rules and tried to cover up their actions. Chase's stupendous losses were a result of illegitimate bets that should never have been made, not standard investment positions executed within accepted rules and regulations.

No doubt Dimon - and his fellow CEOs - will be running a tighter ship in the future. That's not the worst way for them to earn their lavish pay.

Jason R. Gold is director of the Progressive Policy Institute's "Rebuilding Middle Class Wealth Project" and senior fellow for financial services policy. Keep up with his work at PPI here and follow him on Twitter at @PPI_JGold.

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