Vulnerable Dragon

By ALAN ABELSON | MORE ARTICLES BY AUTHOR

A consideration of Jamie Dimon's and JPMorgan Chase's debacle with a supposed hedge transaction. Also, the dark visage under China's smiling, prosperous image.

 

You can't win 'em all. Every gambler, from sidewalk crapshooter to bet-a-million roulette habitué in Las Vegas, can to his rue verify the truth of that ancient homily. And so can Jamie Dimon, who runs this rich nation's biggest bank, JPMorgan Chase . Last week, he mournfully disclosed that the bank had lost two billion smackers when a supposed hedge transaction involving derivatives and stocks went sour.

Dimon, who has been on a roll for many years and who always struck us as the class act in banking, an industry not famous for its extraordinary execs, refused to soft-soap the enormous hit, blaming "errors, sloppiness, and bad judgment" for the disastrous trade. And he added, in a conference call to shell-shocked analysts and portfolio managers, "Just because we were stupid doesn't mean anyone else was." It's a fair assumption that the "we" really somewhat royally referred to himself.

It's more than a touch ironic that Dimon, who guided Chase so skillfully through the financial crisis, came to grief (if only momentarily) by ignoring the irrefutable fact that derivatives can be weapons of mass financial destruction and are not infrequently an excellent hedge against capital gains.

In this instance, it proved a particularly costly oversight, exposing the bank's stock (ticker: JPM) to a fierce drubbing, and rattling the financial sector as a whole. It also lit a fire under the dithering regulators.

Now, if any institution can absorb a $2 billion whack without fatal damage being inflicted on its balance sheet, if not its amour-propre, it's Chase. But this sort of thing can have a long and annoying tail, so we'll wait to see how quickly and how briskly the bank and Dimon snap back.

For a spell now, Dimon has been butting heads with Paul Volcker over the so-called Volcker Rule, aimed at curbing banks' proprietary trading. And talk about irony, as we did a few paragraphs above, the day before Dimon made his sorry disclosure, Volcker testified before the Senate Banking Committee, beating the drums for the merits of the rule, a key provision of the Dodd-Frank regulatory overhaul, due to take effect in July.

Beside curbs on banks dabbling in proprietary trading, Volcker made a pitch for restrictions on trading in derivatives. Who knows? In his present angry, confessional mood, even Jamie Dimon might think that's not such a bad idea.

After a brief and truncated rally, the stock-market response to the Chase fiasco was neither very much here nor there, as investors obviously decided to take the weekend to think it over. That, we suspect, will prove a wise decision.

THAT COLOSSUS OF NATIONS, CHINA, whose astonishing economic growth has become one of the seven wonders of the world (elbowing out the Hanging Gardens of Babylon or the Mausoleum at Halicarnassus; we forget which) is, not surprisingly, the cynosure and envy of this aching planet. But lately, the country has attracted global attention for a vastly different and juicier reason: a lurid glimpse of the corrupt and inhumane visage beneath the smiling face of the ruling regime.

The corruption and ruthlessness of that regime was personified by Bo Xilai. By all description, Bo is no beau. He rose through the bureaucratic ranks by hook and crook, especially the latter, to provincial governor and a spot in the Politburo, the claque of devils that runs the nation. But thanks to his insatiable ambition, unrestrained self-promotion, and take-no-prisoners approach to dealing with underlings and rivals, he's never wanted for enemies, a number of them powerful.

So not too many tears were shed when the roof fell in on Bo.  He has been suspended from the Politburo and is being held at some unrevealed location while under investigation for "serious violations" of Communist Party rules. In China, that can mean anything from spitting on the sidewalk to scooping up for yourself a few hundred grand of the government's stash.

It obviously doesn't help poor Bo that his wife, a lawyer and far from a shrinking violet, is a suspect in the murder of Neil Heywood, a Brit living in China, who was both a friend and a business associate and with whom she argued over money shortly before he was killed.

In China's inscrutable political system, punctuated by periodic struggles for power, today's outcasts can become tomorrow's top dogs. And while such a reversal doesn't seem imminently in the cards for Bo, weirder things have happened. A safe bet is that whoever replaces him is likely to embody the same corrupt and self-aggrandizing impulses.

As to the regime's less-than-stellar respect for humanism, the repulsive treatment of Chen Guangcheng, the courageous blind dissident who finally sought to escape from years of bullying, imprisonment, and house detention and somehow traversed a couple of hundred miles to refuge in the American Embassy in Beijing, is more than eloquent testimony. At last report, he was in a hospital, suffering from internal ailments and a broken foot sustained during his escape, awaiting approval to depart for America and voicing concern that his extended family would be subject to vicious retaliation.

The spotlight on corruption and mistreatment of its populace couldn't shine at a less propitious time for Beijing. For one thing, the country's leadership is passing the baton. And, perhaps more importantly, China's fab economy is showing serious signs of strain. Exports, the engine of the nation's remarkable growth, are lagging; in April, they edged up a mere 4.9%, roughly half as much as economists had predicted. Imports meanwhile managed to eke out a miserable 0.3% rise, far below the 11% anticipated.

Moreover, factory output came in at 9.3%, the smallest increase since May 2009. And residential real estate has hit the skids.

Hard landing, anyone?

THAT AT LEAST IS THE SEEMING PURPORT of a paper on China penned by Harald Malmgren. We've had the pleasure of passing along from time to time Harald's insightful comments on global markets, including our own precious bourse. The eponymous investment firm that he manages advises mostly big-bucks clients -- the likes of financial institutions, sovereign wealth funds, governments and central banks. He's a big picture man and very well clued-in.

In sizing up China, Harald says that he tapped the sentiment of what he dubs the country's "investor class." an amorphous slice of the population that encompasses a sweep of private investors, including high-net-worth families, managers of giant investment funds, and individual entrepreneurs. Such investors, he observes, have growing influence on how China's economy functions and, in consequence, increasing political influence as well. The good thing, presumably for Harald and for us, too, is that their opinions are not very earnestly pursued by the media or academic economists or market analysts.

Harald feels that China's exports are being hurt because foreign demand has been dramatically weakened by the Great Recession and its aftermath and the erosion of China's competitive edge by the rising costs of labor, materials and energy. Domestic demand is simply not sufficient to pick up the slack from faltering exports.

Meanwhile, he notes, the country's "financial bubbles in real estate and commodities are bursting, its banking system is crumbling under the weight of massive misallocated and nonperforming debt," while the ordinary citizen is suffering from inflation in food, fuel and other essentials.

Around the world, Harald relates, investors are weighing what's in store for the Sino economy -- a soft or a hard landing. The answer, he asserts, depends in part whether or not the global economy can stage a real recovery from the financial shocks of the past few years. But, he avers, it also depends upon how quickly China's new leadership can come up with, and act on, fresh approaches to deal with the serious stresses on the economy, which, in turn, will be determined by whether the political transition is smooth or roiled by a lengthy period of power struggles.

The investor class, reports Harald, is worried stiff that the transition will not go smoothly and, to make matters worse, will stretch out over a considerable time span. And they fear that the transition will replace current office holders with a heap of novices lacking virtually any experience of governing.

Another, perhaps more pressing worry is that the new gang in control will include many new leaders and officials hot to gather wealth and wouldn't mind at all shaking down current members of the investor class to get it. There are concerns, too, according to Harald that if China's economy doesn't come up to snuff in the next few years, the new leaders will blame their predecessors for faulty management and corruption, triggering a wealth transfer from the ancien regime to the new one.

Much of the investor class, observes Harald, sees a weak economy ahead for China, and they shrug off Beijing's data as anything but reliable. At best they expect growth to fall shy of the official target of 7.5%, and obviously it could be worse. Maybe the most telling trend is that investors are looking for better opportunities abroad, and that somewhere down the road, the powers-that-be may be confronted by capital flight.

What does it all add up to? A situation that's fluid and likely to get more so, and less than inviting for investors.