Lessons learned from JPMorgan Chase's unexpected loss

May 15, 2012

JPMorgan Chase is the largest banking corporation in America. It stood out as a beacon of stability during the recent U.S. financial meltdown. But not anymore.

The bank shocked Wall Street last week with a $2 billion loss. More losses may be on the way.

On this week's Money Matters, financial commentator Greg Heberlein and KPLU's Dave Meyer look at some of the lessons to be learned from this surprising development.

What happened?

Think of it this way: it’s like buying insurance on your home. The home isn’t destroyed, but all of the money you spent on the insurance has been wiped out. You are now totally at risk.

The biggest lesson to learn from this is that no investments – even the gold-plated ones – are "safe". 

JP Morgan is the country’s largest bank. Its stock is the bluest of blue chips. Its leader, Jaime Dimon, has been showered with applause by media and investors alike. It seemed like he could do no wrong. 

As we’ve said so many times, invest in a diversified way. Select individual stocks across a wide array of industries or stick to broad indexes that buy pieces of hundreds of stocks.

Derivatives – what JP Morgan bought – are extremely dangerous.

In a derivative, an investor doesn’t buy the actual instrument but a piece of paper representing it. Derivatives are like an iceberg: you can see some of the danger atop the sea, but the biggest threat is underneath.

The value of all derivatives exceeds $1 quadrillion. That’s one million billions, or 20 times all of the world’s economies.

Well-known investor Warren Buffett bought derivatives several years ago. They collapsed. An apologetic Buffett now calls derivatives instruments of mass destruction.

JPMorgan offers a further lesson: greed, not risk reduction, was the crime here. Adopt conservative investment principles. Avoid new strategies, as this one was, that haven’t stood the test of time.

Another lesson:  Although not yet clear, JPMorgan may have used depositors’ money. That is precisely the sin that led to the stock market’s downfall in 2008.

Finally, the JPMorgan error rested on foreign investments. It is difficult, even for experts, to assess investments that are not nearby. Just look at the savage losses this year in funds that invest overseas.

Some of the results of JPMorgan’s giant mistake:

  • Derivatives are generally unregulated – expect more regulation.
  • Expect more shoes to drop, definitely more losses at JP Morgan, possibly losses at other banks and investment houses who adopted the same strategy.
  • Just when the investment community expected the Facebook stock offering to bring back small investors burned in 2008, the JPMorgan incident dampens the outlook.

Last, but not least: Gordon Gekko had it wrong.

Greed is not a good thing.