What Happens When JPMorgan Fails?

JPMorgan Chase (NYSE: JPM  ) CEO Jamie Dimon was hauled before Congress yesterday for a finger wagging over the bank's recent $2 billion trading blunder. For all the haranguing and grandstanding, Sen. Jerry Moran asked one of the only relevant questions of the hearing; he wondered if JPMorgan failed, then could it go down without costing taxpayers money? The answer was also the most telling.

"Yes," Dimon replied.                                                            

And at 11:42 EDT, reality died.

The timing couldn't have been better. The day before, a JPMorgan internal assessment of what it would take to push the bank into bankruptcy was released. The conclusion: a loss of $50 billion.

JPMorgan had $2.3 trillion of assets at the end of last quarter. A $50 billion loss, then, is the equivalent of just 2.17% of assets. That's one of the scariest simple math equations that exists in today's economy.

No need to worry, the report assures. After failing, the bank could be hosed down, cleaned out, and "returned to private sector as a new bank with a clean balance sheet." Taxpayer money used to keep the bank operating in the interim would be repaid, the report promises. Everyone lives happily ever after.

Maybe that's what would happen, but I doubt it. It's inconceivable to think that a bank JPMorgan's size could fail without the FDIC and other taxpayer-backed bank authorities being utterly overwhelmed. The numbers here are astronomical: JPMorgan has more than $1 trillion in deposits, and its balance sheet equals 15% of the country's gross domestic product. Nothing works as planned with a bank that size.

But let's assume for a moment that JPMorgan could fail without costing taxpayers a dime. Is that the end of this story?

Not even close. Nearly everyone in the country would pay a price.

We don't have to do much assuming here; we have 2008 as a template. If JPMorgan failed, we have a good idea what would happen.

Credit markets would freeze
As the financial system ponders who's holding the bag, everything stops and credit grinds to a halt. Anything not called U.S. Treasuries is deemed too toxic to touch. Even the bluest of blue chip companies suddenly can't access credit markets, and thousands of businesses around the country that rely on credit to fund inventory and payroll go bug-eyed. Nobel Prize-winning economist Robert Solow described this in 2008:

So businesses that would normally be investing in a new computer or a new fleet of trucks or whatever that would need to borrow, can't borrow. And if they could borrow, they would be paying a very high rate of interest. So they stop.

And then the real economy begins to slow down, and people lose their jobs because their firms can't sell to consumers, can't sell to other businesses. A modern economy is a more complicated piece of machinery than a simple barter economy. Production is very complicated. You start with God knows what, and you end up with some extraordinarily complicated piece of equipment or the machinery that appears in my dentist's office when I sit down. That can't be directed without a good deal of action which is taken now and can only pay off many stages later. And that's where the credit mechanism comes in. Industry that depends on it has to slow down, simply because it can't get the funds that enable each stage in production to pay off the previous stage.

Other banks would fail
In May 1931, an 80-year-old, well-connected, highly respected bank called Credit-Anstalt in Vienna failed. The global banking world was stunned. How could such a large and powerful bank fail? And if it can fail, who's next? It was sheer panic. Princeton historian Harold James explains the ensuing chaos: "The Viennese panic brought down banks in Amsterdam and Warsaw. In June and July the scare spread to Germany, and from there immediately to Latvia, Turkey, and Egypt (and within a few months to England and the U.S.)." BusinessWeek's Peter Coy puts it more bluntly: "Thus the failure of Credit-Anstalt accelerated the financial panic that turned a recession into a global depression."

There is never just one cockroach in the kitchen, and there's never just one major bank failure. Panic spreads like wildfire.

Markets would crash
This is standard in any financial crisis. Hedge funds and other institutional investors that do business with or are in any way connected to wobbly banks freak out, sell whatever they can and crawl into a bunker. Selling begets more selling, and on and on. By the time the dust settles the world is a few trillion dollars poorer, confidence is shot, businesses are undercapitalized, and unemployment spikes as consumer spending dries up. The Federal Reserve eventually stems the panic with massive intervention, but God knows what the eventual outcome of that is.

And all of that from JPMorgan losing 2.17% of assets.

This is real, folks
None of this is speculative fiction. It's what history tells us happens every time a large bank fails. The same scenario would play out if Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , Goldman Sachs (NYSE: GS  ) , or any other too-big-to-fail bank were to go under. And eventually, they probably will.

Some might make the doubtful argument that JPMorgan's failure wouldn't cost taxpayers a penny. But no one, not even Dimon, can argue with a straight face that horrific damage wouldn't be inflicted on the rest of the economy if a big bank collapsed. Everyone pays the price for too big to fail.

Fool contributor Morgan Housel owns preferred shares of Bank of America. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Bank of America, Citigroup, and JP Morgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs Group. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (21) | Recommend This Article (46)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 14, 2012, at 3:42 PM, prginww wrote:

    Also, JP Morgan has over 60 trillion dollars of gross derivatives exposure, most of which is interest-rate sensitive.

    We will never see US interest rates go up, ever again.

  • Report this Comment On June 14, 2012, at 4:23 PM, prginww wrote:

    Yep, the counterparty risk of a JP Morgan failure in the time of opaque derivative madness would take down everyone. Derivatives are weapons of mass destruction compared to the simple explosives they had in 1931.

    But big companies own the government (yes, unions have a minority ownership too). No way will regulations be put in to change things. Think about it, all big companies really have to do is make it known that any politician that plays ball and loses an election is set for life. Then they fund potential replacements and attack ads on the opponents and while they don't control every politician, they certainly control most of them.

  • Report this Comment On June 14, 2012, at 6:24 PM, prginww wrote:

    But I thought Dodd Frank was going to solve all the problems?

  • Report this Comment On June 14, 2012, at 6:27 PM, prginww wrote:

    <<But I thought Dodd Frank was going to solve all the problems?>>

    Who said that? I think even the most bullish supporters of Dodd Frank have always been resigned to its woeful shortcomings.

  • Report this Comment On June 14, 2012, at 6:43 PM, prginww wrote:

    There is no regulation that can prevent an unscrupulous company from doing bad things and failing. Eliminating the moral hazards (Fed bailouts and FDIC) would go a long way toward making the risks real in the minds of management, but would not eliminate it. Probably the biggest deterrent to bank failures would be 100 % reserves. Dodd Frank will not prevent anything from happening; it will only result in some from of punishment after the fact.

  • Report this Comment On June 14, 2012, at 6:55 PM, prginww wrote:

    Glass Steagall was the answer that worked from the 30's to the not so distant past. The opportunity for more and faster money overcame the reasoning that was Glass Steagall.

    If the scenario presented above did happen it would be the insurance company that sold the policies that might fail. Right after the government paid 100 cents on the dollar to cover the loss...

  • Report this Comment On June 15, 2012, at 1:05 AM, prginww wrote:

    You're damn right. What's more horrifying is that we have done almost nothing to fix too-big-to-fail.

  • Report this Comment On June 15, 2012, at 3:45 AM, prginww wrote:

    the only thing that matters is how much you earn at the end of the business year while you work to earn honestly and responsiblly for yourself, other employees, the company, the stockholders, and your customers with the goods and services you provide. dealing with hundreds of billions dollars, losing two billion dollars is bad, steps need to be taken so it doesn't happen again. Who and how was this loss allowed in view of all the blame placed I believe wrongly on wall street. The question to ask is why this big bet wasn't covered better?

  • Report this Comment On June 15, 2012, at 3:49 AM, prginww wrote:

    ask yourself, who are the people really bailing out loser companies?

  • Report this Comment On June 15, 2012, at 10:03 AM, prginww wrote:

    if they fail (again), we the taxpayers will bail them out (again). maybe that's why they're so reckless?

  • Report this Comment On June 15, 2012, at 11:13 AM, prginww wrote:


    If I read your second to last paragraph correctly, you think it likely that the big banks will eventually go under. That's a pretty bold assertion. Would you care to expound on your line of thought.

  • Report this Comment On June 15, 2012, at 11:14 AM, prginww wrote:

    ^ It's pretty simple: I'm old enough to remember 2008.

  • Report this Comment On June 15, 2012, at 11:17 AM, prginww wrote:

    Blithering, fear mongering, nonsense.

    Markets clear. The longer you prevent them from clearing, the more painful the clearing process will be.

    So keep promoting bailouts of big banks and crony capitalists, and all you do is make the process of clearing (the INEVITABLE process) all the more painful down the road.

    If you let them fail, we move on. Markets clear. New entrepreneurs buy up the assets of the failed entrepreneurs.

    A flawed system gets replaced with a stronger system.

    Markets clear.

    David in Liberty

  • Report this Comment On June 15, 2012, at 11:20 AM, prginww wrote:

    ^Lol. Morgan I had the exact same though go through my head.

    It's not complicated. Too big to fail is too big.

  • Report this Comment On June 15, 2012, at 1:56 PM, prginww wrote:

    I think it's even simpler. Banks fail because they are undercapitalized. More banks fail because they, too, are undercapitalized, and their linked exposure to other banks stresses their capitalization.

    Capital is insulation; banks with a lot of capital are like a guy swerving his car to avoid a deer on a lonely road. He might drive into a ditch, he might be fine, but the effect will not spread because the nearest car (or bank, in the analogy) is a mile away. Banks with low capital have the same insulation from other shocks that NASCAR drivers have from each other. They're inches away and if one swerves, everybody crashes.

  • Report this Comment On June 15, 2012, at 2:05 PM, prginww wrote:

    <<Banks fail because they are undercapitalized. More banks fail because they, too, are undercapitalized, and their linked exposure to other banks stresses their capitalization.>>

    No doubt true, but a lot has to do with bank runs. A bank can go from "well capitalized" to bankrupt in a very short period of time when there's a panic. Lehman Brothers had a Tier 1 capital ratio of 11% 48 hours before it went bankrupt.

  • Report this Comment On June 15, 2012, at 3:39 PM, prginww wrote:

    So Morgan, are you assuming another too big to fail bailout? Or will there be no bailout this time and we have a Great Depression like crash? If this is your assumption, I'm guessing you want no part of common stocks.

    I wish my crystal ball was as clear as yours.

  • Report this Comment On June 16, 2012, at 8:08 AM, prginww wrote:

    Important reality check, Morgan. Great job!

  • Report this Comment On June 16, 2012, at 12:54 PM, prginww wrote:

    On a related note, since the key governments and central banks have all etched their playbooks in stone that further intervention will be provided in whichever quantity is required to further delay the invitable delevering process, investors may wish to carefully consider whether the outlook for further currency debasement has been integrated into their investment strategy:

  • Report this Comment On June 19, 2012, at 1:03 AM, prginww wrote:

    "By the time the dust settles the world is a few trillion dollars poorer..."

    Interesting. I always think of money as semi-solid, win/lose deal, i.e., it goes somewhere and someone gets it. This suggests money is like a gas. It contracts into something much smaller.

  • Report this Comment On June 19, 2012, at 11:18 AM, prginww wrote:


    Fiat currency is like a gas. If you want something more solid, may I suggest some hard money in the form of silver and gold?

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