What We Really Need to Be Asking About JPMorgan

JPMorgan Chase's (NYSE: JPM  ) "London Whale" is still on the tip of everyone's tongue. That's as it should be since the debacle has already cost the bank close to $6 billion.

But, if we step back for a moment, the question we should be asking is: Why does JPMorgan's chief investment office -- the source of the rapidly metastasizing trade -- have an investment portfolio of $323 billion in the first place? Or, in other words, why is JPMorgan trading its deposit base rather than making loans?

The chart below was adapted from a JPMorgan handout (link opens PDF file) that it provided with its second-quarter earnings.

Source: JPMorgan Chase.

The first thing to notice is the CIO portfolio at the top of the asset pile. JPMorgan's CIO is typically described as the bank's arm that's responsible for investing the bank's "excess deposits." Excess deposits are exactly what they sound like: depositors' money that hasn't been reinvested in loans. So when the banking business is slow -- at least, the banking business as defined by loaning out depositors' funds -- JPMorgan turns to the CIO office to protect that money and earn some conservative returns on it until the bank finds a place to loan it out. Or so the story goes.

Move further down the graphic and we see the loans on the asset side and the deposits on the liability side. Deposits are much larger than loans and JPMorgan highlighted that in the chart by helpfully calculating the gap between deposits and loans. It's as if the bank is telling us, "See, we can't help it. We have all of this money we can't loan out so we need this huge CIO portfolio to invest that cash."

A $423 billion story
The $423 billion loan deposit gap comes to 38% of the bank's total deposits. That's a massive difference between loans and deposits.

But what does it mean? One logical conclusion is that there simply isn't borrowing demand right now. As consumers and businesses buckle down due to economic uncertainties, the last thing they want to do is take on a whole bunch of new debt.

That's an easy story to check up on, though. If JPMorgan is unable to find adequate loan demand, then it stands to reason that other banks are facing the same sagging demand. But that doesn't seem to be the case.

Total Deposits
Net Loans
Loan-to-Deposit Gap as a Percentage of Deposits
JPMorgan $1,116 billion $693 billion 38%
Bank of America (NYSE: BAC  ) $1,041 billion $870 billion 16%
Wells Fargo $930 billion $748 billion 20%
Citigroup (NYSE: C  ) $906 billion $619 billion 32%
US Bancorp (NYSE: USB  ) $234 billion $207 billion 12%
M&T Bank $61 billion $60 billion 2%
Huntington Bancshares (Nasdaq: HBAN  ) $45 billion $40 billion 11%

Source: Company filings. Note: All bank data is as of the first quarter 2012, except JPMorgan, which is as of second quarter 2012.

Citigroup's gap between loans and deposits is as close to JPMorgan as it gets, but other major banks around the country don't seem to be having nearly the same struggle as JPMorgan when it comes to lending out depositors' money.

If I were cynical, I might say that JPMorgan would rather not find new loans. I might suggest that JPMorgan would rather kick those "excess deposits" out to its CIO and invest the money instead. After all, the CIO arm reported combined 2009 and 2010 profit of $7.9 billion. That's against total JPMorgan net income of $29 billion in those years. During those same two years retail financial services delivered a paltry $1.4 billion in profit, while the asset management division -- which had $1.8 trillion in assets under supervision at the end of 2010 -- managed just $3.1 billion in profit.

It certainly seems like there would've been good reason to want to get more "excess deposits" in the hands of the CIO.

Not quite back to banking
In the wake of the financial meltdown, JPMorgan and its outspoken CEO, Jamie Dimon, have been vociferous critics of the new regulations that some lawmakers and industry experts would like to see put in place. In particular, they've had plenty to say about regulators' attempt to curtail big-bank proprietary trading activities.

There are large financial companies that we're comfortable letting trade as much as they want. They're called hedge funds. The deposit insurance and too-big-to-fail backing -- yes, you better believe it's still there -- that we provide to big banks should not be there to allow bankers to chase trading profits in an effort to justify huge salaries.

If regulators are smart, they'll make the most of the fortuitous timing of the London Whale incident. Make deposit-taking banks leave the proprietary trading to hedge funds. Let them get back to the business of banking.

JPMorgan notwithstanding, some top investors have been zeroing in on the banking sector. To find out who's been sniffing around and what banks you should be watching, check out The Motley Fool's free special report "The Stocks Only the Smartest Investors Are Buying."

The Motley Fool owns shares of JPMorgan Chase, Citigroup, Bank of America, and Huntington Bancshares. Motley Fool newsletter services have recommended buying shares of Wells Fargo. 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.

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (22) | Recommend This Article (70)

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 July 16, 2012, at 5:20 PM, SkepticalBen wrote:

    Terrific insight. JP Morgan, the biggest critic of regulation and limitations for large banks has ironically provided the impetus that just may permit meaningful change. Billions of dollars wagered on, not invested in, derivatives, products that don't really exist. This isn't banking, it's video poker.

  • Report this Comment On July 16, 2012, at 5:23 PM, xetn wrote:

    The basis for this article is the idea that fractional reserves are minimally maintained with the difference (say 90% or a 10% reserve requirement) be loaned out. If this were to be done, JPM would then create about $380 billion of new cash which would be circulating in the economy. This, on top of the huge increase in the money supply created out of thin air by the Fed. The reason why we have not seen much higher prices in the general economy (although there have been a lot already depending on who is counting) is the huge amount of excess reserves held at the Fed by its member banks and paid a .025% interest rate.

    I might add though, that these excess reserves have been created by the Fed out of thin air by buying all manner of debt at face (Fannie, Freddie, Treasuries, and foreign debt.). The fed does this by the click of a mouse, adding reserves to some bank and an equivalent amount to its balance sheet.

  • Report this Comment On July 16, 2012, at 5:31 PM, jtmonrow wrote:

    And these deposits would, of course, be FDIC insured money.....? Golly, I'd rather trade with other peoples money, too! Say, isn't this what happened in 2008? Lucky these guys have bought all 535 members of the House and Senate......... Oh, and by the way, you <1% guys, you're screwed.

  • Report this Comment On July 16, 2012, at 5:38 PM, Quaker08 wrote:

    I admit it. I had to look up the definition of "metastasizing"

  • Report this Comment On July 16, 2012, at 5:50 PM, hank321 wrote:

    Depositors who do not like JPM policies should find a nice credit union so they can collect .11 % per annum. Shareholders who find too much risk with JPM, should invest in a lcore arge Cap ETF.

    I like JPM, always have liked it. My feelings toward our government and our media are not so rosy. Too many yammering turkeys.

    The problem folks at JPM with the bad trades are long gone from JPM, they should be. For me, that is the end of the story.

  • Report this Comment On July 16, 2012, at 6:01 PM, Clint35 wrote:

    So in other words Dimon's full of crap. Raise your hand if you didn't know that already. Anyone, anyone, anyone. He might be smart and he might be a smooth talker but that doesn't mean he's honest. If regulators were smart... that's funny. I think regulators have proven they're not smart.

  • Report this Comment On July 16, 2012, at 6:15 PM, Clint35 wrote:

    @hank321 if you really think the problem folks doing the bad trades are gone you're kidding yourself. Dimon is still there. The so-called lone trading whale was doing what he was told. He had a boss and his boss has a boss and it goes all the way up to Dimon. That whale wasn't the only whale that's ever done a bad trade at JPM and he won't be the last.

  • Report this Comment On July 16, 2012, at 6:21 PM, TMFMTHead wrote:

    Dimon wasn't aware of the 'Whale' before the trade came to light. What makes anyone think the same thing cannot happen again? Personally I believe it is time to re-regulate the banks and take them out of the 'investing' of insured funds.

    What is the difference between an investment made by JPM and a bet made in a Vegas casino? If you cannot think of the answer, it is because there is no difference.

  • Report this Comment On July 16, 2012, at 6:41 PM, johstonk wrote:

    To hank321, that's okay as long as those bad guys that are now gone are not replaced with new ones. Kind of like drug dealers, just because we get rid of one there are always plenty to replace them and it all goes on. I personally would rather keep them out of my chicken house.

  • Report this Comment On July 16, 2012, at 7:36 PM, pauldelang wrote:

    In the end all boils down to responsibility. Responsible depositors depositing money to a responsible bank to keep and lend out to responsible borrowers or traders to trade responsibly, governed by responsible rules and regulations crafted by wise and responsible law makers.

    But the opposite is true. In any environment where everybody screams for profits and put people under pressure to make insane amounts of money you are bound to have risk takers who end up on the losing side of bets. Couple that with influenced politicians who either fail to craft proper regulations or crafted rules and regulations applicable only to one side then you are bound to have serious failures every now and then.

    That is called risk and risk is with us every day. Nobody can legislate zero risk and nobody should expect 100% protection against any risk.

  • Report this Comment On July 16, 2012, at 7:45 PM, dennyinusa wrote:

    You can hate the government all you want, but the only reason anybody still puts money in a bank is because of the FDIC insurance. Without the FDIC they could lose everybody’s savings, and then declare bankruptcy and you get your pennies for dollars and they walk away free and clear. If the government had not bailed out these houses of cards you could have kissed your deposits at JPM goodbye.

    As the articles clearly states, real banks do not have high loan to deposit gaps, since it shows the Jamie Dimon’s of the world do not understand a banks purpose we need to have a strong regulating agency to do this. They have proven time and again they are not capable to police themselves.

    If you really hate socialist policies let’s get rid of bankruptcy rules where the Donald Trump’s and Jamie Dimon’s of the world can run companies which make huge bets with borrowed, leveraged or depositors money, funnels the money to them as CEOs if they make money, but declares bankrupt if they lose thereby screwing the rest of the society. They walk away free and clear. There is no way these people should be able walk away with any personal wealth from a failed adventure, there should be claw back rules in place to recoup the money they were paid because they certainly did not earn their inflated salaries.

    Banks and corporations should not only benefit those running it or they are useless to a society.

    They have turned their back on the people of the countries that allowed them the opportunity to have success. They have forgotten the help they received in tax breaks, subsides and having society pay to educate their workers.

    Banks and corporations also are able to take many risks because of bankruptcy laws that allow them to escape debts they accumulate if they are mismanaged. They have socialized the costs, but profits are private.

  • Report this Comment On July 16, 2012, at 9:54 PM, eldetorre wrote:

    "The problem folks at JPM with the bad trades are long gone from JPM, they should be. For me, that is the end of the story."

    So the folks are gone...but are the losses? NO!!! Are the "problem folks going to pay back all the excess losses? NO!!!

    That's the problem with equating corporations with people. Corporations are something people hide behind to profit and run. Thee is no real accountability, or at least no accountability that exceeds the potential for profits. If the reward for bad behavior exceeds the personal risk (PERSONAL RISK not financial risk) bad behavior will abound.

    I actually would not mind banks taking financial risks, but it should be from a different class of non-insured deposits with a completely separate and higher fractional reserve requirement.

  • Report this Comment On July 16, 2012, at 9:58 PM, nickjob wrote:

    Dimon should pay down some of his liabilities like the money he and Corzine stole from MF Global customers. No big deal for him to take a $6 bln hit, but the cheap screw wont give money back to farmers and ranchers. What a guy!

  • Report this Comment On July 16, 2012, at 10:01 PM, nickjob wrote:

    Bring back honesty and integrity to the boardroom! I realize that is a strange concept for Dimon.

  • Report this Comment On July 17, 2012, at 12:50 AM, Terrang wrote:

    Many of these comments do not address the central question. Why is JPM speculating instead of loaning money.

    As I recall Paulson said the banks had to be bailed out to save them and prevent rioting in the streets. Well the Occupy movement was a form if riot, aimed at Wall Street and its banksters.

    Jobs are still stagnant. People who need money cannot get it...the rationale being they have bad credit. Well, speculation in dertivatives is a bad credit risk too.It is just taking some of that out of thin air Fed fiat money and posting it as profit. None of this derivatives poker playing creates jobs or does anything meaningful - except create bonus pool money for people who have done nothing creative for the broader society.

    I think derivatives should be abolished and the collapse of 2008 is the reason why - but bought off Congress won't do anything even as the Honeywell CEO says the federal government should file for bankruptcy is has been so badly run by managerial class drawn from a too narrow segment of the population..

  • Report this Comment On July 17, 2012, at 2:31 AM, DrKin wrote:

    The whole concept of "corporations" seems to be to allow certain individuals to get away with murder at the expense of the investors. There is no way in hell that some of these modern CEO's should be allowed to loot the corporation and walk away with their bankrolls intact while the line employees and the investors go bust! This is a nineteenth century concept that needs to be drastically overhauled. As far as I can see Donald Trump's vaunted "business model" is 1) Borrow tens of millions for a business venture from banking bigwig buddies you entertain on your yacht for the weekend 2) Pay yourself millions of dollars out of that debt while keeping the other investors on the hook, 3) Drive the whole thing into the ditch and walk away smelling like a rose! And for this he's worshipped by the media moguls! The same crooks by the way who suck up all of those BILLIONS we spend on "electioneering" every 2 to 4 years...while selling "air time" which we the taxpayer "license" to them for a pittance!

  • Report this Comment On July 17, 2012, at 11:20 AM, Brent2223 wrote:

    Ok, a bank takes deposits and gives loans, and there is an overage/underage - that makes perfect sense. And based on this, I can make an informed decision about the risk involved in this.

    My question is, what the heck are those big green blocks on the chart? And Isn't it concerning that the green liabilities are bigger than the green assets? That's the 'I don't understand what the company does, so I'm not going to touch it' Buffet moment for me....

  • Report this Comment On July 17, 2012, at 11:26 AM, Hawkwin wrote:

    Who would they loan it to?

    Car loan rates are below 3%.

    Mortgage rates are nearly 3%.

    Believe me, no bank is sitting on their hands by trying to avoid lending money out. Rates keep getting lower as incentive for people to borrow - but you can't make people borrow money they don't want or need. So what is JPM or any bank to do with the money? Invest it is the only rational alternative.

    The author states exact this here, "One logical conclusion is that there simply isn't borrowing demand right now. As consumers and businesses buckle down due to economic uncertainties, the last thing they want to do is take on a whole bunch of new debt."

    The author correctly points out that CIti is close the same ratio of loans to deposits but then BOA would be there too if they did not buy Countrywide. Larger banks tend to have a higher ratio than smaller banks because they tend to get larger corporate and multinational customers that do not necessarily need to borrow.

    If the author really wanted to do a comparison, they should look at a ratio that compares applications to booked loans - but I am not sure such is available. That would give a better sense of demand.

  • Report this Comment On July 17, 2012, at 1:35 PM, rhealth wrote:

    Sounds like Enron.

  • Report this Comment On July 17, 2012, at 2:20 PM, mtf00l wrote:

    First, Glass Steagall

    Second, people who need to borrow don't qualify.

    Derivitives are the cash cows of the finance industry and they all think they will win.

  • Report this Comment On July 20, 2012, at 1:09 PM, jebwait1 wrote:

    I have heard what a great leader Jamie Dimon is for many years. I'm not sure if he was in charge when I bought JPM in October, 2003, at what seemed like a reasonable price of $35.10/share. Today, over 8 1/2 years later, JPM is $33.94, or down over 3.3%. During the same time period, the dividend was cut from a high of $1.52 to $0.20 in 2009 and only stands at $1.20 today, which is still below where it was ($1.28) 12 years ago in 2000. I am a believer in reinvesting dividends and holding...except every single reinvested JPM dividend since 2003, except one in January, 2009, is below the reinvested price, some by as much as 35%. The bottom line is that by reinvesting every dividend over the last 8 1/2 years, JPM has yielded a net annualized return of--are you ready...? just a fraction over 2.7%. I wonder how much money Mr. Dimon made during this same time period. I think it's time to say goodbye to JPM and its great leaders...corruption at its finest.

  • Report this Comment On July 21, 2012, at 1:42 PM, whyaduck1128 wrote:

    "I might suggest that JPMorgan would rather kick those "excess deposits" out to its CIO and invest the money instead."

    Had they INVESTED the money, none of this would have happened. They don't invest, they gamble, just like all the big banks. A derivative is simply a bet, little different from my $10 bet on the pass line.

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