The Economy

JP Morgan Preps for Fiscal Cliff

The year-end threat of large government-spending cuts combined with higher tax rates has the financial institution running scenarios on the possibl...
Vincent RyanOctober 12, 2012

Megabank JP Morgan Chase is trying to forecast the possible knock-on effects of the United States’s “fiscal cliff,” when, beginning in January, federal legislation could trigger higher taxes and automatic federal spending cuts to many government programs.

During the question-and-answer with analysts on JP Morgan’s third-quarter earnings call Friday, Jamie Dimon, the company’s chief executive officer, said that although the bank didn’t have a formal “war room” set up to deal with the fiscal cliff, as it does for the euro-zone crisis, it’s preparing for all possible outcomes as year-end approaches.

“If the fiscal cliff actually happens, you have to be prepared for various scenarios, including the worst possible one even if you don’t predict it,” he said. “What are we missing? How bad could it be? We have to be prepared for it. We’re hoping it doesn’t happen.”

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Dimon was elaborating on remarks he made to the Council on Foreign Relations (COFR) earlier in the week, when he said that JP Morgan had formed a “fiscal cliff war room” to gauge the potential ramifications of the federal budget cuts and tax increases that could transpire. While he backed off on the war room comment on Friday, Dimon did say the bank is busy running scenarios of the economic and market risks for the bank and its clients.

Referring to the U.S. federal debt-ceiling crisis in the summer of 2011 as a similar situation, Dimon noted that JP Morgan spent “$50 million or so” getting prepared for it.

Absent congressional action, at the close of 2012 temporary payroll tax cuts, some tax breaks for businesses, and lower rates on capital gains and dividends will all expire, just as government spending cuts outlined in the Budget Control Act of 2011 are scheduled to take effect.

Asked whether the economic effects of these changes would dampen the outlook for JP Morgan’s investment and commercial banking divisions in the fourth quarter, Dimon said it wouldn’t show up in the commercial bank’s results but “the investment bank will be more sensitive to what the market reacts to if [it] gets very scared about the fiscal cliff . . . but we just don’t know.”

While securities trading and issuance volumes could conceivably drop dramatically as a result of fiscal-cliff-related market stress, Dimon said, “I can give you arguments why the fiscal cliff can drive volumes up in the short run.”

On the euro-zone crisis, Dimon sounded a bit more optimistic Friday than he did at the COFR event. There, Dimon said if Greece defaults without there being a firewall between it and Italy and Spain, “Italy and Spain don’t have the wherewithal to stop a run on the banks.”

On the earnings call Friday, though, Dimon noted that European Union leaders had made a lot of progress, citing the EU Central Bank’s moves to become a lender of last resort in the government bond markets and the ongoing discussions about a banking union and guarantee programs that would shield financial institutions in Spain and Italy.

But Dimon also said Europe would continue to be a roller coaster. “There’ll be ups and downs as good things happen or bad things happen,” he said. Dimon pointed out that the EU is in only a mild recession, and that JP Morgan continues to conduct business in France, Germany, the United Kingdom, Spain, and Italy. “We’re going to be prepared for bad outcomes, but we’re there,” he said. “And if there are opportunities — we haven’t seen unbelievable opportunities like asset sales or something like that — we’ll participate, if we have assets we want or things we want to do.”

JP Morgan’s exposure to the “peripheral” euro-zone countries increased in the third quarter on a net basis, to $12 billion from $6.3 billion, but Dimon said the increase was “mostly from the reduction in short positions.”

For the quarter, JP Morgan reported a $5.7 billion, or $1.40 per share, profit, versus $4.26 billion, or $1.02 a share, a year earlier. Revenue increased 6% over last year, to $25.9 billion.

“We maintained our number one rank in year-to-date global investment banking fees, we had record deposits in [consumer and business banking], [and] record production revenue in the mortgage bank,” said CFO Doug Braunstein.

Braunstein had been the subject of media reports Thursday that said he was stepping down as CFO and considering a job in the firm’s investment bank. He was promoted to CFO in 2010 after serving as head of investment banking. Until this summer, he reported to Dimon; however, in the wake of the bank’s $6 billion trading loss by its chief investment office, Braunstein was relegated to reporting to the one of the firm’s co-chief operating officers.

On the earnings call, Dimon took issue with the rumors about Braunstein, saying he found it “extremely irritating” that people “yap to press like that.” Braunstein has “been a top CFO and we have no — we will let you know when and if we intend to make changes when we make them, not gossip in the press,” Dimon said. “We always have a conversation with senior people and everybody about the future for them, their career, what they want to do next.”

The $6 billion in losses from trading in credit-derivative indices by JP Morgan’s chief investment office earlier this year led to an earnings restatement. For the third quarter, the bank said it recorded a $449 million loss related to the credit-derivative trades, but that it had closed out the positions.