By 2006, JPMorgan Chase’s mortgage securitization business was booming, and the company had begun to ramp up its activities in the subprime market, as both a mortgage originator and packager of mortgage-based assets. JPMorgan Chase was a major player in other types of debt securitization, so growing its presence in the subprime market, where other Wall Street giants were raking in billions in fees, seemed to make sense. “It would have been a natural for us,” said Bill Winters, who was co-CEO of the investment banking unit at the time. However, JPMorgan Chase is famous on Wall Street for its rigorous risk-management system and a culture of careful analysis and thoughtful strategizing. For example, managers are expected to compile and understand highly detailed reports on their areas of responsibility so that Dimon and the executive team can clearly see the costs, profits, and risks involved in every line of business. In late 2006, Dimon and his top managers saw a crucial warning sign: Late payments on competitors’ subprime mortgages were rising. The subprime loans JPMorgan Chase had written itself continued to perform reasonably well, but Dimon concluded that lending standards were “deteriorating across the industry.” Even though its own mortgage origination business was maintaining its usual standards, by pooling subprime loans from multiple sources, its mortgage securitization business exposed the company to the risky practices of other lenders. The firm considered using credit default swaps to hedge against the risk of widespread loan defaults in its securities portfolios. However, the cost of credit default swaps was rising as well, reflecting the growing default rates, to the point that paying to hedge its positions in subprimes would have cost the company as much as it could earn. “We saw no profit, and lots of risk, in holding subprime paper on our balance sheet,” Winters later explained. By reviewing market conditions across all of JPMorgan Chase’s lines of business, Dimon was one of the first to recognize that the subprime market was about to transform from a cash-generating dream machine into an economy-destroying nightmare. Ironically, in light of the criticism that repealing GlassSteagall and letting companies combine commercial and investment banking contributed to the economic meltdown, it was the ability to see both ends of the subprime bubble at once—the individual loans on Main Street and the securitization business on Wall Street—that alerted Dimon to the danger. “We have a goldmine of knowledge,” he explained. Armed with this information, Dimon moved quickly. He telephoned the executive in charge of securitized products, who was on vacation in Rwanda, and instructed him to start moving JPMorgan Chase out of the subprime market. Dimon was blunt: “This stuff could go up in smoke!” Managers across the bank responded, selling $12 billion worth of the company’s own subprime mortgages, curtailing its securitization business in subprimes, and advising private banking clients to sell the subprime securities they held. It meant walking away from a business that was still generating mountains of money and even losing key employees to banks that stayed in the business, but as Dimon explained later, “Everyone was trying to grow in products we didn’t want to grow in, so we let them have it.” At that point, for example, Bear Stearns and Merrill Lynch each held roughly $40 billion of subprime debt. JPMorgan Chase didn’t escape the meltdown unscathed, to be sure. Its vast exposure to mortgages, credit card debt, and auto loans led to some losses as the economy crumbled, and its large stock holdings in Fannie Mae and Freddie Mac were all but wiped out. However, during a time when losing less was considered winning, JPMorgan Chase was definitely one of Wall Street’s winners. Its subprime losses were “only” $5 billion, compared to the $26 billion lost by Merrill Lynch and the $33 billion lost by Citigroup, and it remained healthy enough to acquire Bear Stearns and the assets of Washington Mutual when those two giants fell on their faces. Dimon and company also helped refute the notion that large, multifaceted banking companies are a risk to the economy simply by virtue of being “too big to fail.” It was JPMorgan Chase’s vast scope that helped Dimon recognize a complex, interconnected problem that was about to sink the entire economy.63
1. How might the pressures of being public corporations have affected the decision making of JPMorgan Chase’s competitors?
2. What might have happened if JPMorgan Chase’s competitors had tried to bail out of the subprime market at the same time that Dimon was directing his company to do so?
3. Did the executives at companies that chose to stay in the subprime market behave unethically by not bailing out when JPMorgan Chase did? Why or why not?