Jamie Dimon’s Warning of an Economic Hurricane

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Is the American banking system truly safe and secure? Yes! I mean, the banks have extraordinary liquidity and extraordinary capital. When they report earnings next quarter, the earnings can be quite good. In my opinion, I don't think this is that kind of crisis that you're going to have ongoing forever.

JPMorgan's CEO, Jamie Dimon, is certainly not one to be afraid of voicing his opinions. In fact, last year he caused a big stir on the world stage when he described an economic hurricane on the horizon in the United States. I'm going to change the storm clouds out there every day. Look, I'm an optimist, you know I said there's storm clouds; they're big storm clouds. It's a hurricane. But recently, he's been grabbing media attention for a completely different reason, and this time the message is that things are okay; the economy isn't that bad, and the banks will be all right.

This is very interesting to hear from Dimon specifically because, well, he's right at the epicenter of the U.S. banking system. He is the CEO of America's largest bank. What's really handy for us investors is that, in the past week or so, Dimon has sat down for an exclusive interview with CNN on the banking crisis, and he's also published his detailed annual shareholder letter explaining his views on the economy.

By far, the biggest takeaway from Dimon's words over the past few weeks is that he genuinely believes the U.S. banking crisis isn't really a crisis at all, and it certainly isn't a 2008 scenario. I just read your annual letter that just came out this week, and let's dive into the banking crisis because you write a lot about it. Is the current banking crisis over?

"I... this is not 2008. Okay, this is a much more limited... there are only a handful of banks that have this particular problem. They'll eventually be resolved one way or another, and I think then people should take a deep breath. In a week or two, a lot of these banks can be reporting earnings. I think they'll probably be pretty good. The Federal Reserve made some, you know, bold dramatic moves to help it easier for some of the issues they had, and I'm hoping it will resolve, you know, rather shortly."

So, Jamie's point here is that when you look at the banks, there were a few that really messed up their risk management, and yes, they got punished. But when you look at the big players and the banking system as a whole, it's not really in crisis mode.

Silicon Valley Bank, for example, got caught out because it had a concentrated client base and held a lot of long-term government bonds that weren't hedged, and then they ran into trouble when those small number of clients all wanted out at the same time. Dimon actually noted this in his annual letter. Writing, "Regarding the current disruption in the U.S. banking system, most of the risks were hiding in plain sight: interest rate exposure, the fair value of held-to-maturity portfolios, and the amount of SVB's uninsured deposits were always known both to regulators and the marketplace. The unknown risk was that SVB's over 35,000 corporate clients and activity within them were controlled by a small number of venture capital companies and moved their deposits in lockstep."

Is this a situation like, you know, Warren Buffett famously said, "Only when the tide goes out, you learn who's been swimming naked"? Were these banks swimming naked?

"Yeah, so I said they're hiding in plain sight. Everyone knew about uninsured deposits; everyone knew about interest rate exposure; everyone knew about held-to-maturity portfolios. The only difference, the only real difference was we called concentrated clients. So Silicon Valley Bank had, you know, a handful of people control 35,000 corporate accounts and they just left, you know, 140 billion dollars or something or of course a course of two days."

That's not happening to other regional banks. It was when all those clients tried to take out their deposits that the bank obviously didn't have enough cash on hand to meet withdrawals, and it collapsed.

But Dimon notes that the situation is obviously very different in the critical U.S. banks. They have a diverse number of customers, they have hedged their bond portfolios better than SVB, they are well capitalized, and from all accounts so far, they have the full backing of the Federal Reserve.

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But back to Jamie Dimon's thoughts on the banks. Essentially, long story short, SVB management failed pretty badly to control risk, but luckily there isn't really that level of mismanagement throughout the whole financial system, according to Dimon.

But with that said, what comes next? Do you expect more banks to fail this year?

"I... I don't know, but if there are, I don't honestly think they'll be resolved, and it'll probably be the last of them. I think, again, near the end of this particular crisis and fewer financial institutions. Remember, in '08 it was hundreds of institutions around the world, far too much leverage. We don't have that huge problem in mortgage markets; we don't have that. This is nothing like that, and the American public shouldn't think that this will resolve and then we should go look at, you know, what went wrong and fix it, you know, in the clean light of day."

That was one big talking point from Jamie's annual letter, that really the public should not be concerned that this is simply another 2008-style bank crisis. He said recent events are nothing like what occurred during the 2008 global financial crisis, which barely affected regional banks.

In 2008, the trigger was a growing recognition that a trillion dollars' worth of consumer mortgages were about to go bad, and they were owned by various types of entities around the world. At that time, there was enormous leverage virtually everywhere in the financial system: major investment banks, Fannie Mae and Freddie Mac, nearly all savings and loan institutions, off-balance-sheet vehicles, AIG, and banks around the world—all of them failed.

This current banking crisis involves far fewer financial players and fewer issues that need to be resolved, and he's absolutely right on this point. Really, the bank crisis we've seen play out over the past month or so, it's really just a crisis of confidence at a select few poorly managed institutions. At its core, this little panic is really just a result of some banks being forced to recognize losses on long-term government bonds because interest rates have gone up, and then enough people have panicked, withdrawn money, and those banks have been unable to meet those withdrawals.

But this isn't the first time interest rates have gone up, and it's very rare that a bank does an SVB and leaves itself so exposed to a rise in interest rates. That's why Jamie recommends everyone just take a deep breath, and when the dust settles, make the appropriate regulatory changes.

"But is the crisis where you wrote in your letter repercussions for years to come?"

"Well, that's different. I think those repercussions are regulatory, like see and you know, acknowledge—think obviously we have a problem, things need to change. But, you know, I'm begging the regulators: let's just take a deep breath. There are hundreds of rules. You know, you have to be very careful. What do you want in the banking system? What do you want out? How do you make it easier for community banks and regional banks? How do you reduce their costs, not increase their cost, but also make it safe?"

Now, of course, the skeptic will say, "Hold on. This guy is the CEO of a major bank; of course, he doesn't want any further regulation," and that's a fair comment to make.

But here, Dimon isn't necessarily saying he wants no additional rules or regulations. He's just saying he wants to avoid a situation where lawmakers just slap new rules on the banking system before they've properly thought them through. In his shareholder letter, he said, "Let's be very thoughtful in our reaction to the recent events. While this crisis will pass, lessons will be learned which will result in some changes to the regulatory system; however, it is extremely important that we avoid knee-jerk, whack-a-mole, or politically motivated responses that often result in achieving the opposite of what people intended."

The debate should not always be about more or less regulation but about what mix of regulations will keep America's banking system the best in the world, such as capital and leverage ratios, liquidity and what counts as liquidity, resolution rules, deposit insurance, securitization, stress testing, proper usage of the discount window, tailoring, and other requirements, including potential requirements on shadow banks.

Because of the recent problems, we can also add to this mix the review of concentrated customers, uninsured deposits, and potential invitations on the use of held-to-maturity bond portfolios.

Ideally, new rules and regulations would also make it easier for banks to provide credit in tougher times.

So no, Jamie is not advocating that nothing be done; instead, he just wants the regulators to avoid rushing in with a half-thought-out idea that ends up causing more problems than it solves. In fact, in this instance, he actually does believe a few more rules could actually help the system.

"You know, look, it's not again when you talk about regulations. They're looking at one thing, and I'm looking at multiple others. So they had high liquidity requirements, high capital requirements; they met the requirements. They had too much interest rate exposure, and things should change, but they were not out of line, but super, you know, with regulations. But it wasn't the regulatory change; it was other things, and by in life that's going to happen. This notion that somehow you can make everything perfect is wrong."

"I know, but you don't want big well-known banks to collapse."

"No, you don't. But you also really want is that every now and then something will happen and the system can handle it. And of course, that's what the—yes—failure is okay. You just don't want this domino effect. And so when you have a bank run, you end up with some kind of domino effect."

So I guess my point is we are close to it getting to the point where a bank can fail and it doesn't have this kind of effect.

"I think just monitoring, changing a few things can get much, much closer to that."

This is actually a reasonably smart idea that Jamie raises. You don't want a system where no banks can fail because then banks start taking more and more risks. But on the flip side, you don't want a bank's failure to be able to cause a massive domino effect throughout the whole banking system and the whole economy.

So as Jamie says, it's the right mix of regulations that's important, not just more or less. And that's the other thing to remember: generally speaking, the more regulations that are implemented, the harder it is for healthy competition in a given market. The big players tend to form an oligopoly because it's simply too hard, from a regulatory standpoint, for a small player to stand up and compete. Thus, they die or they get absorbed by one of the big boys.

That was actually something that Hamish explained to me on the most recent episode of the Young Investors Podcast.

So overall, a very interesting take by Jamie Dimon. And please let me know your thoughts down in the comments. But overall, guys, with that said, I hope you enjoyed the video. Be sure to leave a like if you did, of course subscribe if you want to see more. And with that said, as always, I'll see you guys in the next video.