J.P. Morgan's 47% Profit Jump: It's Your Money!

A look at how easy money inflates bank earnings

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Historically speaking, the roots of J. P. Morgan Chase & Co. make it arguably the most influential financial institution since the turn of the 19th century. JPM enjoys a prominent position as the second largest bank in the U.S. with roughly $2.12 trillion in total assets, and acts as the ‘go-to’ firm for the Federal Reserve in times of economic turbulence.

On January 14, 2011, The Wall Street Journal reported, “J.P. Morgan Chase & Co.’s (JPM) fourth-quarter profit jumped 47%, as the banking giant’s asset quality improved and it said consumers and businesses were looking for more loans.” Full-year 2010 net income totaled $17.4 billion. However, according to this chart from a Bloomberg report on JPM’s 2010 loan history, even though consumers and businesses are looking for more loans, fewer loans are being extended:

JPMorgan 2010 Loan Chart

How is it that JPM, along with its brothers Bank of America, Citigroup and Wells Fargo – all of which make up the “Big Four” – are able to post such stellar profits in the face of a flagging economy, rising food & energy prices, record foreclosures, high unemployment, and tight credit? The following are three ways easy money pumps up their earnings:

1) Banks earn 0.25% interest on excess reserves held at the Federal Reserve.

Consider the $2.5 billion in free money banks ‘earn’ each year on the $1 trillion in excess reserves held by banks at the Fed – free money the Fed just snaps into existence;

2) A ‘money drop’ from excess reserves is considered earned income. In JPM’s case,

it released $7 billion in pretax reserves which was counted as net profit. And while on deposit at the Fed, that $7 billion ‘earned’ JPM $17.5 million in interest payments; and

3) The most creative “gift” to the banking industry is what I call their “Fed/Treasury-engineered taxpayer-backed guaranteed stream of income.”

How does this work? First, the Fed artificially holds the fed-funds rate down at 0.25%. Then, primary dealers, like the Big Four, borrow from the Fed’s Discount Window at a preferred rate of 0.75%. They borrow billions as they please without even having to give a reason for taking the loan. They put up collateral for loan, and it’s done.

What collateral does the Fed accept? Commercial, industrial, or agricultural loans; consumer loans; residential and commercial real-estate loans; corporate bonds and money-market instruments; obligations of U.S. government agency and government sponsored enterprises; asset-backed securities; collateralized mortgage obligations; U.S. Treasury obligations; and state or political subdivision obligations. Oh, I’m sorry, are you trembling in shock as I did when I realized this? The Fed actually accepts this... stuff as collateral for billions in ultra-low-rate loans to banks.

But here’s the interesting part: Banks take out loans at 0.75% and can buy Treasuries that yield on average about 1.65%. Borrow at 0.75% and buy at 1.65%, which gives banks a 0.9% spread. This may not sound like much, but if JPM puts up 20% of its assets, such as listed above ($424-billion worth), they would “earn” $3.82 billion a year, which, after stripping out the $7-billion money drop from excess reserves, would account for over a third of JPM’s full-year 2010 net income. Imagine how juicy earnings reports will be for the other banks over the coming quarters, thanks to Fed/Treasury free money!

All this is great information, but the real kicker is this: The earnings I just described is your money. It derives from taxpayer dollars transferred to banks. And from the money the Fed puts into play through reverse repos and security substitutions on banks’ behalf to the interest the Treasury pays banks, you and I are on the hook for every penny of it.

But there is another problem on the consumer side of the equation. Can you feel the inflationary effects of this Fed/Treasury dollar-proliferation program? The more dollars created, 1) the further each greenback devalues; 2) the more of them international suppliers demand; and 3) the higher producer & consumer prices rise. Certainly you’ve noticed how high gasoline prices have become over these quiet winter-driving months? Oil suppliers are requiring more dollars for the same amount of product. And have you observed how metals (gold, silver, copper) and various other commodities (coffee, cocoa, sugar, corn, wheat, cotton) are moving higher in price? Producers want more dollars for their goods, and those costs are being passed on to the American consumer.

Back to the chart, why aren’t banks as generous in lending to consumers & businesses as the Fed is in lending to banks? Bottom line, it’s not profitable for them. The U.S. went from being a 19th-century producer to a 20th-century consumer. And now that we have passed the production baton to 21st-century emerging nations, and depleted our savings, banks recognize we are crippled with debt and have limited means by which to pay it off.

To add insult to injury – and evidence of how the U.S. no longer where the profits are – Goldman Sachs just announced that the bank holding company is excluding its U.S. clients from the private offering of as much as $1.5 billion in shares of social-media company Facebook, citing “intense media attention.” Say what it wants, but allow me to cut to the chase: If Goldman – a top-in-class laser-focused profit-producing predator – thought the money to be made was in the U.S., it would fight to the finish. But its decision to bar Americans from the private offering, along with JPM’s retreat from U.S. lending, signals that the banking sector has determined the grass is greener outside U.S. borders. To think: An American bank underwriting shares of an American company is shutting out American investors! I guess I will just have to get used to my backseat economic status.

As banks fare well on the back of taxpayer dollars, all I want in return from banks at this point are these: free checking, free debit-card use, and a lollipop on each branch visit.

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