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Chesapeake and JPMorgan: Risk (mis)management with other people's money

If I were to stake you $50,000 and set you loose in the world's largest casino, you might try your luck in a big way at a number of games to see if you could double or maybe even triple your good fortune. But it would be an entirely different matter if the $50,000 were your own money. You might decide to take advantage of the casino's restaurant for which you would at least get a meal in return for your money. And, you might even test your skills with a few hundred dollars. But unless you were a gambling addict, you would be on your way pretty soon after the house had taken the few hundred dollars you decided you could afford to lose.

Running some of America's largest corporations is more like the former situation than the latter. And, this week two corporate titans proved just how easy it is to gamble with other people's money, especially when you know you have little to lose personally.

Some may doubt my characterization applies to Chesapeake Energy Corporation since Chesapeake's CEO, Aubrey McClendon, has so much of his own wealth on the line.

Let's go back to 2008 to understand why his case is really like that of the gambler given free money. Back then McClendon was riding high as his huge stake in Chesapeake made him a billionaire. His personal fortunes truly seemed tied to the company. And, when the bottom fell out of the natural gas market (and the stock market as well), he was forced to sell virtually all his shares because he had purchased them on margin. So far, so good. The CEO suffers the same fate as the shareholders only more so.

But, a curious thing happened in 2009. A five-year contract that had just been negotiated in 2007 was scrapped, and McClendon was given a $75 million bonus as part of his new contract and special access to purchase a part of every well his company drills. Like my hypothetical gambler, McClendon was given free money to start his gambling all over again, courtesy of Chesapeake shareholders.

Unfortunately, McClendon's shareholders are getting pummeled by a crashing stock price, partly due to ground-hugging natural gas prices brought on by a glut created through Chesapeake's and the industry's overdrilling and partly due to a revulsion among shareholders who now realize that McClendon's interests aren't really aligned with theirs.

In the parallel universe where banking is done, Jamie Dimon, CEO of JPMorgan Chase & Co., received $23 million in total compensation last year. But none of the country's major banks would even be alive today were it not for the massive U.S. government bailout of banks in 2008 and 2009 and the grossly unfair (to savers) zero interest rate policy of the U.S. Federal Reserve Bank. That zero interest rate policy is nothing more than a subsidy for banks paid for by savers and by taxpayers as banks borrow interest free money from the Fed and invest it in risk-free U.S. Treasury bonds, the interest on which you and I as taxpayers end up paying.

Well, it turns out that some of Dimon's subordinates weren't content with simple risk-free returns courtesy of taxpayers. The bank reported a $2 billion loss on a recent series of complex, related trades. You can wade your way through a detailed explanation here and an inscrutable graphic presentation here. Did you get that? Apparently, neither did the traders at JPMorgan Chase.

And, that brings me to my main point. If you were personally faced with betting on such complicated nonsense with your own money, you'd never do it. But JPMorgan was betting with other people's money, with deposits, with INSURED deposits no less. Now, JPMorgan traders thought they understood the risks. Obviously, they didn't. And, probably they couldn't. They pretended to be able to understand the world through models that simply cannot account for unquantifiable risks, risks in the real world.

No matter. I expect Jamie Dimon's pay this year to be larger than his pay last year despite the big screwup. Call it executive welfare. But wouldn't it be a pity if he were forced to live on half of what he made in 2011, scraping by on a mere $11.5 million?

A friend of mine recently provided this hypothetical to explain what is happening. He said imagine you are sitting near someone getting up from a table in a restaurant who leaves a $100 bill behind. You might run after the person just to make sure he or she meant to do that. Now imagine that the amount is $1,000. You might walk, the friend said, rather than run to reach the person. Now imagine if the amount were $100,000. You might find yourself morally paralyzed as you debated whether you might help yourself to some of that money without anyone really noticing.

That's what we witnessed last week. Except that the characters in last week's drama aren't common thieves who would have merely pocketed the $100,000 tip. No, they are far too slick for that. Instead, they would have sanctimoniously put the money in trust under its owner's name, promptly deducted $5,000 for management fees, and then taken the other $95,000 to the dog track.

The financier character, Gordon Gekko, in Oliver Stone's Wall Street had one thing sort of right:

In the days of the 'free market' when our country was a top industrial power, there was accountability to the shareholders. The Carnegies, the Mellons, the men who built this industrial empire, made sure of it because it was their money at stake. Today management has no stake in the company.

Well, that was back in 1987 and today, management does have a stake in the company except it's one purchased for them with shareholder money--and purchased again if they end up losing it all. There's never a real downside.

As for banks, the way they used to be run a long, long time ago is that the owners and directors were personally liable for the debts of the bank. Imagine how much more staid banking would be today if that were still true.

But now, when banks and industrial corporations provide opportunities for individual managers to hoover up far more than the amounts in my simple illustration, you can see why nobody's going to stop taking these big risks--with other people's money, naturally--unless we as a society decide to put a stop to it. But, of course, that won't happen until a government currently owned by the country's CEOs and financiers is thrown out.

Don't hold your breath.



Kurt Cobb is the author of the peak-oil-themed thriller, Prelude, and a columnist for the Paris-based science news site Scitizen. His work has also been featured on Energy Bulletin, The Oil Drum, 321energy, Common Dreams, Le Monde Diplomatique, EV World, and many other sites. He maintains a blog called Resource Insights.

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