JP Morgan Chase 2014 Annual Report Download - page 35

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IV. SOLID STRATEGY AND FUTURE OUTLOOK
• In a crisis, everyone rushes into Trea-
suries to protect themselves. In the last
crisis, many investors sold risky assets
and added more than $2 trillion to their
ownership of Treasuries (by buying
Treasuries or government money market
funds). This will be even more true in the
next crisis. But it seems to us that there
is a greatly reduced supply of Treasuries
to go around – in eect, there may be a
shortage of all forms of good collateral.
Currently, $13 trillion of Treasuries are
outstanding, but, according to our esti-
mates, less than half of this amount is
eectively free to be sold. Approximately
$6 trillion is accounted for by foreign
exchange reserve holdings for foreign
countries that have a strong desire to
hold Treasuries in order to manage their
currencies. The Federal Reserve owns $2.5
trillion in Treasuries, which it has said it
will not sell for now; and banks hold $0.5
trillion, which, for the most part, they are
required to hold due to liquidity require-
ments. Many people point out that the
banks now hold $2.7 trillion in “excess”
reserves at the Federal Reserve (JPMorgan
Chase alone has more than $450 billion
at the Fed). But in the new world, these
reserves are not “excess” sources of
liquidity at all, as they are required to
maintain a bank’s liquidity coverage ratio.
In a crisis, if banks turn away deposits,
most investors will have other options,
which include:
1. Buying Treasuries directly.
2. Buying money market funds, which
own Treasuries.
3. Buying repos, which are collateralized
by Treasuries.
4. Investing directly at the Fed for a
limited set of investors (government-
sponsored enterprises, money funds).
5. Purchasing credit instruments like
commercial paper.
Buyers of credit (loans, secured loans,
underwriting and investments) will be more
reluctant to extend credit
• In the crisis, many banks lent against
various forms of good collateral (but not
necessarily the highest quality collateral)
to help clients create liquidity and navi-
gate through the crisis. The collateral often
came with significant haircuts and was of
the type that banks thought they easily
could risk-manage, and, for the most part,
they did. In the last crisis, JPMorgan Chase
did tens of billions of this type of lending.
In the next crisis, banks will have a hard
time increasing this type of credit because
it will require capital and more liquidity.
• In a crisis, clients also draw down revolvers
(for JPMorgan Chase alone, this peaked
at approximately $20 billion at one point
in 2009) – sometimes because they want
to be conservative and have cash on hand
and sometimes because they need the
money. As clients draw down revolvers,
risk-weighted assets go up, as will the
capital needed to support the revolver. In
addition, under the advanced Basel rules,
we calculate that capital requirements can
go up more than 15% because, in a crisis,
assets are calculated to be even riskier. This
certainly is very procyclical and would
force banks to hoard capital.
• In addition, banks may have a decrease
in capital because new regulatory capital
rules require losses on investment secu-
rities to reduce regulatory capital. This
would be particularly true if interest rates
were rising in the next crisis, which cannot
be ruled out. (Typically, Treasury yields
drop dramatically in a crisis, and that
possibly could happen in this case, too,
especially as they would be in short supply.
But, again, one cannot rely on this.)
• In the last crisis, some healthy banks used
their investment portfolios to buy and
hold securities or loans. In the next crisis,
banks will not be able to do that because
buying most types of securities or loans
would increase their RWA and reduce
their liquidity.