If you take our federal and state energy authorities at their word, you just might be convinced that the $410-million penalty dropped Tuesday on JPMorgan Chase for manipulating energy markets in California and the Midwest is a big deal.
"A historic fine," declared Commissioner Tony Clark of the Federal Energy Regulatory Commission, which reached the settlement with Morgan. He said it "sends a strong signal."
Over at the California Independent System Operator, the quasi-state agency that was directly victimized by JPMorgan's behavior, the penalty was hailed as "a success story for market monitoring and market oversight," as ISO general counsel Nancy Saracino stated on a conference call with the news media. "It's a huge deterrent for the rest of the market," she said.
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Here are some better ways to think about this "historic" penalty, which was imposed for JPMorgan's $125-million rip-off of California and Midwestern consumers: It's chicken feed. A pittance.
It will have no more deterrent effect on white-collar wrongdoing at JPMorgan or anywhere else than telling its traders they've got to take the Ferrari to work instead of the Lamborghini, though they can still take the Lambo to the beach house. Our top regulators actually think they've gotten the better of a huge illegal enterprise, which is a good sign that they're delusional. They didn't even get Morgan to admit that it had done anything wrong.
Look at the numbers. Of the $410 million, $125 million represents the disgorgement of illicit profits from Morgan's scheme — money the bank wouldn't have collected at all if it operated within the law. (The sum is supposed to be returned to ratepayers.) So that doesn't count. The real punishment is the balance of $285 million. How badly will that hurt JPMorgan Chase? Well, the big bank collected $97 billion in net revenue last year, so it represents a little more than a single day of intake.
Ask yourself: If you could steal $125 million, with the only downside being that if you got caught you might have to give the money back and lose a single day's income, would you give it a go? Me too.
What's worse is that even though FERC identified four JPMorgan employees as the perpetrators of the manipulation — Andrew Kittell and John Bartholomew of the bank's Houston-based Principal Investments unit, their supervisor Francis Dunleavy, and his supervisor Blythe Masters, Morgan's commodities mastermind — there's no indication that these individuals will suffer any consequences for this rip-off.
They're not the ones paying the penalties; Morgan's shareholders are. The four individuals haven't been referred for criminal prosecution or barred from the commodities business. It's true that they're specifically named in FERC's settlement documents as having fomented a $125-million scam, but for all we know, they'll be happy to put that on their resumes.
This leaves the question of what the proper penalty should be, and for that we need to revisit the offense. When I first wrote about JPMorgan's misdeeds a year ago, I got an indignant email from a bank spokeswoman calling my column "disappointingly skewed" for comparing Morgan to Enron. She had a point. The comparison was unfair. As the FERC documents make clear, Morgan was worse than Enron — because despite the lessons of Enron, it engaged in this manipulative behavior anyway.
The chicanery started in January 2011, when Morgan acquired contract rights to the electrical output of 12 Southern California power plants. The rights landed in its possession as a result of its 2008 purchase of the failed investment bank Bear Stearns, which had the contracts in its portfolio — but for the most part the rights had been subleased temporarily to Southern California Edison through 2010. The plants themselves belong to AES Energy, not Morgan — it's just their output that's traded.
The problem for Morgan was that the plants were money-losing old relics, some of them dating to the 1950s. That's where Masters and her team came in. Starting in September 2010 they developed a host of bidding schemes designed to turn a profit from the plants' output. They called this their "asset optimization strategy," and it proved to be spectacularly successful.
The key was that the California ISO market operated under an auction system in which bids were judged and accepted automatically, by software, with minimal human intervention.
Morgan's traders pitilessly exploited loopholes in the automatic system. They would alternate high bids and low bids in a way they knew would result in their getting paid at the highest-bid rate. Sometimes they received $999 per megawatt-hour when the market price was $12.
Other times they received twice or three times the going market rate. They collected millions of dollars in make-good payments just for offering to provide electricity if the ISO grid needed it, although they never actually intended to supply the power. They were just fooling the software.
For two years, ISO market overseers seemed always to be behind the curve. The ISO had to submit new market rates and regulations for FERC approval five times over that period in its effort to wipe out Morgan's scheming. On at least two occasions, according to the FERC settlement documents, Morgan employees flatly misled ISO officials about the rationale for their bidding.
After FERC started investigating — at the ISO's prompting — Morgan lied and withheld crucial documents, the FERC enforcement staff has asserted. Still, the investigation did almost nothing to moderate the firm's bid-rigging; FERC says that of the 12 manipulative bidding schemes it investigated, Morgan started 10 after the investigation began.
Plainly what we have here isn't a basically law-abiding business enterprise that stepped over the line, fessed up and resolved to fly right. JPMorgan was a serial abuser of the law, and lied when it got caught. Morgan appears to have concluded that it was easier to make money through fraud than through legitimacy, and it lacked the basic scruples to care about the difference.
Faced with a portfolio of unprofitable power plants, JPMorgan didn't invest a dime to upgrade them or make them more efficient, and didn't look for ways to serve a need in the California electricity market. Morgan made the plants profitable by cheating.
As FERC put it Tuesday, Morgan's purpose "was not to make money based on market fundamentals, but to create artificial conditions" that would garner illicit profits. There's no better description of why commercial banks like Morgan shouldn't be allowed anywhere near commodity markets that don't have anything to do with banking. Like electricity, for instance.
For some reason, ISO officials are very proud of their performance in this case, calling it an example of how "the system worked."
They're wrong. This is a case in which the system failed. The Midwest ISO, which manages the electric grid from the Dakotas to Michigan and was Morgan's other target in these schemes, has a system to manually override any bidding it considers suspicious. The MISO throttled some of Morgan's schemes at birth. As a result, of the $125 million that FERC says was lost to Morgan's manipulation, only $1 million was lost by MISO. The rest slipped through the California ISO's fingers.
During the conference call Tuesday, California ISO officials tried to assure consumers that Morgan's deeds, as well as scams allegedly perpetrated by Deutsche Bank and Barclays Bank that have drawn the fire of FERC enforcement agents, are "the exceptions to the rule."
To say these are "the tip of the iceberg" is "a cynical interpretation," asserted Eric Hildebrandt, the ISO's director of market monitoring. But cynics are made, not born, and the record thus far indicates that manipulative schemes can go on for months, even years, before they're uncovered by regulators. When will we finally learn about the ones that may be taking place today?
The only remedy is to take the market out of the electricity business, returning to the regulated utility model that served American ratepayers for decades. The markets clearly don't work to consumers' benefit, because the regulators can't handle the task of staying ahead of the gamers.
The question is, do they even want to regulate? FERC Commissioner Clark praised Tuesday's settlement as the best that could have been hoped for. "In a settlement no one gets everything he or she may have wanted," he stated. This is a shocking thing to hear from a government official whose agency, on the evidence before us, had the goods on a con game. He pointed out that by settling, the government closes the case "without expending further resources."
Is that what we pay our regulators for — justice on the cheap? JPMorgan's behavior was disgusting, but FERC's decision to let the bank get off for pennies on the dollar is inexcusable.