When a Bank Loses Billions, Who Wins?

*President and CEO of JPMorgan Chase Co. Jamie Dimon testifies before a Senate Banking Committee hearing in June. The committee was hearing testimony from Dimon on how JPMorgan Chase lost billions in stock market trades. Photo by Mark Wilson/Getty Images.* *Paul Solman frequently answers questions from the NewsHour audience on business and economic news here on his [**Making Sen$e**](http://www.pbs.org/newshour/economy/makingsense/) page. Here is Wednesday's query:* **Name: Hill Kemp** **Question:** When Morgan Stanley loses $7 billion, does that money just disappear into the ether or does some other party(s) make $7 billion? **Paul Solman:** I'm not sure if you mean JPMorgan Chase instead of Morgan Stanley. Before the 1930s, they were the same firm, but the Banking Act of 1933, often referred to as "Glass-Steagall" after its congressional sponsors, effectively hived off investment banking from commercial -- deposit -- banking in order to limit risk. Thus the two "Morgans." Moreover, if you mean JPMorgan/Chase, then the total amount of its recent loss is reported to be $5.8 billion and [**could reach $7 billion**]( http://investing.businessweek.com/research/stocks/news/article.asp?docKey=600-201207131121UPI_____BUSITRAK_094742_9019-1¶ms=timestamp||07/13/2012%2011:21%20AM%20ET||headline||JPMorgan%20Chase%20profits%20fall%209%20percent||docSource||United%20Press%20International||provider||ACQUIREMEDIA||bridgesymbol||US;JPM&ticker=JPM:US). I'd give the same answer if the amount were $70 billion and the losing entity was named Morgan Frank (after the actor who played the Wizard of Oz): There are two sides to every trade and what one party loses, the *other* party gains. That's why those who make trades in the market are known as *counter*-parties. For every loss, there is an equal and opposite gain. "So what's the big deal?" you may well ask. The answer is that the Morgans -- and all the other major players in the markets -- make their trades with borrowed money. This is called leverage because you're using the lever of borrowed money to use only a little of your own to control or lift a lot more. It's like buying a house with only a small down payment -- say, for the sake of example, $10,000 on a $330,000 home, a leverage ratio of 32:1. The beauty of leverage is that if the house rises in value by a mere $10,000, you've doubled your money. The danger, of course, is that if *drops* by $10,000, your equity -- your ownership stake -- is wiped out. The same thing happens with financial institutions and indeed, they *do* sometimes make trades in which their own stake is as little as 3 percent: a 32:1 leverage ratio. So if a trade goes bad, yes, a counterparty gains just as much as the loser *loses*, but the loser may be busted. If that loser is one of the Morgans and a major player in the global economy -- a counterparty to trades with lots of other players, that is -- than the whole system can freeze. That's what happened in 2008. See our explanation of the same, complete with [**falling dominoes**](http://www.pbs.org/newshour/bb/business/jan-june08/domino_03-21.html). *As usual, look for a second post early Wednesday afternoon. And please don't blame us if events or technology overtake us. This entry is cross-posted on the [**Rundown**](http://www.pbs.org/newshour/rundown/)- NewsHour's blog of news and insight.*

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