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JP Morgan’s Alleged Power Manipulation Worse Than The “London Whale”

Regulators and the media are right to point to botched trading by JP Morgan Chase Bear Stearns that may result in as much as $7.5 billion in losses as evidence that “too big to fail” financial institutions continue the recklessness that prompted the 2008 meltdown. As attention is focused on the legal trading shenanigans of JP Morgan, many have overlooked their potential illegal trading. JP Morgan Ventures Energy Corp, the company’s energy trading unit, may be run like an Enron-esque enterprise, allegedly rigging bids to overcharge electricity consumers more than $70 million. Yet Dimon isn’t calling for the heads of those responsible, and hasn’t threatened to revoke the pay and bonuses of the traders that allegedly stole millions from American households. Moral of the story: if you lose money at JP Morgan, you’re fired. If you make money through potentially illegal and improper overcharges to the utility bills of tens of millions of

American families: no worries. That’s why Blythe Masters and other executives responsible for alleged price-rigging be fired if the allegations by the California Independent System Operator are true.

Back to the legal credit risk trading scandal, where Bruno Iksil (the “London Whale”) and his managers (including Javier Martin-Artajo) concealed from the company the risk involved, showing the weaknesses of JP Morgan’s internal

controls. CEO James Dimon had pushed the division into more risky, but potentially profitable, “higher-yielding assets such as structured credit, equities and derivatives,” but apparently soured on the team when their bets lost money.

There is nothing showing these trades involved manipulation: it was legal trading that went the wrong way for the company. The fallout of the magnitude of the losses has been swift, with Dimon announcing the firing of “managers

responsible for the transactions and [the company] will claw back their pay after an internal inquiry found traders may have intentionally tried to hide souring bets during the first quarter.” It might be possible that these hemorrhaging losses put pressure on other divisions to increase revenues, even if that meant tweaking electricity market rules. Which reminds me of Enron: accounting fraud sent its executives to prison, but no one ever went to jail for stealing billions of dollars from West Coast electricity consumers.

And there’s the rub. To understand how JP Morgan may have skimmed from utility bills, you first have to understand the mess of our deregulated electricity markets. Prior to the 1990s, the Federal Energy Regulatory Commission (FERC) used to actually review every electricity rate under its jurisdiction to ensure they met the federal “just and reasonable” standard. Then came California and Montana and New York and the other deregulation fiascoes, when FERC outsourced federal law enforcement to the mall cops of the industry, so-called Independent System Operators (ISOs), private organizations with internal voting structures dominated by power sellers and utilities. FERC waves its magic wand, legally determining that every single mall-cop ISO oversees a “competitive” market, and then grants all power sellers “market based rate authority”, giving financial middlemen and power plants alike the right to charge whatever price the market will bear, since, in FERCs infinite wisdom, markets automatically produce “just and reasonable” rates. FERC’s idea of regulation is delegating to markets and mall cops the protection of hundreds of millions of Americans from excessive utility rates.
In September 2011, both California’s ISO and the Midwest’s ISO noticed that certain “bid cost recovery” payments more than quadrupled. See, prior to deregulation, a utility had a legal “obligation to serve” its customers—part of the compact of being a “public utility”. But when we deregulated, the obligation to serve was replaced with lucrative incentive payments used to convince power suppliers to serve the market. Doesn’t that make sense? Replace a legal obligation with throwing money, begging on your hands and knees! So now CAISO, MISO and other mall cops provide complex minimum payment structures to incentivize power sellers to make power available to keep the lights on, whereas twenty years ago utilities had no choice but to provide that power as a public service. So the ISO asks power sellers to make electricity available, and, if it turns out the power wasn’t needed, CAISO and MISO pass on to consumers the market-based costs

the power seller occurred to make the (unnecessary) power available.

Well, JP Morgan saw these CAISO and MISO rules and allegedly saw opportunities to inflate their bids to get overpaid for not ultimately providing electricity. And do you know what’s even better? JP Morgan doesn’t own a single power plant in California. Just like Enron, JP Morgan’s presence in the market is to buy and sell contracts to deliver or procure energy. They’re not creating jobs, or paying local property taxes—they have a group of traders in Houston looking at computer screens, drooling at the prospect of gaming arcane rules to possibly overcharge working families nearly $100 million in California and across the Midwest.
So back to our story. The California and Midwest mall cops see this, and in March 2012 CAISO asks FERC for permission to change their rules to disallow the practice, in the process telling FERC that one company is responsible for gaming the system: JP Morgan.
FERC then confronts JP Morgan, and subpoenas the company’s emails. But JP Morgan has little to fear from the mall cops or from the most toothless of federal agencies, FERC. That’s because FERCs market-based rate program means that FERCs ability and interest at making consumers whole from the market-wide impacts of manipulation are severely limited because FERC can no longer effectively order malfeasant companies to repay consumers refunds. FERC issues press releases touting settlements that have companies disgorging their profits or paying a meager fine, but the true costs of manipulation strategies often raise prices in markets across the board, meaning one manipulation scheme can raise prices that consumers pay five- or ten-fold. FERCs toothless market-based regulations have eviscerated the Federal Power Act’s consumer protections, particularly over refunds.
To further illustrate JP Morgan’s infatuation with potential gaming of electricity markets, look no further than a filing the company made at FERC this month. Again, CAISO noticed that, over the last two years, generators and paper-traders like JP Morgan were able to game the bidding rules to overcharge California households by at least $209 million, and sought to return the ill-gotten gains. CAISO offered to close this loophole, and every party in California agreed except one: JP Morgan. In its filing, JP Morgan doesn’t dispute that the loophole resulted in families getting ripped off on their utility bills, but the company argues that it shouldn’t be subjected to “retroactive” refunds. This is the type of moral bankruptcy that plagues JP Morgan’s energy trading under its leader, Blythe Masters. Remember, Ms. Masters invented the Credit Default Swap, so she knows a thing or two about how to design a “vast, unproductive expansion of our financial sector…[and Wall Street] extracting billions from the economy with a lot of pointless speculation in stocks, bonds, commodities and derivatives.”
Now, JP Morgan isn’t alone. Morgan Stanley paid a paltry $4.8 million fine in September 2011 and didn’t have to admit wrongdoing for its role in an Enron-esque scheme to intentionally shut down a power plant in New York in order to drive prices up. Barclays was accused in April 2012 of ripping off utility consumers over a two year period, and in December 2011 Deutsche Bank was accused of manipulating the California electricity market.
But JP Morgan is different. Confronted with accusations of wrongdoing, the company refuses to cooperate with the most basic requests (such as turn over emails) as part of the investigation (FERC v JP Morgan, US District Court, Case #

12-mc-00352). They’ve been fined so many times before: for manipulating municipal bond auctions, conspiring with Enron to hide its debt, collusion between the company’s research division and its investment bank to rip off its

customers and the public (and fined for destroying documents related to that investigation) and dipping into customer funds.

Enough is enough. If it is shown that JP Morgan did what CAISO and MISO accuse it of doing, Public Citizen has 3 urgent recommendations. First, if the market manipulation allegations are true and if she did indeed have managerial responsibility, we call on Blythe Masters to be fired or resign. Firing Ms. Masters will send a clear signal to Wall Street that manipulative activity will not be tolerated.Second, FERC must revoke market based rates for all of JP Morgan’s energy trading affiliates. Justice won’t be served if the only penalty for price-gouging basic utility service is a financial slap on the wrist. Violating the law cannot simply be a cost of doing business. There must be sanctions, and the most powerful sanction FERC can invoke is to no longer allow JP Morgan to engage in the charade of deregulated energy markets. If FERC revokes their market-based rate authority, the agency will send a shockwave signal to the whole industry that they are on notice and manipulation will not be tolerated.

Third, at a minimum, we must open the electricity market mall cops to increased public scrutiny. People representing the interests of household consumers must serve on the board and hold a majority of voting shares. The organizations should be subject to Freedom of Information Act requests, and all meetings must be held before the public.

Tyson Slocum is Director of Public Citizen’s Energy Program. Follow him on Twitter @tysonslocum