[Bloomberg Column] Wall Street's 'Cockroaches'... Dimon's Warning Becomes Reality

"If You See One Cockroach, There Are Probably More"
Dimon Urges Vigilance Over Financial Sector Insolvencies
A Series of Fraud Allegations Following Tricolor Bankruptcy

Paul J. Davis Bloomberg Columnist.

'The cockroach sightings are multiplying.'

Last week, following the consecutive bankruptcies of Tricolor Holdings and First Brands Group, two regional banks disclosed losses caused by fraud. On top of this, key industry figures criticized excessively lax lending standards, further heightening investor anxiety. On the surface, these appear to be isolated incidents resulting from management failures or misconduct. However, as suspicions of fraud continue to emerge among highly leveraged companies, the common threads between these cases are becoming increasingly apparent.

Each time a new case of distress surfaces, there are growing concerns about a 'domino effect,' where even seemingly healthy loans may be impacted in succession. This is because distress could spread from regional banks and non-bank lenders to the core of large commercial and investment banks, which are closely interconnected through funding structures.

On October 16, Josh Wander, co-founder of Miami-based private asset manager 777 Partners, was indicted on charges of fraud amounting to approximately $500 million against lenders and investors. While Wander has denied all charges, the company’s former Chief Financial Officer has reportedly admitted guilt and is cooperating with prosecutors.

Also last week, Jefferies Financial Group issued a public letter to defend its plummeting stock price, explaining that its exposure to losses related to First Brands was "not significant." While this explanation seemed reasonable on the surface, it did not address the potential for indirect losses such as lawsuits, regulatory fines, or reputational damage.

JPMorgan Chase disclosed that it had suffered a $170 million loss related to the Tricolor incident. The bank believes that fraud was involved in this case. Jamie Dimon, CEO of JPMorgan, has consistently warned about underlying market risks, even as the bank has maintained solid performance, positioning himself as Wall Street’s seasoned watchdog in recent years. During the earnings announcement on October 14, when asked about Tricolor and First Brands, Dimon remarked, "If you see one cockroach, there are probably more behind it. Everyone should be on alert about this issue."

His warning quickly became reality. On October 16, regional banks Zions Bancorporation and Western Alliance disclosed loan losses related to investment funds. These funds reportedly took on excessive leverage to purchase commercial mortgage-backed securities (CMBS). As with previous incidents, all parties involved have denied any fraud.

Although the losses at these two banks were much smaller than in earlier cases, they were not enough to quell concerns about a broader wave of distress. News of these losses alone triggered a sharp drop in bank stocks, and European financial stocks followed suit the next day. While some stocks regained stability as the U.S. market reopened, it is clear that financial stocks overall have been undergoing a correction in recent weeks.

Most businesspeople or financiers do not set out to commit fraud from the outset. Typically, it begins with taking a small risk, acting with a bit more greed, or telling a minor lie to cover up a small problem.

The current financial environment is particularly susceptible to such temptations. Since the beginning of this year, markets around the world have experienced frequent volatility and uncertain rebounds, with persistent uncertainty surrounding the direction of inflation and interest rates. Additionally, the unpredictability of which country or industry the United States might target next with tariffs has left market direction unclear.

If the massive public funds injected to cushion the economic shock of the COVID-19 pandemic had not fueled asset price bubbles, today’s risks would be far less severe. Amid abundant liquidity and easy lending, some investors and companies have become excessively leveraged and exposed to risk. Now, they have become so vulnerable that even minor mistakes or small shocks can destabilize them.

Nevertheless, many still hope for a swift escape from this crisis, as they have grown accustomed to central banks pouring money into markets to calm turmoil over the past decade. Ultimately, the expectation that "someone will rescue us again" still lingers in the market.

As market tensions rose last week, criticism focused on private credit. For example, CEO Dimon questioned some asset managers’ lending standards, prompting executives at major asset managers such as Blue Owl Capital to push back, instead blaming the banking sector.

However, the real issue is the chain of risk between banks and non-banks. The key link here is non-bank lending. This segment has grown rapidly in recent years because it has been the most efficient way for major banks to expand lending with relatively little capital. It includes a wide range of borrowers, many of whom are ordinary companies far removed from the "high-risk" category.

According to JPMorgan’s analysis, the amount of lending by private credit managers to business development companies (BDCs) with similar structures is relatively small. As of the end of 2024, exposure to these entities accounted for less than $100 billion out of the total non-bank funding supply, which exceeds $1 trillion.

Still, this is no reason for complacency. Kian Abouhossein, a JPMorgan analyst, pointed out, "Non-bank lending is increasing at an abnormally rapid pace," and added, "This likely signals that lending standards have become more relaxed." He also warned, "Non-bank institutions are subject to relatively weak oversight, creating opportunities for regulatory arbitrage. A lack of transparency between lenders, investors, and depositors is also a problem."

This lack of transparency becomes a catalyst for confusion and anxiety when things start to go wrong. Even if the recently revealed cases are not severe, information asymmetry and a lack of trust can amplify fear throughout the market. The incidents mentioned above have not been definitively proven to be fraud. However, the growing signs of distress spreading throughout the system should not be taken lightly.

Paul J. Davis, Bloomberg Columnist

This article is a translation by The Asia Business Daily of the Bloomberg column "Jamie Dimon's Cockroaches Keep Appearing."

This content was produced with the assistance of AI translation services.