Monday, March 18, 2013

A Critique of the Whale But Not the Captain: JP Morgan Trading Failure

A Critique of the Whale But Not the Captain: JP Morgan Trading Failure

The United States Senate’s Permanent Committee on Investigations has issued a report[1] and held hearings last week to expose multiple failures inside JP Morgan’s Chief Investment Office.  The Office was responsible for $6 billion in losses as a result of a series of credit derivative trades, known as the Whale, that went wrong.  The report is a detailed examination of the things that go wrong when a trading or investment organization starts to lose money.  There’s nothing surprising in the report, and yet the politicians and news reports have been incredulous over JP Morgan’s conduct.
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JP Morgan was supposed to be the good bank because it got through the credit crisis with limited damage and also worked with the Federal Reserve and FDIC to salvage Bear Stearns and Washington Mutual.  As a result Jamie Dimon, the bank’s CEO, was lauded for his superior management skills.  Unquestionably, JP Morgan made a series of sound decisions in avoiding the toxic mortgage exposure that brought down many other institutions.  However, the mentality and culture of JP Morgan is quintessentially Wall Street, and thus it shouldn’t be surprising that the bank’s systems broke down exactly just like those of every other bank.

The Committee’s report exposes the four things that always go wrong when trading operations fail:  the pricing of securities breaks down; the risk models don’t work properly; the reports to management aren’t accurate; and, the disclosure to investors and regulators is flawed.  Clearly, the losses at JP Morgan don’t compare to total failures at AIG, Lehman, or Bear Stearns.  However, JP Morgan managed to follow the well-worn path of failings, despite the passage of Dodd-Frank.

Predictably, the Congressional report calls for greater rigor in pricing, more adherence to risk parameters, better reporting, and enhanced disclosure to regulators and investors.   Nevertheless, this report joins all the other reports and inquiries in failing to address the culture that fosters unwarranted risk-taking and deception.  In reporting on the hearings, The New York Times provides insight into the disease that continues to go unaddressed:

“Mr. Dimon’s supporters, including several shareholders, also argue that he has good cause to be arrogant. Even with the trading loss, Mr. Dimon in 2012 produced the bank’s most profitable year ever.[2]

Financial success does not justify arrogance, and yet investors and boards of directors are willing to accept it when a bank, or for that matter money managers, make a lot of money.  Arrogance, however, is a toxic trait when things go wrong.  Mr. Dimon’s arrogance spread to his subordinates and created the culture that fostered excessive risk-taking and then tried to cover it up when things went wrong.


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