As reporters keep digging into the “London Whale” story, the picture that emerges about the caliber of risk controls and management supervision at JP Morgan only look worse and worse.
The latest revelations comes via the Wall Street Journal. First, that there was no treasurer during the period when the CIO entered into the loss-making trades. The idea that a bank of any size, let alone one as big as JP Morgan, would go for months (five in this case) without a treasurer in place is stunning. JP Morgan contends this is not germane, since (allegedly) the CIO did not report to the treasurer. Then pray tell, why was it housed in the treasury at all? And the bank’s efforts to make this all sound normal are undermined by this part of the story:
Joseph Bonocore, who left the treasurer’s post last October before the trading losses ballooned, reviewed weekly the positions being taken by the office and had raised general concerns about risks being taken by the London office that placed many of the questionable trades, according to a person familiar with the situation. Mr. Bonocore knew the investment unit well; he previously was its chief financial officer for roughly 11 years.
So the former treasurer was looking over the positions, even if he was not part of the reporting line (or was he?).
But worse, the risk manager tasked to the oversight of the unit appears underqualified for the job, and that might not be unrelated to the fact that he is the brother-in-law of a JP Morgan executive. The Key extracts:
J.P. Morgan Chase JPM -4.31% & Co. didn’t have a treasurer in place during a five-month period when the bank’s Chief Investment Office placed trades that led to more than $2 billion in losses.
In addition, the executive put in charge of risk management for the Chief Investment Office in February, Irvin Goldman, was a former trader, not a risk manager. He is also the brother-in-law of another top J.P. Morgan executive, Barry Zubrow. JP Morgan argued that many risk professionals come from trading (true) but his background does not look logical for oversight of a business dealing in complex “hedges”:
Mr. Goldman had little risk-management experience before taking the chief risk officer post at the Chief Investment Office. He spent most of his career as a trader, starting at Salomon Brothers in the 1980s. He oversaw interest-rate product sales and trading at Credit Suisse First Boston and in 2003 joined Cantor Fitzgerald, where he was president of its debt capital markets and asset management divisions. Mr. Goldman ultimately left Cantor in October 2007 after his unit piled on trading losses during the previous summer.
Even though his role at Credit Suisse might sound relevant, he left that position nearly 10 years ago, and I would anticipate practice has changed quite a bit. Cantor is known primarily as an inter-dealer broker in Treasuries. Readers are welcome to correct me, but I am not aware of Cantor being a significant player in complex derivatives, and they would not seem to be positioned to play that role (you need a large balance sheet and good market share in the related cash products to be competitive).
An article at CNBC yesterday raised another troubling issue, that the CIO had a more permissive value at risk model than the rest of the bank. This is consistent with the idea raised by Michael Crimmins earlier today, that the “whoops we allowed that model to put on a lot of risk, didn’t we?” was not an accident, but a way to allow a unit that was expected to take risk to put it on, and/or put less capital against those positions. From CNBC:
The JPMorgan Chase unit that lost more than $2 billion through a failed hedging strategy had looser risk controls than the rest of the bank, according to people familiar with the situation.
The risk of losses is tallied by the bank using a so-called value at risk (VaR) calculation. However, the Chief Investment Office, the unit responsible for the high-profile loss that JPMorgan disclosed last Thursday, had a separate VaR system.
It used a less stringent calculation that gave a lower risk assessment of its trades, according to people who previously worked at the bank. The unit also reported directly to CEO Jamie Dimon, a factor which allowed it to maintain a separate risk monitoring set-up to other parts of the investment bank, these people said.
Despite repeated warnings from executives inside the firm as long ago as 2005, the CIO unit remained notably free from oversight. A source with knowledge of the situation said that these warnings included the size of the CIO, the fact that its risk reporting was not transparent and the scope for the unit to get “bigger and bigger” because it had a lower cost of funding than the rest of the investment bank.
Until April, the CIO unit’s unusual autonomy allowed it to build up risky positions without triggering alarms.
Sports fans, letting a unit run with lower VaR and is completely inconsistent with the JP Morgan party line, that the CIO was in the business of hedging. And this part is therefore no surprise:
Indeed, the unit was encouraged to be a profit center, as well as hedging against risk…
The facts in the public domain about this unit are damning. And if Jamie Dimon survives, as expected, it will serve as yet another bit of proof of how deeply the Obama Administration is in bed with major banks.