I don't think they thought that way when they traded!
JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon told Congress the bank let traders take risks they didn't understand while he didn't answer key questions about more than $2 billion in trading losses.
In testimony prepared for a hearing today, Dimon expressed regret over losses in the bank's chief investment office, saying that its trading strategy was "poorly conceived and vetted" by senior managers who were "in transition" and not paying adequate attention.
"This portfolio morphed into something that, rather than protect the firm, created new and potentially larger risks," Dimon said in the remarks ahead of his appearance today before the Senate Banking Committee. "We have let a lot of people down, and we are sorry for it."
Dimon, 56, makes his first of two appearances on Capitol Hill to face lawmakers probing how the largest and most profitable U.S. bank, often praised for its "fortress" balance sheet, could have taken such risks after coming through the 2008 financial crisis largely unscathed. His remarks left unanswered what he knew when about the trading strategy and losses that accelerated in March and April.
"We all bought into the idea that Jamie was the best manager in the world," said Paul Miller, a former examiner for the Federal Reserve Board of Philadelphia and analyst at FBR Capital Markets in Arlington, Virginia. "For a guy who is known for risk management, he certainly didn't put in place a top-tier risk management system or board."
VaR Switch
Dimon also didn't address changes made earlier this year to a company measurement known as value-at-risk, or VaR, that underestimated the potential for losses. The switch -- and the timing of the firm's disclosures -- are the focus of an inquiry by the Securities and Exchange Commission, agency chairman Mary Schapiro told the Senate panel on May 22.
Other government investigations of New York-based JPMorgan include a study of internal oversight by the Federal Reserve, a probe of the trades by the Comptroller of the Currency, and additional inquiries by the Department of Justice and the Commodity Futures Trading Commission.
Dimon said that the risk committee structures and processes were not as robust in the CIO as they should have been. The division's London team built up a book of credit derivatives that became so large by that employees couldn't unwind it without roiling markets or incurring large losses.
Feels 'Terrible'
Dimon said he feels "terrible" that the firm will lose shareholder money, yet defended the bank by saying lawmakers needed to put the losses "into perspective," noting that no client, customer or taxpayer money was impacted. He said the second quarter would be "solidly profitable."
Dimon explained that the bank instructed the CIO in December to reduce its risk-weighted assets to prepare for new international capital rules. Instead, the office in mid-January "embarked on a complex strategy that entailed adding positions that it believed would offset the existing ones," Dimon said. The portfolio grew and the problem got worse.
[To read Dimon's full testimony, click here.]
Shares of the bank have dropped 17 percent from May 10, when Dimon disclosed the losses, through yesterday, lopping about $26.5 billion from the firm's market value. The furor cost former Chief Investment Officer Ina Drew her job.
Senator Tim Johnson, the panel's chairman, said in remarks prepared for the hearing that he expected Dimon to answer how the investment office, a unit designed to protect the company from risk, could lose billions of dollars instead.
Making Money
"How can a bank take on 'far too much risk' if the point of the trades was to reduce risk in the first place?" the South Dakota Democrat asked. "Or was the goal really to make money? Should any hedge result in billions of dollars of net gains or losses, or should it be focused solely on reducing a bank's risks?"
Senator Richard Shelby of Alabama, the top Republican on the panel, will focus on the specific nature of the bank's trades, according to Jonathan Graffeo, his spokesman. The senator also intends to ask whether management ignored warning signs inside the CIO and whether Dimon supports higher capital standards, he said.
Volcker Rule
Dimon, who's set to face the House Financial Services Committee on June 19, will also find himself in the middle of a renewed debate about whether regulators should tighten curbs on trading by deposit-taking banks after mortgage bets pushed the financial system to the brink of collapse four years ago.
Senator Jeff Merkley, an Oregon Democrat, has used the trading losses as ammunition in his fight to tighten exemptions in the so-called Volcker rule. Merkley, who co-wrote the provision in the Dodd-Frank Act along with Senator Carl Levin of Michigan, has said that the draft rule released by regulators in 2011 had loopholes that would allow banks to maintain much of their proprietary trading operations.
Five U.S. agencies are working to complete the rule, which is named for former Fed Chairman Paul Volcker and is intended to reduce risky trading by banks with federally insured deposits and access to the central bank's discount window.
Investors and bankers, including Dimon, have speculated that the loss may hurt their efforts to soften the Volcker rule and other provisions of Dodd-Frank, which was passed to curb the kinds of banking practices that contributed to the 2008 financial crisis.
Hard Distinction
The current draft of the Volcker rule permits banks to continue trades for hedging but not for proprietary trading designed to generate profits. Banks have said the distinction can be hard to make.
JPMorgan's trading losses "could lead to a more stringent interpretation of the Volcker rule," Standard & Poor's said in a May 11 report. "That, in turn, could affect JPM's hedging strategies going forward by disallowing certain tactics, adding risk to JPM's portfolio."
The bank's pay policies might offer some insight to lawmakers, said Simon Johnson, a former chief economist at the International Monetary Fund.
"What was the compensation arrangement for people in the CIO, including traders and executives?" asked Johnson, who now teaches at Massachusetts Institute of Technology's Sloan School of Management. "If they were paid based on firm-wide results, they were hedging. If they were paid based on returns in CIO itself, this is prop trading."
JPMorgan's biggest competitors, including Bank of America Corp., Citigroup Inc. (C) and Wells Fargo & Co. (WFC), have said their corporate investment offices avoid the use of the kind of derivatives that led to the trading losses and buy fewer bonds exposed to credit risk. The rivals said their offices don't trade credit-default swaps on indexes linked to the health of companies.
Dimon's apology is a first step in the company's plan to assuage concerns of investors, said David Hendler, an analyst at CreditSights Inc. in New York.
"It's not like you went through a stop sign and got a slap-on-the-wrist ticket," Hendler said. "It'll have to be every quarter for the next couple of years or so. That's basically job No. 1 for Jamie Dimon."
To contact the reporters on this story: Dawn Kopecki in New York at dkopecki@bloomberg.net; Phil Mattingly in Washington at pmattingly@bloomberg.net
To contact the editors responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net; David Scheer at dscheer@bloomberg.net
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