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JPMorgan Trading Loss: Did Regulators Miss the Risk?

Scores of federal regulators are stationed inside JPMorgan Chase’s Manhattan headquarters, but none of them were assigned to the powerful unit that recently disclosed a multibillion trading loss.

JP Morgan Chase
CNBC.com
JP Morgan Chase

Roughly 40 examiners from the Federal Reserve Bank of New York and 70 staff members from the Office of the Comptroller of the Currency are embedded in the nation’s largest bank.

They are typically assigned to the departments undertaking the greatest risks, like the structured products trading desk.

Even as the chief investment office swelled in size and made increasingly large bets, regulators did not put any examiners in the unit’s offices in London or New York, according to current and former regulators who spoke only on condition of anonymity.

Senior JPMorgan executives assured the bank’s watchdogs after the financial crisis that the chief investment office, with hundreds of billions in investments, was not taking risks that would be a cause for concern, people briefed on the matter said.

Just weeks before the trading losses became public, bank officials also dismissed the worry of a senior New York Fed examiner about the mounting size of the bets, according to current Fed officials.

The lapses have raised questions about who, if anyone, was policing the chief investment office and whether regulators were sufficiently independent. Instead of putting the JPMorgan unit under regular watch, the comptroller’s office and the Fed chose to examine it periodically.

The bank pushback also suggests that JPMorgan had sway over its regulators, an influence that several said was enhanced by the bank’s charismatic chief executive, Jamie Dimon, long considered Washington’s favorite banker.

Now, as regulators scramble to determine whether the chief investment office took inappropriate risks, some former Fed officials are asking whether the investigation should be spearheaded by the New York Fed, where Mr. Dimon has a seat on the board.

Some lawmakers and former regulators also have reservations about the comptroller’s office, which is investigating the trade and was the primary regulator for JPMorgan’s chief investment unit.

“The central question is why Jamie Dimon was able to so successfully convince both its regulators that there was nothing to see at the chief investment office,” said Mark Williams, a professor of finance at Boston University, who also served as a Federal Reserve Bank examiner in Boston and San Francisco. “To me, it suggests that he is too close to his regulators.”

Regulators, for their part, say they cannot micromanage a bank or outlaw its risk taking and did not bow to bank pressure when assigning examiners.

William C. Dudley, president of the New York Fed, has said that JPMorgan’s losses did not pose a threat to the bank’s viability.

In a statement on Friday, the comptroller of the currency, Thomas J. Curry, said, “I am committed to ensuring this agency provides strong supervision for all of the institutions we oversee.”

Regulators are not typically stationed at divisions like JPMorgan’s chief investment office, which are known as Treasury units. The units hedge risk and invest extra money on hand, and tend to make short-term investments.

But JPMorgan’s office, with a portfolio of nearly $400 billion, had become a profit center that made large bets and recorded $5 billion in profit over the three years through 2011.

Officials of JPMorgan declined to comment on its relationships with regulators.

Long before the recent trading blunder, JPMorgan had a pattern of pushing back on regulators, according to more than a dozen current and former regulators interviewed for this article.

That resistance increased after Mr. Dimon steered JPMorgan through the financial crisis in better shape than virtually all its rivals.

“JPMorgan has been screaming bloody murder about not needing regulators hovering, especially in their London office,” said a former examiner embedded at the bank, adding, in reference to Mr. Dimon, “But he was trusted because he had done so well through the turmoil.”

Even now, executives at JPMorgan disagree with some regulators over how quickly the bank should unwind the soured trade, according to people briefed on the negotiations.

JPMorgan would like to be done with the bad bet that has resulted in at least $3 billion in losses already, but senior executives argue it is a delicate process, especially as traders and hedge funds on the opposite side of the trade seize on the fact that JPMorgan is under pressure to exit the position.

Senior staff members at the Federal Reserve want the bank out of the position “yesterday,” according to a regulator privy to the discussions who insisted on anonymity because the talks are private.

Some politicians — including Senator Bernard Sanders, independent of Vermont, and Elizabeth Warren, a Democrat running for Senate in Massachusetts — argue that Mr. Dimon’s position at the New York Fed further compromises regulatory oversight.

“Mr. Dimon should not be in a position to have such influence on a major regulator,” Ms. Warren said.

When asked on PBS’s “NewsHour” last week about JPMorgan, Treasury Secretary Timothy F. Geithner said that regulators needed to “be above any political influence.”

He did not say Mr. Dimon should resign from the Fed, but he acknowledged that the perception of a conflict was “a problem.” At the bank’s annual shareholder meeting last week in Tampa, Fla., Mr.

Dimon pointed out that he served as an economic adviser at the New York Fed.

Bankers who sit on the New York Fed do not have a say about the supervision of banks or the writing of rules, but provide guidance on the state of the economy, according to Fed officials.

Mr. Dimon, however, has been a vocal critic of some bank regulatory reforms being drafted in Washington.

Current and former regulators said that lower-level officials at JPMorgan had at times tried to undermine their supervision of the bank.

JPMorgan has a reputation for challenging regulators more forcefully than rival banks like Citigroup and Goldman Sachs, former New York Fed officials said.

Long before the recent trade, an embedded examiner said he had asked for JPMorgan’s three- to five-year capital plan, and after waiting a couple of days was told that the bank’s management had gone over his head and “already sent it to my bosses.”

By cutting out lower-level regulators, the bank officials telegraphed a message that those concerns were irrelevant, the former examiner said. JPMorgan also kept its regulators somewhat in the dark about the troublesome trades.

Senior executives, for example, did not tell the Fed that they had changed their value-at-risk measure in the first quarter to evaluate potential losses at the chief investment office.

Though reporting such a change was not required, the size of the office alone merited more oversight, said Mr. Williams, the former Fed examiner.

“From a regulatory standpoint, it needs to be scrutinized because it was a hedge fund,” Mr. Williams said.

Bank officials played down the trade after it began to sour, according to a senior supervisor at the Federal Reserve.

The supervisor said he was assured in the first week of April that the bank’s senior management was not concerned about Bruno Iksil, the trader who earned the nickname the London Whale for his outsize bets in the credit markets.

The Office of the Comptroller of the Currency is also facing scrutiny about whether it is too cozy with the banks it oversees.

At JPMorgan, when media reports surfaced that the bank was making aggressive bets on credit derivatives, comptroller officials began taking a closer look, people briefed on the matter said.

After thumbing through the bank’s own projections for the related risks in early April, the people said, the examiners pushed for more answers but saw no immediate need to change course.

The agency notes that it does not bless specific trades.

In a briefing on Capitol Hill last week, two comptroller officials told a room of Congressional staff members that it was “common” and “appropriate” for banks in general to hedge their exposure to various risks, according to people who attended.

“I know in college they teach you everything is black and white,” one official said in response to hypothetical questions about creating the perfect hedge. “But it’s not that way in the real world.”

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