March 21, 2023

Fair Game: JPMorgan’s Follies, for All to See in a Senate Report

That’s the takeaway for both investors and taxpayers in the 307-page Senate report detailing last year’s $6.2 billion trading fiasco at JPMorgan Chase. The financial system, thanks to dissembling traders and bumbling regulators, is at greater risk than you know.

After bailing out the nation’s banking system in 2008, taxpayers and investors have been assured that such a crisis will not happen again. The Dodd-Frank legislation was supposed to make our system safe from the kinds of reckless banking activities that brought the economy to its knees.

The Senate report disproves this premise with vigor.

Its pages of e-mails, testimony, telephone transcripts and analysis show that traders in the bank’s chief investment office hid money-losing derivatives positions, if only temporarily; that risk limits created by the bank to protect itself were exceeded routinely; that risk models were changed to minimize losses; that bank executives misled investors and the public; and that regulations are only as good as the regulators enforcing them.

Remember that this is a report examining JPMorgan Chase, the bank that enjoys the best reputation among its peers. One can only wonder: if JPMorgan Chase traders think nothing of misrepresenting the value of their trades to minimize losses, what are the financial world’s lesser players up to?

Unfortunately, that is not something investors are likely to learn until it is too late and a wrong-way bet blows up an institution’s balance sheet.

Before delving into the report and its findings, let’s congratulate the Permanent Subcommittee on Investigations, led by Senator Carl Levin, a Michigan Democrat. This is the second time in recent history that this subcommittee and its staff have served the public by illuminating the dark corners of the financial world — the first being the riveting hearings and reports on the causes of the 2008 financial crisis, which dove deep on Washington Mutual, Goldman Sachs and the credit ratings agencies.

The hearings on Friday were equally compelling, with Mr. Levin and John McCain, the Arizona Republican who is the subcommittee’s ranking minority member, subjecting current and former JPMorgan executives, including Ina Drew, the former head of the chief investment office, to penetrating and pointed questions.

“Besides the traders who mismarked the book, who should be held accountable for breaching JPMorgan’s own internal risk limits and adjusting its risk models?” Mr. McCain asked of Douglas L. Braunstein, vice chairman at the bank. After Mr. Braunstein cited the significant reductions in compensation of JPMorgan executives as one measure of accountability, Mr. McCain replied: “It’s hard for me to accept that serious responsibility was assumed by the top management of JPMorgan especially in light of e-mails that say that these decisions were, according to Ms. Drew, fully discussed and vetted by the top management of JPMorgan.”

Hoping to understand JPMorgan’s practice of relaxing its valuation method on the troubled investment portfolio, Mr. Levin asked of Mr. Braunstein: “Is it common for JPMorgan to change its pricing practices when losses start to pile up in order to minimize the losses?”

After a bit of back and forth, Mr. Braunstein said: “No, that is not acceptable practice.”

Not acceptable, perhaps, but that is what occurred, as the Senate report shows. Normal practice at the bank and across the industry is to value these kinds of derivatives at the midpoint between the bid and offer prices available in the market. But in early 2012, as it became apparent that JPMorgan’s big trades at the chief investment office were going bad, the bank began valuing the portfolio well outside the midpoint. This reduced its losses.

For example, in January 2012, the portfolio valuations hewed closely to the midpoint on all but 2 of the 18 measures, the Senate investigators found. A month later, 5 of the 18 valuation measures deviated from the midpoint. In March, however, all 18 deviated, and 16 were at the outer bounds of price ranges. In every case, the prices used by the bank understated its losses.

While these valuation shifts were taking place in the chief investment office, JPMorgan’s investment bank officials continued to mark their identical positions using the midpoint value.

RISK limits, intended to protect the bank from losses, were also routinely breached at JPMorgan Chase, the report found. From late 2011 to the first quarter of 2012, Senate investigators saw a huge jump in the number of risk-limit breaches — to more than 170, from 6. Then, in April 2012 alone, risk limits were exceeded 160 times.

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