[Vision2020] Whores Undressed

[Art Deco]

  [image: The New York Times] <http://www.nytimes.com/>

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March 16, 2013
JPMorgan’s Follies, for All to See By GRETCHEN
MORGENSON<http://topics.nytimes.com/top/reference/timestopics/people/m/gretchen_morgenson/index.html>

BE afraid.

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<http://topics.nytimes.com/top/news/business/companies/morgan_j_p_chase_and_company/index.html?inline=nyt-org>.
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<http://www.hsgac.senate.gov/subcommittees/investigations/hearings/chase-whale-trades-a-case-history-of-derivatives-risks-and-abuses>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<http://www.hsgac.senate.gov/subcommittees/investigations>,
led by Senator Carl
Levin<http://topics.nytimes.com/top/reference/timestopics/people/l/carl_levin/index.html?inline=nyt-per>,
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<http://www.levin.senate.gov/newsroom/press/release/us-senate-investigations-subcommittee-releases-levin-coburn-report-on-the-financial-crisis>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<http://topics.nytimes.com/top/reference/timestopics/people/m/john_mccain/index.html?inline=nyt-per>,
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.

“Should someone have investigated the risky trading activities that
triggered all these breaches?” Mr. Levin asked. Yes, but no one did, the
report concluded. The risk limits were either ignored or modified to make
the portfolio look better.

JPMorgan Chase has repeatedly said it made mistakes and has changed its
policies.

The Senate report also raises questions about the rigor with which JPMorgan
conducted its own investigation into the trading loss. That report was
published in January.

Mr. Levin cited the internal report’s failings in his questioning of
Michael Cavanagh, a task force member and co-C.E.O. of JPMorgan’s corporate
and investment bank. “You just told us that shifting pricing practices to
minimize losses is not acceptable,” Mr. Levin said. “Did you say that in
your report? Did you say that’s what happened?”

“I don’t believe we called that out in the report,” Mr. Cavanagh answered.

The report recommends what regulators should do to prevent similar events
at other banks. It suggests that regulators should be on the lookout for
manipulation of an institution’s risk models and should encourage banks to
use independent pricing services to ensure the integrity of valuations.

But the true value in this Senate investigation is its spotlight on the
ability of bank executives to hide hundreds of millions of dollars in
losses and yet survive internal valuation reviews. This “shows how
imprecise, undisciplined, and open to manipulation the current process is
for valuing credit derivatives,” the report said.

JPMorgan, don’t forget, is the largest derivatives dealer in the world.
Trillions of dollars in such instruments sit on its and other big banks’
balance sheets. The ease with which the bank hid losses and fiddled with
valuations should be a major concern to investors.

As for taxpayers, the Senate report clearly indicates that JPMorgan Chase
is too big to regulate. The report found that the bank failed to provide
crucial portfolio data to its regulators at the Office of the Comptroller
of the Currency and that those regulators did not investigate questionable
trading at the bank. The overseers accepted the bank’s assurances that
nothing was amiss.

We already know that banks of JPMorgan’s size are also too big to be
allowed to fail and too big to prosecute. Such banks are too big to
regulate and apparently too big to manage. So how much more evidence do we
need that banks like JPMorgan are simply too big a risk for taxpayers to
bear?


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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