JP with madeira and a tea cake* March 17, 2013 at 11:52 am
It seems that JPMorgan’s travails have become a spectator sport, to be enjoyed with a snack of your choice. I am only half way through the senate report, let along the appendices, so I won’t add to the (already comprehensive) guides to the action‡.
Instead I want to focus on four key issues which emerge from this debacle.
- CIO wasn’t hedging. Like Matt Levine, I had bought the firm’s line that the original portfolio was a macro hedge against the loan book. It is now clear that while that might, in the mists of time, have been the original motivation, the CIO’s office had turned into a prop trading center by 2012. This happened without, as far as I can tell, any authorisation, any redesign of the risk framework, or any changes in oversight. Mind you, given that the risk framework was not based on how well they were hedging anyway, that is hardly a surprise.
The Machiavellian analysis of this is that they were trying to prop trade while avoiding Volcker. My gut feeling is that it wasn’t that: they were simply out of control.
- As Lisa says, mis-marking is key here. The practice whereby, in complete violation of what the accounting standard actually says, US banks are permitted to mark derivatives anywhere between bid and offer must now receive attention. Supervisors must ensure that firms mark at where they can exit the position as it is absolutely clear that external auditors cannot be relied upon to police valuation practice.
- My earlier conjecture that capital management was central to the whale losses is born out. But it is worse than I thought: capital optimisation was mostly about changing the model so that it generated lower numbers. This was wholly cynical, and is bound to increase the pressure to reduce the capital benefit available from the use of internal models§.
- While JP undoubtedly kept things from the OCC, the OCC’s process allowed JP to make model changes without sufficient oversight, did not exercise control over valuation practices, and had little idea what was going on in the CIO. After all, the story was broken by journalists based on public information.
While all the focus so far has been on JP’s mis-deeds, JP’s supervisors do not emerge from this covered in roses.
It will be interesting to see if the Senate can keep up the (encouragingly bipartisan) momentum here. One is uncomfortably aware that a confrontation may be brewing with politicians and public on one side, and the big banks, the OCC, and perhaps the FED on the other. If it really does pan out that way, the legitimacy of current regulatory arrangements may not survive the fall-out.
*The reference is to an extraordinary radio interview that Paul Roy, ex-head of equities at Merrill, gave about the old days on the London Stock Exchange, in which he claimed his equity traders used to enjoy a glass of madeira, or perhaps champagne, as a mid-afternoon pick-me-up. O Tempora, O Mores.
‡See also here and here. One delicate point, by the way, which I have not seen anyone really pick up on, is what ‘lag’ means in the transcripts. It seems to mean the time between general economic improvements affecting the HY vs. the IG indices, but it could also mean the difference between it affecting the spread of the components vs. the index itself. Given that JP’s opponents where hedging mostly using the components, JP was very exposed to the index/components basis.
§See the recent speech from Stefan Ingves here. Ingves says that “Major [Basel Committee] projects currently under way include: … completing the review of the trading book capital requirements. This entails an evaluation of the design of the market risk regulatory regime as well as weaknesses in risk measurement under the framework’s internal models based and standardised approaches.”