The most widely read post on this blog is from September 2011, on the subject of AIG, financial risk management, and rogue traders. Reading the current report absolutely convinces me about the merits of the arguments I made in the 2011 post. Further, it is also clear that the TBTF ("Too Big To Fail") argument is off the point.
Institutions like J.P. Morgan are TCTM ("Too Complex to Manage") The talk about the "London Whale" does nothing more than anthropomorphize the huge, systemic risk posed by institutions like J.P. Morgan Chase. The 2012 CIO losses cannot legitimately be attributed solely to the behavior of one trader, or even to a group of traders.
To have outsiders look at the Synthetic Credit Portfolio ("SCP") would have been prohibitively expensive and time-consuming. It would have also shed no more light than does the current report. The internal report is poorly written, alternatively simplistic and opaque, and completely exonerates the cast of incompetents, charlatans and cynics that populated the CIO. Any reader who understands Wall Street will understand where the issues lie after reading the report, although the reader may not understand the fine details of the SCP's portfolio implosion.
The whole premise of the SCP is unconvincing. It was supposed to be a vehicle for deploying excess deposits in the system to inoculate J.P. Morgan's core credit portfolio from unanticipated changes in interest rates, inflation rates, and economic growth. SCP's overall strategy, trading tactics, and management truly describe a proprietary trading vehicle, a distinct profit center. It was certainly not managed as a hedging vehicle.
Here's the arc of the story in numbers and events:
- At month-end January 2011, cumulative mark-to-market (M2M) losses on the SCP portfolio were $100 million;
- At month-end February, M2M losses are $169 million;
- At month-end March 2011, M2M losses are calculated at $718 million.
- On April 5, 2011, CEO Jamie Dimon, the CFO and CRO are told the SCP's risk was "balanced," the market for credit index swaps"dislocated" and the M2M losses "temporary." One trader, without any defensible basis, says that the losses would "mean revert."
- On the basis of these dubious assurances, CEO Dimon utters the infamous quote on a 4/13/2011 conference call describing investor concerns about the SCP portfolio as "a tempest in a teapot." CFO Braustein says that he is "very comfortable" with the portfolio's position and risk profile.
- All during the month of April, losses in the SCP continue to mount. Non-CIO personnel, primarily from the Investment Bank, take over management of the portfolio. Taking a more rigorous and defensible look at the portfolio risk, they analyze correlations between the instruments and estimate risks across a range of different scenarios. Their basic conclusion: SCP's risk was much higher than than was reported to senior management ahead of the April quarterly conference call. Markets had become illiquid because other savvy investors like Boaz Weinstein had come to understand months before, the extent of SCP's predicament. So, the comments given to management about credit index swap markets being dislocated was disingenuous. A noose had been slipped on JPM and tightening for months.
- By May 2011, M2M losses were more than $2 billion!
- Around this time, CEO Dimon says that the SCP investment strategy was "flawed, complex, poorly reviewed, poorly executed, and poorly monitored."
- JPM's external auditors, PwC had reviewed the portfolio marks in conjunction with the report of the first quarter's financials and found no issue with them. Their subsequent May 2011 investigation found that the portfolio markets lacked "integrity." Whereas PwC had expressed confidence in the process and outputs of the M2M, they now opined that the marks no longer represented "good faith estimates of fair market value," according to the report.
- By 6/30/2011, cumulative M2M losses on the SCP stood at $5.8 billion.
- on 7/13/2011, JPM restated the first quarter's net income based on the inadequate M2M marks, reducing it by $459 million.
"On calls with reporters and analysts Wednesday, he (Dimon) was his usual swashbuckling self, intensely proud of the bank he runs and sometimes impatient with critical questions.He said the portfolio where the troubled bets were made is "very close to being a non-issue" as far as trading losses are concerned. .../When analyst Guy Moszkowski asked about the "exotic investment strategies" of the Chief Investment Office, where the loss occurred, he shot back, "It has got not a damned thing to do with exotic investment strategies – zero, nada, nothing. OK?"Unfortunately, Mr. Dimon probably scored the debating point against Mr. Moszkowski. The investment strategies at the SCP were not at all "exotic." To mash up Mr. Dimon's words with the findings of the report, the investment strategies were hare-brained, incompetently designed for the wrong purposes, not vetted by CIO management, implemented with Tinker Toy tools, left in the hands of unsupervised individuals, and reported to the CEO through folks whose economic interests clashed with their duty of candor. All the same cultural issues remain. But, perhaps we are closer to future trading losses being a non-issue.
Looking for a bridge to buy?