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Regulators Close Aquarium Door Behind Escaped Whale

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Once upon a time there was a whale, and he had a synthetic credit portfolio, and one day he did terrible terrible things with that synthetic credit portfolio, and the next day he woke up and realized he had lost $5.8 billion, and he was sad. The question for you is: was that a disaster? I think a sensible answer is:

  • Well, for the whale, yes.1
  • For, like, the human race, nah.2

Having a sense of proportionality here is a good idea. For one trader, losing six billion dollars, give or take, really is in the far left tail of Worst Things You Can Do, and so the whale himself was fired in infamy, though an infamy mixed with a certain envy. For his direct manager and that manager's manager, it is probably even worse, since failing to prevent your direct report's $6 billion loss lacks the "wow-that-takes-balls" element of actually going out there and losing six billion dollars like a whale. So they were fired too. For the bank ... meh. For the Second Bank of North-Central Indiana, I'm sure losing six billion dollars would be the sort of existential disaster that would require firing the CEO, tearing down the building, and salting the earth on which it stood, but there's a reason this didn't happen at the Second Bank of North-Central Indiana. It happened at JPMorgan. For which it wasn't all that much of a disaster.3

What about for JPMorgan's regulators? I go with, like, our financial system is still here, not really any the worse for wear, but others disagree, and regulators don't have the same "well we were profitable for the quarter" defense that JPM had.4 And so today the Fed and OCC engaged in a well-lawyered barn-door-closing exercise, issuing consent orders to JPMorgan that basically say (1) you done fucked up, but (2) you fixed it, so (3) keep doing what you're doing. Here is the Fed:

Within 60 days of this Order, JPMC shall submit to the Reserve Bank an acceptable written plan to continue ongoing enhancements to its risk management program, particularly with respect to the matters set forth below.

Harsh words, man. "If you don't continue those ongoing enhancements, you'll be in serious trouble!"5

The recommendations are sensible in the way you'd expect of recommendations that don't say anything; the main lesson learned seems to be encapsulated in the demand that JPM (continue to) take "measures to ensure that controls for Trading Activities across lines of business are consistent." If you build a trading business with risk limits, and then you build another business that does the same thing but doesn't have risk limits, then bad things will happen, and probably not in the business with risk limits. This is not particularly an insight that is new to me, or the Fed, or anyone. It's a thing that everyone knew, and JPMorgan briefly forgot, with disastrous-over-some-domain consequences, and now they're better and will be continuing those enhancements.

I guess the other lesson learned is where the Fed urges JPM to (continue to) take "measures to ensure that material risk management issues relating to Trading Activities are escalated in a timely manner to senior management and the board of directors or a committee thereof." The Wall Street Journal notes that JPMorgan's board is about to release a report on the Whale, and that:

The committee [of independent directors] concludes in its written report that independent directors aren't culpable for the losses since they saw no red flags about the disputed trades, this person said.

They would say that wouldn't they? It seems like a bit of a failing, though, not to see those red flags, and a failing of a different quality from Dimon's failing. Dimon had the facts (ignoring, for a minute, that the bank's VaR models may have understated the risk to him), but chose not to worry sufficiently about the risks. If the board didn't have the facts ... you could legitimately ask them, hey, board, why didn't you have the facts? (Meanwhile the OCC and the Fed don't even bother to exonerate themselves in their reports, though Lisa Pollack for one has argued persuasively that they definitely had the facts and so should have seen red flags.)

Who should have had the facts? Here you can read Kevin Roose arguing that the answer is "everyone":

If it wanted to, JPMorgan's board could mandate a full reveal of all the CIO's trading positions on a quarterly basis. This level of disclosure can be costly, since it amounts to revealing proprietary strategy and gives away much of the bank's informational advantage. ... But the board has a chance, with Wednesday's report, to make its disclosure practices the most transparent in the industry, and make investors more confident that they won't be caught by surprise by a huge trading loss again. It should take advantage of that chance ....

This strikes me as bad advice; remember the whale's problem was like one part bad directional bet, three parts everyone finding out about it and picking him off. But, yes: a thrust of the post-whale postmortems does seem to be that not enough people got to take a deep look at the whale's positions, with Dimon shielding the Chief Investment Office from prying non-CIO traders and board members alike. And the regulators' call for risk management that is more consistent across divisions, and more closely supervised by the board, seems to endorse that viewpoint. More transparency to shareholders may not be the cure, but more transparency to directors would surely help.

A little, anyway. The regulators - presumably! - had complete information on JPMorgan's concentration in synthetic credit, and didn't raise an eyebrow until after the fact. Same for Jamie Dimon for that matter. Giving executives, directors, or regulators mountains of information can only go so far, if those executives, directors and regulators know that failing to scrutinize that information won't lead to disaster for themselves. And nothing about that seems to have changed.

J.P. Morgan Ordered to Fix Lapses [WSJ]
Fed press release and consent order [FRB]
OCC press release and consent order [OCC]

1.You could quibble with this proposition: the whale, who was actually a person named Bruno Iksil, was fired in what you could loosely call "disgrace," but (1) he's not, like, poor, (2) he probably won't go to jail or anything (I think?), and (3) he'll probably find other gainful employment: losing six billion dollars is a sign of rare skill that a lot of people would pay for. There is much boring discussion of investment-bank-comp convexity that one could have here but let's skip it. I posit that, for the Whale, losing six billion dollars and being fired from his job was a really sad event.

2.Ugh, this has fallen down on the fact that the whale is a whale but also a human. You get the idea. It's like Wilbur Falcone.

3.So much of the scolding of Jamie Dimon has to say things like:

In Dimon's defense, the bank is expected to report record profit later this week. Dimon has at least done that part of his job well.

"That part of his job" being his job but whatever.

4.Ha no kidding one of JPMorgan's regulators - the Fed - was totally profitable for the quarter.

5.This is perhaps a little unfair; there are more specific recommendations too, though it sounds like they're all things that are already being done. The OCC consent order is particularly, even comically, detailed:

Ensure that all spreadsheets are formally documented and file-versioned, and provide details of changes implemented to formulas, macros, and queries, and include procedures for proper usage.

Your tax dollars at work, on spreadsheet file-versioning.