At a Senate hearing on Friday over JPMorgan Chase’s London Whale trade, Senator Carl Levin, grilled several of the bank’s executives about breaching risk limits, hiding losses, traders mis-marking positions and withholding data from their main regulator.
The Senate Subcommittee on Permanent Investigations, led by Levin, a Democrat from Michigan, released a 300-page report on Thursday, blasting the bank for tripling the size of its synthetic credit derivatives portfolio in the first quarter of 2012 without notifying regulators and dodging oversight by the Office of the Comptroller of the Currency (OCC).
At the hearing, Ina Drew, the former head of JP Morgan’s chief investment office, admitted that “mistakes were made,” but largely deflected any blame for the derivatives losses to other departments who were responsible or to numbers that she was given. Drew, who resigned in May after $2.2 billion in losses were made public, said that said that her oversight of the credit derivatives portfolio was undermined by two critical factors.
“The company’s new VaR [Value at Risk] model was flawed and significantly understated the real risks in the book that was reported to me, and some members of the London team failed to value the book correctly. They minimized losses-and failed to report to me the true risk of the book,” Drew told the senators.
The bipartisan report also talks about how traders were pressured to change the way they marked their positions, from picking fair value by using midpoint prices to more aggressive prices. This led Bruno Iksil, the trader dubbed the London Whale, to call the prices "‘idiotic," noted Levin at the hearing.
One testy exchange between Levin and Drew focused on the size of the losses that were initially reported to OCC. “Why did you tell the OCC that the first quarter losses were $580 million, when they were $719 million?” asked Levin. In response, Drew said she reported the number she received from risk and central finance. But Levin pointed out, that an internal report showed the loss was already $1.6billion, yet she told the OCC it was $580 million.
Levin questioned Drew about whether data on the synthetic credit derivatives portfolio (dubbed SDP) was provided to the bank regulator.
“To the best of my knowledge, the OCC was given daily mark to market reports on profit and loss reports for the total CIO mark to market activities of which the synthetic credit portfolio was included,” said Drew.
However, later on in the hearing, it was revealed that the OCC didn’t receive daily mark-to-market reports on the value of the synthetic credit derivatives portfolio.
Also, though JP Morgan said the purpose of the strategy was for long-term hedging, Levin showed that the bank was doing a lot of short-term trading and that the book grew from $51 billion to $157 billion in the first three months of 2012. While the SDP was rapidly increasing in size, a meeting with OCC took place on Jan. 31 at which the OCC was told that the book was decreasing in size. Also, in January 2012, the CIO stopped sending data to the OCC for four months. It didn't send its executive reports with financial data and its valuation control reports, noted Levin.
“I do not know, Senator," said Drew, adding that she didn’t have any part in sending reports to regulators. Levin kept trying to nail down who was responsible for sending reports. When pressed, Drew said finance and risk sent the reports.
Breaching risk limits was another hot topic. The synthetic credit portfolio had five risk levels, including the VaR limit – which sounded alarms when the portfolio was losing the maximum dollar amount in a day. According to Levin, the synthetic derivatives portfolio had a huge jump in breaches from six in September 2011 to 170 as of April 2012. “The CIO breached all the risk limits. When the risk limits impeded their behavior they decided to manipulate the risk models,” commented Sen. John McCain at the hearing.
So, they were hitting all these risk limits but they were still trading credit derivatives. Levin was incredulous that with all these risk alarms going off it took until the end of the March quarter for the bank to take action on its trades. "Rather than ratchet back the risk, JPMorgan changed the risk controls to silence the alarms," said Levin.
But JPM executives defended the breaches. “Breaches can occur. The team was already in crisis mode trying to figure out what was the best way forward to escape the position,” said Peter Weiland, who was in charge of risk management for the CIO.
There was more discussion over the new VaR model, which cut the VaR in half overnight and was full of operational errors. The new VaR depended on analyzing a new stream of daily data. But instead of developing a new interface that would automatically feed in the data, Levin said the new VaR risk mode for the CIO’s $350 billion portfolio including SDP was run manually using error prone spreadsheets with operational flaws.
Patrick Hagan, a quantitative analyst for the CIO, was entering the data manually and staying up and late to get the work done, noted Levin. When asked by Levin why the bank approved the VaR knowing there were problems, Drew said: “It’s very shocking. I have no idea,” noting that the risk group was staffed by PhDs who run the models.
Ashley Bacon, the bank’s acting chief risk officer spoke about the changes the bank made to address the problems, including firing traders, clawbacks and implementing new risk controls. "We should be clear that this whole thing is regrettable but the onus on us is ...we can make the entire firm safer," said Bacon. "This failed because of multiple things that should have been caught. The two obvious ones are trading governance, management oversight on the ground failed, and second, risk failed [due to] the granularity, the limits and the pushback," said Bacon, noting that the bank had taken corrective action of each of these accounts.
Overall the hearing shed new light on the complexity of JPMorgan’s synthetic credit derivatives trade, and the internal chaos that went on while the losses piled up. But the senators also blamed the regulators, and said the OCC was asleep on the job. It's expected that the hearing could spark debate over too-big to fail banks and lead to a finalization of the Volker Rule to ban proprietary trading.