JPMorgan Chase & Company
JPM: NYSE; Financials/Banks
J.B. Reed/Bloomberg News
In October 2011, JPMorgan Chase was ranked the No. 1 bank in the country.
However, in May 2012, the company’s reputation was severely tarnished when it was disclosed that one of the bank’s trading groups had suffered “significant” losses in risky credit investments. Jamie Dimon, the company’s chief executive, initially estimated losses at $2 billion, but that figure grew to around $6.25 billion.
The trading blunder was a rare misstep for Mr. Dimon, once lauded as one of the keenest risk managers on Wall Street. The bad bet has dogged the bank, provoking scrutiny from regulators and federal agents and compelling Mr. Dimon to appear before Congress.
In spite of the multimillion-dollar losses, 2012 was a good year for JPMorgan. In January 2013, the bank reported a record profit of $5.7 billion for the fourth quarter, up 53 percent from the period a year earlier. Revenue was also strong, rising 10 percent, to $23.7 billion for the period.
At the same time, the bank said that it had cut Mr. Dimon’s pay in half for 2012 — to $11.5 million from $23 million a year earlier — in a move seen primarily as a message from the board to regulators and worried investors that it was a strong watchdog over the nation’s largest bank.
At the same time the bank reported its earnings, it released a report assessing the actions of its executives. The 129-page report, written by a JPMorgan management “task force,” spread the blame widely. Not even Mr. Dimon, long celebrated for his risk management prowess, was spared, being portrayed in the report as somewhat complacent.
Background
As its name suggests, JPMorgan Chase is the product of many combinations involving some of the most storied names in American banking. In a 10-year stretch beginning in 1991, three of the biggest and oldest New York financial institutions — Chase Manhattan Bank (founded by Aaron Burr), Chemical Bank and Manufacturers Hanover Trust Company — were joined with J.P. Morgan and Company, the venerable investment bank. Then, in 2004, the combined company merged with Bank One Corporation, in a $58 billion deal that remains the largest of its kind.
The merger combined Bank One’s vast branch retail network with JPMorgan’s investment banking franchise. It also brought in Bank One’s chief executive, Jamie Dimon, who had been a former rising star at Citigroup before being forced out by Sanford I. Weill, his former mentor. Mr. Dimon was named chairman and chief executive of the combined company in 2006.
Like other financial institutions, JPMorgan Chase was badly battered by the financial crisis of 2008. It received $25 billion under the federal bailout package in late 2008. In June 2009, it became one of 10 banks to repay its share of bailout funds. The bank was allowed to repay the money after it had passed a stress test given by government regulators. JPMorgan’s strong showing since then may put to rest some worries that the bank was allowed to pay back taxpayer investment too early.
JPMorgan Chase was not as deeply exposed to the mortgage market as some of its rivals, and was able to profit from others’ pain: it absorbed Bear Stearns and Washington Mutual in deals brokered and supported by the federal government. The two moves allowed it to leapfrog rivals in the investment banking rankings and expand its consumer lending franchise. The bank’s performance as it emerged from the credit crisis earned it a spot at the pinnacle of American finance.
In October 2011, JPMorgan Chase was ranked the No. 1 bank in the country, after the struggling Bank of America — with its shrinking balance sheet and assets — surrendered its title.
Acquiring Bear Stearns and WaMu
While JPMorgan Chase was formed by acquisitions, Mr. Dimon proved to be notably cautious about further big deals. Though losses from mortgage-related securities drove profits down at the end of 2007, the bank in early 2008 appeared to have avoided the worst of the battering that was damaging its competitors. The company was in a good position to move quickly when Bear Stearns came face to face with bankruptcy in March 2008. Known as a tough negotiator, Mr. Dimon struck a bargain that had Wall Street gasping when it announced on March 16 that it was buying Bear Stearns for a mere $2 a share — a tenth of its closing price — together with a Federal Reserve loan for $30 billion secured by Bear Stearns’s shaky portfolio.
With the advent of the credit crisis, Washington Mutual, a giant savings and loan that had been hobbled by bad mortgages, teetered on the brink of collapse. Federal regulators called a familiar name: Jamie Dimon. The head of the Federal Deposit Insurance Corporation told him the agency was about to seize WaMu — and then sell it to JPMorgan. JPMorgan paid $1.9 billion to the F.D.I.C. to acquire all of WaMu’s assets, branches and deposits. With WaMu, JPMorgan had $905 billion in deposits and 5,400 branches nationwide, rivaling Bank of America in size and reach. But the bank was also responsible for absorbing $31 billion in losses tied to WaMu’s troubled loans. WaMu shareholders and certain bondholders were wiped out, but a taxpayer-financed WaMu bailout was avoided.
Dealings With Madoff
Internal bank documents made public in a lawsuit on Feb. 4, 2011, show that despite suspicions about the soundness of Bernard L. Madoff’s investment firm, JPMorgan Chase allowed Mr. Madoff to move billions of dollars of investors’ cash in and out of his bank accounts right until the day of his arrest in December 2008 — although by then, the bank had withdrawn all but $35 million of the $276 million it had invested in Madoff-linked hedge funds, according to the litigation.
The lawsuit against the bank was filed under seal on Dec. 2, 2010, by Irving H. Picard, the bankruptcy trustee gathering assets for Mr. Madoff’s victims. At that time, David J. Sheehan, the trustee’s lawyer, bluntly asserted that Mr. Madoff “would not have been able to commit this massive Ponzi scheme without this bank.”
The released material offered the clearest picture yet of the long and complex relationship between Mr. Madoff and JPMorgan Chase, which served as his primary bank since 1986.
According to the trustee, the flow of money between the Madoff accounts and a customer’s accounts should have set off warning bells at the bank. On a single day in 2002, Mr. Madoff initiated 318 separate payments of exactly $986,301 to the customer’s account for no apparent reason, the trustee reported. In December 2001, Mr. Madoff’s account received a $90 million check from the customer’s account “on a daily basis,” according to the lawsuit.
Mr. Picard’s complaint did not speculate about the purpose of the transactions. The transfers should have caused the bank’s money-laundering software to start flashing, the complaint asserted
A Federal Case About Mortgages Settled
In June 2011, JPMorgan Securities agreed to pay $153.6 million to settle federal civil accusations that it misled investors in a complex mortgage securities transaction in 2007, just as the housing market was beginning to plummet.
The Securities and Exchange Commission asserted that the firm structured and marketed a security known as a synthetic collateralized debt obligation without informing the buyers that a hedge fund that helped select the assets in the portfolio stood to gain, in most cases, if the investments lost value.
Penalty for Actions Tied to Demise of Lehman Bros.
In February 2012, government authorities and five of the nation’s biggest banks, including JPMorgan Chase, agreed to a $26 billion settlement related to foreclosure abuse, which was epitomized by high-profile cases of “robo-signing’' — cases in which foreclosures took place based on forged or unreviewed documents.
JPMorgan Chase was also a major lender to Lehman Brothers, which collapsed at the height of the financial crisis, filing the biggest bankruptcy in United States history.
In April 2012, more than three years later, regulators penalized JPMorgan for actions tied to Lehman’s demise. The Commodity Futures Trading Commission filed a civil case against JPMorgan on April 4, the first federal enforcement case to stem from Lehman’s downfall. The bank settled the Lehman matter and agreed to pay a fine of approximately $20 million.
The Lehman action stems from the questionable treatment of customer money — an issue that has been at the forefront of the outcry over the collapse of MF Global in October 2011. JPMorgan was also intimately involved in the final days of that brokerage firm.
The trading commission accused JPMorgan of overextending credit to Lehman for roughly two years leading up to its bankruptcy in 2008.
JPMorgan extended the credit using an inaccurate evaluation of Lehman’s worth, improperly counting Lehman’s customer money as belonging to the firm. Under federal law, firms are not allowed to use customer money to secure or extend credit.
The arrangement worked well for both parties. Lehman wanted a larger loan, and suggested counting money from the customer account to justify it. JPMorgan complied, treating the money as part of Lehman’s coffers.
The trading commission also accused JPMorgan of withholding separate Lehman customer funds for nearly two weeks, rather than turning them over to authorities. In the course of resolving that matter, regulators became aware of JPMorgan’s questionable credit to Lehman, a person briefed on the matter said.
It is unclear whether JPMorgan knew the money belonged to clients. The agency did not charge JPMorgan with intentionally breaking the law. But in the view of regulators, the bank should have known — the customer funds were kept at a JPMorgan account. The funds belonged to investors trading in the futures market.
The actions did not in and of themselves cause Lehman to fail. JPMorgan neither admitted nor denied wrongdoing as part of the settlement.
Trading Loss Scandal Poses Major Setback
In May 2012, the bank disclosed that one of its trading groups had suffered “significant” losses in risky credit investments. Mr. Dimon, who initially estimated losses at $2 billion, blamed “errors, sloppiness and bad judgment” for the loss; he also estimated that losses could double within the next few quarters.
In mid-July, the bank said that the losses from the trades could climb to more than $7 billion and that the bank’s traders may have intentionally tried to obscure the full extent of the red ink on the disastrous trades.
The trading debacle cost several executives their jobs and prompted the bank to claw back millions in compensation from three traders in London at the heart of the losses. A top bank official said that the board could also seize pay from Mr. Dimon, but did not indicate that it would do so. The growing fallout from the bank’s bad bet threatened to undercut the credibility of Mr. Dimon, who has been fighting major regulatory changes that could curtail the kind of risk-taking that led to the trading losses.
In June, Mr. Dimon testified twice before Congress at the Senate Banking Committee and the House Financial Services Committee. During the House hearing, Representative Carolyn B. Maloney, Democrat of New York, seemed to snare Mr. Dimon with questions about when he understood the full extent of the losses. After briefly speaking with his general counsel, Mr. Dimon said that he had no idea about the full extent of the losses until late April.
Also in June, The New York Times reported that a small group of shareholder advocates had warned top executives at JPMorgan more than a year ago that the bank’s risk controls needed to be improved. The advocates also cautioned that the company had fallen behind the risk-management practices of its peers. But bank officials dismissed the warning.
For nearly a month before the disclosure, United States and British regulators had been looking at JPMorgan’s trading activities as questions surfaced about big bets the investment unit was reportedly making in credit default swaps. Reports emerged in April about a JPMorgan trader in London whose positions were so big that they were distorting the market.
Critics of the bank charged that instead of a hedge — a trade meant to offset risks created by other activities — the transaction was a profit-seeking gamble. The distinction is crucial to the debate over the Volcker Rule, which will restrict proprietary trading by federally insured banks.
The Complex Trades That Led to the Loss
The bank has disclosed little information about the trades that led to billions in losses in the spring of 2012, but hedge funds and other competitors have helped assemble a picture of them. In its simplest form, the complex position assembled by the bank included a bullish bet on an index of investment-grade corporate debt, later paired with a bearish bet on high-yield securities, achieved by selling insurance contracts known as credit-default swaps.
A big move in the interest rate spread between the investment grade securities and risk-free government bonds in recent months hurt the first part of the bet, and was not offset by equally large moves in the price of the insurance on the high yield bonds.
As the credit yield curve steepened, the losses piled up on the corporate grade index, overwhelming gains elsewhere on the trades. Making matters worse, there was a mismatch between the expiration of different instruments within the trade, increasing losses.
Red Flags Went Unheeded
In the years leading up to the multibillion-dollar trading blunder, risk managers and some senior investment bankers raised concerns that the bank was making increasingly large investments involving complex trades that were hard to understand. But even as the size of the bets climbed steadily, former employees say, their concerns about the dangers were ignored or dismissed
An increased appetite for such trades had the approval of the upper echelons of the bank, including Mr. Dimon, the chief executive, current and former employees said.
Initially, this led to sharply higher investing profits, but they said it also contributed to the bank’s lowering its guard.
Top investment bank executives raised concerns about the growing size and complexity of the bets held by the bank’s chief investment office as early as 2007, according to interviews with current and former bank officials. Within the chief investment office, led by Ina Drew, who resigned days after the loss disclosure, the bets were directed by the head of the Europe trading desk in London, Achilles Macris.
Part of the breakdown in supervision, current executives said, was a fundamental disconnect between the London office and the rest of the bank. Even within the chief investment office there were heightening concerns that the bets being made in London were incredibly complex and not fully understood by management in New York.
Despite these concerns, the scope of the chief investment’s offices trades widened sharply following the acquisition of Washington Mutual at the height of the financial crisis in 2008. Not only did the bank bring with it hundreds of billions more in assets, it also owned riskier securities that needed to be hedged against. As a result, the business’s investment securities portfolio rapidly grew, more than quadrupling to $356 billion in 2011, from $76.5 billion in 2007, company filings show.
Sirens had gone off after a series of erratic trading sessions in late March resulted in big gains one day, followed by even bigger losses the next on the London trading desk of the bank’s chief investment office.
Mr. Dimon was convinced by Ms. Drew and her team that the turbulence was “manageable,” executives said. The alarm bells were silenced in early April 2012, but days after first-quarter earnings were reported on April 13, the erratic trading pattern continued, except this time there were few gains to offset the losses, and the red ink was flowing faster by the day.
Mr. Dimon convened a second round of checks, which soon concluded there was a ticking time bomb, but by then it was too late, a situation made worse as traders actually increased their bets instead of shrinking them, resulting in the loss.
Facing Federal Investigations Over Trading Blunders
The bank is contending with investigations by the Justice Department and the Securities and Exchange Commission over its multibillion-dollar trading losses. The Senate Permanent Subcommittee on Investigations, led by Senator Carl Levin, Democrat of Michigan, is examining the trades. And the Office of the Comptroller of the Currency and the Federal Reserve are also looking into the botched trades.
In October 2012, officials said federal authorities are using taped phone conversations to build criminal cases related to the trading loss, focusing on calls in which employees openly discussed how to value the troubled bets in a favorable way. Investigators were said to be looking into the actions of four people who were part of the trading team.
The fallout continued from the trading loss with the announcement in October that JPMorgan is suing Javier Martin-Artajo. a former executive in its chief investment office, a once little-known unit at the center of the bungled trades. Mr. Martin-Artajo, a former executive in the bank’s chief investment office, directly supervised Bruno Iksil, the so-called London Whale, who has also left the bank.
Some phone recordings suggest that Mr. Martin-Artajo encouraged Mr. Iksil to value troubled positions favorably, according to people with knowledge of the investigation.
Credit Rating Cut
Moody’s Investors Service in June 2012 slashed the credit ratings of 15 large financial firms, including JPMorgan Chase, in a move that could do lasting damage to their bottom lines and unsettle the markets.
The downgrades were a serious blow for the banking industry, which was already dealing with the European sovereign debt crisis, a weak American economy and new regulations.
Banks are particularly sensitive to downgrades because they rely on the confidence of creditors and big customers.
Moody’s downgrades are part of a broad effort to make its analysis more rigorous. The financial crisis stained the reputation of credit rating agencies.
The threat of the downgrade had rippled through the markets for months.
Conflicts and Mutual Funds
In July 2012, the bank came under criticism when some current and former brokers at its mutual funds said that they were encouraged, at times, to favor JPMorgan’s own products even when competitors had better-performing or cheaper options.
JPMorgan, with its army of financial advisers and nearly $160 billion in fund assets, is not the only bank to build an advisory business that caters to mom and pop investors. Morgan Stanley and UBS have redoubled their efforts, drawn by steadier returns than those on trading desks.
But JPMorgan has taken a different tack by focusing on selling funds that it creates. It is a controversial practice, and many companies have backed away from offering their own funds because of the perceived conflicts.
Settlement in Suit Over Handling of Subprime Mortgages
JPMorgan Chase agreed to pay $296.9 million in a settlement with the Securities and Exchange Commission over its handling of subprime mortgages, the agency said in November 2012. The bank did not admit or deny guilt.
Robert Khuzami, director of the S.E.C.’s Division of Enforcement, in a statement called mortgage products like those sold by the bank “ground zero in the financial crisis.”
The settlement ended the agency’s investigation into how JPMorgan dealt with its mortgage securities acquired through Bear Stearns, the troubled unit it purchased in the depths of the 2008-9 financial crisis.
Several other Wall Street firms also packaged and sold subprime mortgages, which resulted in billions of dollars in losses for investors.
The S.E.C. has brought more than 100 cases related to the financial crisis, but has struggled to secure a big victory against individuals responsible for some of the reckless behavior that nearly felled the American economy.
The settlement also included Credit Suisse, which agreed to pay $120 million.
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