,
estimating losses at $2 billion. Mr. Dimon blamed “errors, sloppiness
and bad judgment” for the loss; he also estimated that losses could
double within the next few quarters.
But the red ink has been mounting since then. In late June, The New York Times reported that the company’s losses
, far exceeding earlier public estimates.
JPMorgan plans to disclose part of the total losses on the soured bet
on July 13, 2012, when it reports second-quarter earnings. Despite the
loss, the bank has said it will be solidly profitable for the quarter —
no small achievement given that nervous markets and weak economies have
sapped Wall Street’s main businesses. To put the size of the loss in
perspective, JPMorgan logged a first-quarter profit of $5.4 billion.
More than profits are at stake. The growing fallout from the bank’s
bad bet threatens 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.
Critics of the bank have 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.
Also 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.
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.
In July, the bank came under criticism when some current and former
brokers at its mutual funds said that they were encouraged, at times,
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.
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.
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.
Loss Leads to Resignations and Investigations
The trading group that incurred the losses, called the Chief
Investment Office, makes trades to balance the bank’s assets and
liabilities.
Days after the $2 billion loss disclosure,
Ina Drew, the chief investment officer who presided over the group, resigned.
Ms. Drew, who was blamed for failing to stop the complex bet before it
spiraled into a huge loss, was succeeded by Matthew E. Zames, a co-head
of JPMorgan’s global fixed income group and head of capital markets in
its mortgage division.
Ms. Drew, who earned about $14 million in 2011, was among the most
powerful executives at the firm, overseeing the massive chief investment
office that invested the firm’s own money.
The
Federal Bureau of Investigation is
examining potential wrongdoing surrounding the loss,
people briefed on the matter said on May 15. The investigation, which
is at an early stage, will focus on several possible lines of inquiry,
including JPMorgan’s accounting practices and public disclosures about
the trades that prompted the loss.
Before the disclosure, the
Securities and Exchange Commission had opened a preliminary investigation into JPMorgan’s accounting practices and public disclosures about the trades. Regulators learned about the activities in April.
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.
Mr. Dimon acknowledged that the giant loss gave ammunition to the
proponents of banking reform that his company had fought so hard to
limit.
Red Flags Went Unheeded
In the years leading up to the $2 billion trading loss, 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, these 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.
Instead, the bank maintains that the losses were largely the fault of
the chief investment office. Overall tolerance for risky trading did
not increase, current executives said, just the scale of the office’s
activities because of the bank’s acquisition of
Washington Mutual in 2008 and its more risky credit portfolio.
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 half a dozen current and
former bank officials. Within the 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.
Mr. Macris, who is also expected to resign, failed to heed concerns
as early as 2009 from the unit’s own internal risk officer, said current
and former members of the chief investment office. Mr. Macris and Ms.
Drew were not available for comment.
Risk managers were largely sidelined by Mr. Macris, who had wide
latitude and also had Ms. Drew’s support. At one point, after concerns
were raised about positions assembled by Bruno Iksil, now known as the
London Whale, Mr. Macris brought in a risk officer with whom he had
worked closely in the past.
Risk officers are empowered to halt trades deemed too dangerous, so
the coziness of the arrangement generated talk in New York as well,
according to the former trader within the chief investment office.
A Disconnect Between London and the Bank
Part of the breakdown in supervision, current executives said, was a
fundamental disconnect between the chief investment office in London 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. Nor did anyone on the operating
committee, of which Ms. Drew is a member, question her conclusion — in
fact the full operating committee wasn’t told of the scope of the
problem till early last week, just days before Mr. Dimon went public.
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 a loss that now totals more than $2 billion and
threatens a management team that until now could seemingly do no wrong.
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.
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.
Like all 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.
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.
Echoes of the MF Global Collapse
In some ways, the commission’s case echoes the situation involving MF
Global, which was the biggest financial collapse since Lehman.
In the case of MF Global, JPMorgan received money belonging to the
brokerage firm’s customers, who lost $1.6 billion. The money vanished in
the final week before the firm went under and its disappearance was the
subject of a federal investigation. Unlike MF Global, however, customer
money never went missing from Lehman.
JPMorgan is not accused of any wrongdoing in the MF Global case.
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.
Acquisitions and Mergers
The 2004 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.
While the company was formed by acquisitions, Mr. Dimon proved to be
notably cautious about further big deals. And while losses from
mortgage-related securities drove profits down at the end of 2007,
JPMorgan 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 F.D.I.C. 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 does 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.
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