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Investment Office At JPMorgan Chase Allowed to Chase Profits and Downplay Risk

As more becomes known about JPMorgan Chase’s Fail Whale trade, we learn that the Chief Investment Office, where the trades were placed, was the most dysfunctional trading desk this side of AIG’s Financial Products Unit. Early success turned it from an office that was supposed to be hedging risk into a profit center. And this led to a downward spiral chasing profits:

As early as 2010, the senior banker who has been blamed for the debacle, Ina Drew, began to lose her grip on the bank’s chief investment office, according to current and former traders. She had guided the bank through some of the most rugged moments of the 2008 financial crisis, earning the trust of Jamie Dimon, JPMorgan’s chief executive, in the process.

But after contracting Lyme disease in 2010, she was frequently out of the office for a critical period, when her unit was making riskier bets, and her absences allowed long-simmering internal divisions and clashing egos to come to the fore, the traders said.

The morning conference calls Ms. Drew had presided over devolved into shouting matches between her deputies in New York and London, the traders said. That discord in 2010 and 2011 contributed to the chief investment office’s losing trades in 2012, the current and former bankers said.

While I believe this all happened, I think we should step back from the focus on the personal ego clashes a bit. The point is that the CIO was given a free hand to take on more and more risk with more and more money. During the key time when the Fail Whale trades were placed, there was no Treasurer at JPMorgan Chase. The CIO’s risk overseer had no background in risk management, but was a former trader with a history of losses. And the bets were so big and complex that the firm is having trouble winding them down, taking what has already been described as a $3 billion loss into expectations for as much as $5 billion.

As long as the CIO made money, they were treated with kid gloves, without the kind of oversight we would expect when hundreds of billions of dollars were at stake. And this should serve as a warning about the dangers of laissez-faire capitalism. Indeed, JPMorgan Chase encouraged with its conduct higher and more risky trades. The regulatory apparatus, we learn, does not know how much danger exists in the system, just a few years after the economy was almost taken down by the same bankers.

Whenever Wall Street is confronted with a decrease in profits, we see the same response: Increase leverage. We usually don’t hear about it until some market wobble causes the excessive leverage to blow up in someone’s face. This time, the novelty cigar was smoked by Dimon, and the damage was inflicted on his reputation. The losses, we learned, were a “mere” $2 billion, described as manageable […]

One thing that makes the JPMorgan trade look especially foolish is that it’s nearly the same sort of recklessness that AIG exhibited: selling derivatives against zero reserves. As Doug Kass, who heads the hedge fund Seabreeze Partners Management, explained: “Under the knowledge of Dimon, the JPM investment office sold massive amounts of CDS [credit-default swap] premium on large U.S. corporations in 2011. Like AIG, they accumulated a large amount of reported profits in the three-year period ending 2011. In an equally familiar manner, the principals of the London investment office were handsomely rewarded. And so was Dimon.” […]

The parallels to AIG continue to mount, including on the JPMorgan risk management committee. Astonishingly, Ellen Futter, who was a director at AIG, was also on the risk management committee at JPMorgan. It’s unclear what you need to do to get kicked off that committee, but the directorial equivalent of steering the Titanic into the iceberg apparently won’t do it.

That’s just astonishing. But it’s par for the course on Wall Street – chase profits, downplay risk, lever up as much money as you can, and act shocked when it comes crashing down. And considering that the end of that sequence could include, if things get really bad, a federal bailout to ensure that the pain goes away, it’s actually quite a logical and reasonable stance. In fact, even Ina Drew, the chief executive overseeing the CIO, will walk away with a $32 million golden parachute.

A number of regulators are now suddenly prowling around JPMorgan Chase, including the Commodity Futures Trading Commission. But the problem lies more with the system on Wall Street, beyond the particular laws we have in place today.

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David Dayen

David Dayen