JPMorgan’s trading loss may call for more Fed scrutiny of risk

“Many errors, sloppiness and bad judgment”

Risk management, chalkboard Risk management, chalkboard

May 12 (Bloomberg) -- JPMorgan Chase & Co.’s trading position that led to a $2 billion loss may call for increased Federal Reserve scrutiny of risk management as the central bank steps up its post-crisis supervision of lenders.

Fed officials are gathering more information about the trading position, which they have known about for several weeks, according to a person familiar with the matter. They don’t view it as their role to approve or reject individual trades, the person said. Rather, their job is to ensure firms have enough capital to withstand losses, said the person, who wasn’t authorized to discuss the matter and asked not to be identified.

JPMorgan Chief Executive Officer Jamie Dimon announced the “egregious” trading loss on May 10, saying there were “many errors, sloppiness and bad judgment.” Dimon said on a conference call with analysts that while the firm kept its regulators “up to date,” he “didn’t have great information” to share with them.

“The fact that Jamie Dimon could come out and make some of those statements” raises “lots of questions about who was watching the store,” said Robert Eisenbeis, chief monetary economist at Sarasota, Florida-based Cumberland Advisors and a former Atlanta Fed research director. The Fed should be “going in and looking at the internal controls and monitoring procedures that the institution is taking, and stress those.”

Dimon announced the trading loss two months after the biggest U.S. bank by assets passed a Fed stress test that put its loans and securities through a scenario of deep recession and a simulated global financial market shock.

‘Small Loss’

“It’s a relatively small loss in a bank of that size,” said William Isaac, a chairman of the Federal Deposit Insurance Corp. in the 1980s and now a senior managing director at FTI Consulting Inc. “The thing that’s rattling people is JPMorgan Chase is widely considered one of the strongest and best banks in the world.”

JPMorgan shares fell 9.3 percent, the most in nine months, to $36.96 at the close of trading yesterday in New York. The KBW Bank Index of 24 financial stocks was down 1.2 percent.

Krishna Guha, a spokesman for Federal Reserve Bank of New York, JPMorgan’s regulator, declined to comment. JPMorgan spokesman Joseph Evangelisti also declined to comment.

The Commodity Futures Trading Commission, the main U.S. derivatives regulator, has been reviewing JPMorgan’s derivatives trading activities since last month, according to a person who was briefed on the matter and spoke on condition of anonymity because the review is private. The CFTC hasn’t opened an enforcement action against the bank, the person said.

SEC Probe

The U.S. Securities and Exchange Commission opened a preliminary investigation into JPMorgan’s disclosures related to the trades, according to another person briefed on the probe who spoke on condition of anonymity because the matter isn’t public.

Fed officials need to examine their own analysis of the bank’s risk management procedures and its governance, said Dino Kos, a former executive vice president at the New York Fed. He said Fed supervisors should ask questions about how information on risk is collected and reported, and what is done with it once it reaches the executive level.

“What information is the board of directors being given? What is being sent to the CEO and the senior managers on the risk committee?” said Kos, now a managing director at Hamiltonian Associates, a New York economic research and consulting firm. “There is a separate question about judgment” if Dimon understood the risks the bank was taking, he said.

Daniel Tarullo, the Fed governor in charge of supervision, has emphasized that boards need to serve as independent monitors of risk. The stress-tests were focused on whether a bank’s staff and boards can put together a plan to manage capital through times of economic turmoil.

Checks and Balances

“It’s exceedingly important for boards to be involved, not in micromanaging, but providing checks and balances on a company,” said Timothy Smith, a senior vice president at Boston-based Walden Asset Management, which manages $2.2 billion. “It’s a fair question to ask if Jamie Dimon says this was just sloppy, where was the board as the $2 billion was being lost?”

Tarullo has piloted one of the biggest overhauls of financial supervision in the central bank’s history. In addition to annual stress tests, the Fed routinely looks at risks across all large banks in a new group formed from economists, examiners, and computer modelers.

The Fed has also boosted its surveillance of financial markets and bank lending to spot asset bubbles that may lead to financial turmoil. Chairman Ben S. Bernanke established a new Office of Financial Stability Policy and Research, which was instrumental in shaping tougher guidelines earlier this year on high-yield, high-risk bank loans.

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