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Ivy Schmerken
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JP Morgan Knew London Traders Were A Problem

Despite his sterling reputation for risk management, JP Morgan CEO Jamie Dimon tolerated risky trades, loose limits and changes in its VaR out of the London chief investment office.

J.P. Morgan knew two years ago that the bank's London-based traders in the chief investment office were making risky bets.

According to a story in today’s Wall Street Journal, JP Morgan had several opportunities to rein in the bank’s London traders before Bruno Iksil, nicknamed the London Whale, made large bets in credit derivatives indexes backfired in April.

Despite the view that the so-called CIO was a conservative arm of the bank focused on hedging its exposures to movements in the broader economy, today's stories paint a picture of a group that was run more like prop trading desk and whose faulty hedge was a ticking time bomb.

The head of the CIO, Ina Drew, who recently retired in the wake of the trading blow up, hired traders who had worked at hedge funds and were savvy in using derivatives and other tools to boost profits or protect the bank.

A second story in Bloomberg News, “House Of Dimon Marred by CEO Complacency,” shows that Dimon's actions at the bank conflicted with this reputation as a tough risk manager. The story suggests that Dimon allowed laxer risk controls to prevail at the CIO office because it had become a profit center for the bank.

Macris's team in London, running a portfolio of as much as $200 billion in trades, had a profit of $5 billion in 2010 alone, more than a quarter of JPMorgan’s net income that year, one former executive said.

Prior to 2008, J.P. Morgan Chase bet against the housing market. Bruno Iksil and others in the CIO group made about $1 billion in profit by betting against slices (a.k.a. tranches) of a derivative index tracking the subprime mortgage debt known as the ABX, as the WSJ reports.

As far back as 2010, bank financial executives were concerned when London-based traders lost about $300 million within a few days, with no offsetting gains, the Wall Street Journal reports. The chief financial officer of the CIO, Joseph Bonocore, had to get permission to order the London traders to reduce the positions, from the bank's chief risk officer Barry Zubrow, which he did.

Last year, executives in the CIO’s New York noticed that once again London was taking large positions, this time, in credit default indexes that were viewed as "illiquid and hard to trade out of." But the CIO’s chief risk officer Peter Weiland and other junior execs were worried that if the bank attempted to sell the positions it would incur steep losses.

According to the Bloomberg article, "Weiland compared efforts to reduce Iksil's outsized position to the difficulty of trying to safely land a Boeing 747 without flying lessons, one executive said. The position was so large and illiquid, Weiland said he couldn’t get the plane below 35,000 feet, the executive said."

However, the CIO office had trouble reining in the London traders. Even though they agreed that the positions had to be reduced over time and they agreed on what to do, "the London office put on new trades [that] year that appeared to be at odds with the strategy," people close to the company told the Wall Street Journal. Weiland became aware this year that the plan was not followed.

Also, last summer Weiland began a review of the CIO's risk limits but his efforts to impose tighter and more specific limits, were never agreed to, sources told the WSJ.

High turnover in the CIO's chief risk officer role was another sign of the turmoil and tension brewing in the unit. Weiland was replaced as chief risk officer by Irvin Goldman, a former trader trader, who had little experience as a risk manager, and who was the brother-in-law of Zubrow,

At the same time, the position of chief risk officer inside the CIO was a revolving door, with at least five executives holding the job in six years, according to people familiar with the matter. Irvin Goldman, appointed in February and replaced in May, had been fired in 2007 by brokerage Cantor Fitzgerald LP for money-losing bets that led to a regulatory sanction of the firm, said three people with knowledge of the matter. Goldman, 51, wasn’t directly accused of wrongdoing.

Another inconsistency is why the CIO unit changes its Value-at-Risk model for the CIO, which rose as high as $60 million a day. Sources suggest that the model was altered to mask the true size of the London Whale’s losses.

From Bloomberg News:

By 2010 Iksil's value-at-risk, or VaR - a formula used by banks to assess how much traders might lose in a day - already was $30 million to $40 million, a person with knowledge of the matter said. At times the figure surpassed $60 million, the person said, about as high as the level for the firm's entire investment bank, which employs 26,000 people.

Meanwhile, Bloomberg News is reporting that Dimon encouraged the CIO to take more risk in search of profits, the unit raised limits on positions and sometimes ignored them, the former executives said.

Contrary to Dimon’s dismissive remarks about the London whales positions, a few days later on April 17, Dimon's top lieutenants told directors at an audit committee meeting that there was a problem in the London office, said the Wall Street Journal.

The latest revelations come a day before Jamie Dimon is scheduled to testify before the Senate Banking Committee on Wednesday, where he is expected to discuss a series of mishaps related to handling the CIO's offices positions. Dimon whose reputation has been tarnished by the hedging fiasco, will be grilled by lawmakers as to what he knew and when he knew it.

No doubt, he will be asked if he misled sell side analysts on a conference call on April 13, when he dismissed their concerns as a "tempest in a teapot."

He may be pressed to explain if the bank misled regulators, who were embedded within the bank, about the danger of the positions, whose losses are now estimated to be $3 billion to $5 billion, and potentially could rise higher.

Tomorrow, Dimon will have to account for these inconsistencies. Advanced Trading will blog his choice responses.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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