Tag: JPMorgan

The Importance of Excel

By James Kwak

I spent the past two days at a financial regulation conference in Washington (where I saw more BlackBerries than I have seen in years—can’t lawyers and lobbyists afford decent phones?). In his remarks on the final panel, Frank Partnoy mentioned something I missed when it came out a few weeks ago: the role of Microsoft Excel in the “London Whale” trading debacle.

The issue is described in the appendix to JPMorgan’s internal investigative task force’s report. To summarize: JPMorgan’s Chief Investment Office needed a new value-at-risk (VaR) model for the synthetic credit portfolio (the one that blew up) and assigned a quantitative whiz (“a London-based quantitative expert, mathematician and model developer” who previously worked at a company that built analytical models) to create it. The new model “operated through a series of Excel spreadsheets, which had to be completed manually, by a process of copying and pasting data from one spreadsheet to another.” The internal Model Review Group identified this problem as well as a few others, but approved the model, while saying that it should be automated and another significant flaw should be fixed.** After the London Whale trade blew up, the Model Review Group discovered that the model had not been automated and found several other errors. Most spectacularly,

“After subtracting the old rate from the new rate, the spreadsheet divided by their sum instead of their average, as the modeler had intended. This error likely had the effect of muting volatility by a factor of two and of lowering the VaR . . .”

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When It Pays To Be Wrong

By James Kwak

Last week I wrote an Atlantic column about the fundamental reasons why big banks are always screwing up. In particular, given the effects of leverage and the short-term incentive structure, it pays to have lousy risk management systems, and it pays for frontline traders to evade those systems—even for the CEO, in the short term.

Today the Wall Street Journal reports evidence that the London Whale was told by his boss to boost the valuations of his trades; according to inside sources, “the favorable valuations might have been aimed at giving the losing trades time to recover and avoid setting off potential alarms at the bank.”

This is clear evidence for the too big to manage hypothesis: not only traders but heads of trading desks manipulating marks to take risks that the bank as a whole might crack down on. But we’ve known for decades that rogue traders (Nick Leeson, Jérôme Kerviel) are out there. The question is why bank managers don’t do a better job putting in place systems and processes to detect them. The most plausible answer is that they don’t want to because, in the short term, they have the exact same incentives as those traders: they like the risk and the higher expected returns it generates. It’s only when things blow up that they act all shocked.

Why Markets Won’t Fix JPMorgan

By James Kwak

Jonathan Macey, a former professor of mine at Yale Law School,* recently wrote an op-ed for the Wall Street Journal (paywall; excerpts here) arguing that we shouldn’t worry about JPMorgan’s recent trading loss because market forces will ensure that the bank does a better job next time. Here’s a key paragraph:

“Thus, far from serving as a pretext to justify still more regulation of providers of capital, J.P. Morgan’s losses should be treated as further proof that markets work. J.P. Morgan and its competitors will learn from this experience and do a better job of hedging the next time. They will learn because they have to: In the long run their survival depends on it. And in the short run their jobs and bonuses depend on it.”

Macey’s central point is that companies don’t like losing money, so losing $2 billion means that they will do a better job of figuring out how not to lose money in the future. That’s obvious. But it’s also beside the point.

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Regression to the Mean, JPMorgan Edition

By James Kwak

I haven’t been writing about the JPMorgan debacle because, well, everyone else is writing about it. One theme that has stuck out for me, however, has been everyone’s reflexive surprise that this could happen at JPMorgan, supposedly the best and most competent of the big banks. For example, Lisa Pollock of Alphaville, who has provided some of the most detailed analyses of what happened, asked, “could this really happen under CEO Jamie Dimon’s watch?” Dawn Kopecki and Max Adelson at Bloomberg referred to “JPMorgan’s cultivated reputation for policing risk.” Articles about Ina Drew’s resignation are sure to point out her relative success at dealing with the financial crisis of 2007–2009.

“Highly intelligent women tend to marry men who are less intelligent than they are.” Why? Is it that intelligent men don’t want to compete with intelligent women?

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The Rise and Rise of Jamie Dimon

As Simon pointed out earlier, Jamie Dimon has been getting a lot of good press recently. The New York Times portrayed his recent rise to prominence as not only the CEO of American’s number one bank (at least, the number one bank that has not recently been compared to a vampire squid), but as a player in Washington and, according to at least one quip, the man Barack Obama turns to on financial questions:

Now that Mr. Obama is in the White House, Mr. Dimon has been prominent when the president wants to talk to big business.

During one such meeting in late March, as Citigroup’s chairman, Richard D. Parsons, was trying to explain banks and lending, the president interrupted with a quip: “All right, I’ll talk to Jamie.”

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Annoying Bank Propaganda

JPMorgan Chase has a “community support” page entitled “The Way Forward.” It features a report by JPMorgan executive Michael Cembalest on the credit crisis called “The Big Dig,” which tries to argue that bank lending has actually increased during the credit crisis. Many more accomplished people than I have debunked this myth in the past, but I couldn’t let this pass.

Here’s the main claim: “Changes in credit are often thought to have been wrought by banks. But a simple exercise in forensics reveals that not to be the case: the rise and fall of securitized loan markets have a much larger impact. Bank lending has remained stable throughout, while securitized markets collapsed.”


in credit are often thought to have been

wrought by banks. But a simple exercise in
forensics reveals that not to be the case: the rise
and fall of securitized loan markets have a much
larger impact. Bank lending has remained stable
throughout, while securitized markets collapsed.

And here’s the evidence:


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New Day, New Bank, Same Story

JPMorgan Chase reported its quarterly earnings today. The headline was $2.1 billion in net income, beating analysts’ estimates. Behind the headlines, it was similar to the story that Goldman told earlier this week: a huge jump in fixed-income trading, status quo everywhere else, and continuing writedowns. For example, if you look at the breakdown of revenue by type of activity (not line of business) on page 4 of the supplement, you’ll see that revenue was flat or down in every category except one: principal transactions, where it jumped from a loss of $7.9 billion to a gain of $2.0 billion. That $9.9 billion improvement more than explains the entire increase in pretax profit from negative $1.3 billion to positive $3.1 billion.

As with Goldman, it was clearly a good quarter for JPMorgan; making money beats losing money any day. But the question to ask is whether it is sustainable, either for JPMorgan or for the banking industry as a whole. To answer that question, here are some pictures.

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