“We’d shown average VaR at $67” million for the chief investment office, CEO Jamie Dimon said. “it will now be $129” million. (Educational aside: VaR is Value at Risk, the amount a company believes is the most it is likely to lose on a bad day in a normal trading environment.)
Morgan had switched VaR models last quarter. Upon further review, the company has concluded, the new one sucks. So it has returned to the prior version; hence the leap in perceived risk.
It sounds like trading strategies that looked solid under the new model were really crappy. In the conference call, Dimon self-flagellates regarding the planning and execution of a flawed trading strategy, which he doesn’t describe but is elsewhere linked to “hedging” by the London Whale, a famous-turned-notorious trader.
“In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored,” he said.
The fact that he doesn’t describe it is ominous. That and other information in the call make me think the trades haven’t been unwound, and if Dimon tipped off what they were, aggressive traders (read: Goldman) would grind the position into dirt.
And Dimon’s applying some sugar-coating, to a banking novice like me.
First, the VaR he cites is a one-day window. (Insurers generally use a one-year window.) That’s standard for banking, so OK.
But not OK: The VaR is a 95% confidence level. Insurers prefer a 99.5% level, or 99.5%. And it takes a lot more capital to support a 99% VaR than a 95% – up to 50% more, based on my back-of-the-envelope playing around with z-tables.
Worse still, the revised VaR is the average for the quarter. But the risky position was built up at the end of the quarter. Quarter-end VaR for CIO was $186M, or about 50% higher than quarter average. Max for the quarter was only $1M higher.
Worse still: Emphasizing CIO’s VaR makes it sound like investments around the rest of the company correlate away CIO’s risk. They do, but not to the degree you might think.
For the whole enterprise, VaR doubled from last quarter, to $170M from $88M. And the company ended Q1 with VaR of $201M. Looking at the ratio of enterprise VaR to CIO VaR at various points in time, it doesn’t look like the hedging strategy really was hedging, but what do I know?
Above, for your enjoyment, I’ve enclosed a screen shot (click to enlarge) of the relevant page from the 10-Q (pdf).
None of this is to suggest the Morgan is imperiled. To my untrained eye, shareholders’ equity is about $190B, seemingly enough to absorb a whole lot of goofy trades and lousy capital models, but not enough to prevent me from reiterating the Agnes Rule: Banks can’t sell anything but money.
As far as the multiple ERM mistakes here, I leave that to the reader as an exercise.
Added bonus: Here JP Morgan explains Value at Risk to the great unwashed.