ERM works. JPMorgan trades prove it.

Well, that’s not the obvious takeaway from today’s story about the London Whale trades:

JPMorgan Chase, the nation’s biggest bank, ignored internal controls and manipulated documents as it racked up trading losses last year, while its influential chief executive, Jamie Dimon, briefly withheld some information from regulators, a new Senate report says.

But when you dig into the New York Times story, you quickly learn that the ERM process worked quite well:

As the traders in London assembled increasingly complex bets, JPMorgan ignored its own risk alarms, according to investigators. In the first four months of 2012 alone, the report found, the chief investment office breached five of its critical risk controls more than 330 times.

The Senate report that triggered the Times story mucks through the grubby detail:

The [Chief Investment Office] used five metrics and limits to gauge and control the risks associated with its trading activities, including the Value-at-Risk (VaR) limit, Credit Spread Widening 01 (CS01) limit, Credit Spread Widening 10% (CSW10%) limit, stress loss limits, and stop loss advisories. During the first three months of 2012, as the CIO traders added billions of dollars in complex credit derivatives to the Synthetic Credit Portfolio [aka the SCP], the SCP trades breached the limits on all five of the risk metrics. In fact, from January 1 through April 30, 2012, CIO risk limits and advisories were breached more than 330 times.

The system was well-designed, and it was setting off the proper alarms.

But alarms only make noise. And JPMorgan did what any groggy soul does after a bender. It ignored the alarm:

The SCP’s many breaches were routinely reported to JPMorgan Chase and CIO management, risk personnel, and traders. The breaches did not, however, spark an in-depth review of the SCP or require immediate remedial actions to lower risk. Instead, the breaches were largely ignored or ended by raising the relevant risk limit.

Actually, that’s not fair. Morgan management didn’t ignore the alarms. They just built a new clock – here, a new VaR model. Rather famously, the new model, built in haste, sucked.

The Senate report offers a better metaphor, perhaps, via Achilles Macris in JPMorgan’s London office. He likened the synthetic credit portfolio to flying an airplane in its marvelous complexity. That would make the ERM reports like flight instruments, noted the Senate report. (Guess that’s why it’s called an ERM dashboard, duh!) Still, you can just picture the dials spinning wildly while the flight crew insists the plane is on course.

So the risk management system in place – the models, the reports – all worked just fine. All they can do is set off alarms, and they set off a lot of them, loud ones.

But no one was listening.




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