Wednesday, June 27, 2012

Why regulators need to be JPMorgan's risk managers | Ben Walsh

JPMorgan is improving risk management by boldly?endeavoring to not make?the same mistake? ? huge positions in credit derivatives ? twice, the WSJ reports. But that?s about as far as the changes go. The CIO will still be able to buy ?asset-backed securities, emerging-markets debt, collateralized debt obligations and troubled corporate debt?. ?That?s an incredibly small correction in response to the CIO?s losses.

The message from Jamie Dimon to traders is clear: our risk management process is fine, keep doing exactly what you were doing before. Just don?t do that (points to ?$2 billion blunder? headline?).

In seeming contrast to his positive view of JPMorgan?s risk management, Dimon had less than kind words for new financial regulation in his testimony last week before the House and Senate. But here?s the weird thing: the two things aren?t actually that different.

In his Senate testimony, Dimon complained that the still to-be enacted Dodd-Frank law was overly complex and vague. Instead, he said he ?[prefers]?a strong, clean regulation system?That?s not what we did?.

This echoes what he said in his annual letter to shareholders: ?[regulatory] complexity and confusion should have?been alleviated, not compounded? As a result of Dodd-Frank, we now have?multiple regulatory agencies with overlapping?rules and oversight responsibilities?. Dimon paired these comments with a?chart that aimed to terrify observers by visualizing regulatory authority using all manner of boxes, colors, lines and (gasp) dotted lines.

Yet here?s Dimon talking about risk management at JPMorgan in his Senate testimony (beginning at the 51-minute mark):

Every business we have has a risk committee. Those risk committees ?and the head of risk in those businesses report to the head of risk at the company and there are periodic conversations between the risk committees and the head of risk of the company and our senior operating group about major exposures we are taking.

There is also oversight from the internal model review committee, the board?s audit, operating and risk committees and various members of senior management on an ad hoc basis. All of which oversee a $2.3 trillion balance sheet. That, in other words, is complexity. I?m sure that if you charted it, ?it would have dotted lines and different colored boxes and all the other things that scare Dimon so much in a regulatory context.

A big reason Dimon prefers his own risk management to new regulation is control. Risk management is largely about transferring control from someone with one set of incentives to someone with a different set of incentives ? from the individual trader, to the desk, to the business unit that oversees that trader. Similarly, regulators function as systemic risk managers, although they have an independent set of incentives.

Dimon?s real problem with regulation, it seems, is that he believes that it?s best that he make a lot of the biggest decisions?personally. That might be bad management, but Dimon has a hard-to-disguise supreme self-confidence. In the case of the CIO, he pushed for increased risk-taking and he got it.

From the public?s perspective, it?s troubling that JPMorgan?s risk management was reportedly being carried out on the whims of a CEO. But to Dimon, that?s presumably a feature, not a flaw. Which is exactly why regulation of this too-big-to-fail bank needs to be at least as robust as JPMorgan?s internal risk management.

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