Value-at-Risk model masked JP Morgan $2 bln loss

Fri May 11, 2012 9:03am EDT

LONDON, May 11 (IFR) - The implementation of a new Value-at-Risk model looks to have masked a US$2bn mark-to-market loss that built up in JP Morgan's chief investment office over the past few months.

JP Morgan chief executive Jamie Dimon admitted the firm will likely experience volatility in its earnings over the coming quarters as it tries to manage a synthetic credit portfolio that the CIO designed to hedge a stressed credit environment, but ended up being extremely costly for the firm.

Dimon revealed the CIO's VaR had almost doubled from an average of US$67m for the first quarter to US$129m, after scrapping the CIO's new model and revising the figures appropriately. JP Morgan has decided to revert to the methodology the CIO used to calculate VaR in 2011.

"In the first quarter we implemented a new VaR model, which we now deemed inadequate, and went back to the old one that we used for the past several years, which we deemed to be more adequate," Dimon explained on a conference call with analysts.

VaR models are used by risk managers to assess the potential future losses a portfolio could be subject to. VaR came in for heated criticism following the financial crisis as many models failed to predict the extent of the losses that devastated many large banks in 2007 and 2008.

The revelations vividly illustrate the potential for banks' internal risk models to produce vastly different results that can have real economic impacts. The case may well bring into focus once more how bank VaR models can hinder as well as aid risk management.

Dimon laid the blame for the CIO losses squarely at the feet of the trading strategy aimed at reducing the CIO's synthetic credit portfolio hedge, which he said was "flawed, complex, poorly reviewed, poorly executed and poorly monitored."

However, there seems little doubt that the new VaR model masked the losses racking up in the CIO by artificially depressing the potential risks the bank was exposed to.

The CIO's average VaR for the first quarter was US$67m under the new VaR model. This was broadly in line with the average CIO VaR for 2011of US$60m, calculated under the old model.

Scrapping the new VaR model and revising figures to be directly comparable to those reported in 2011 shows how much the new hedging strategy increased the bank's risk.

The CIO's VaR at the end of the first quarter was US$186m using the CIO's original model - more than three times bigger than its position a year ago of US$55m.

The new model may also have helped mask volatility of the CIO's new hedging strategy. The CIO's VaR was relatively stable in 2011, remaining between a minimum of US$55m and a maximum of US$64m.

JP Morgan has not detailed how VaR behaved under its new model in 2012. However, it showed that VaR swung around in a range of US$85m to US$187m during the first quarter under the old model.

Dimon declined to elaborate on the decision to switch VaR models in the CIO other than saying: "There are constant changes and updates to models; we're always trying to get them better than they were before. It's an ongoing procedure."

Commenting on the incident in general, the chief executive told analysts: "We have had many lessons learnt and we have already changed some policies and procedures as we've gone along."

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Comments (2)
RangerDan wrote:
So Wall Street and the Republicans want to deregulate these loose cannons? No way until they stand alone and I am guaranteed that my tax dollars will never be used to bail their arses out again. NEVER!

May 11, 2012 9:39am EDT  --  Report as abuse
BoBoJustus wrote:
So 4 years after the meltdown and nothings changed ? Hedge funds and credit default swaps and whatever are still legal ? These scumbags are going to destroy the civilized world and nobody is even trying to stop them.

May 11, 2012 9:45am EDT  --  Report as abuse
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