JPMorgan not triggering major regulatory rethink

NEW YORK Thu May 31, 2012 7:03pm EDT

People exit the lobby of JPMorgan Chase & Co. headquarters in New York May 22, 2012. REUTERS/Eduardo Munoz

People exit the lobby of JPMorgan Chase & Co. headquarters in New York May 22, 2012.

Credit: Reuters/Eduardo Munoz

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NEW YORK (Reuters) - Bank regulators are holding daily, high-level calls to try to understand how a seemingly low-risk unit at JPMorgan was able to amass a $2 billion trading loss, but there are no immediate plans to revamp how the nation's largest banks are supervised, according to a source familiar with the matter.

Regulators have come under scrutiny for not raising red flags earlier about the massive hedging strategy that went awry, despite having more than 100 examiners embedded at JPMorgan Chase & Co.

The source, who was not authorized to speak publicly, said lessons will be learned from the JPMorgan trading loss and there may be some changes in how regulators make sure banks have good risk-management systems in place.

But regulators believe it was not their responsibility to flag the hedging strategy as something dangerous and it is upon banks to effectively manage their own risks.

"People are going back and asking: ‘Is there any way we could have seen this?' I don't know that that will yield the next great radar screen," the source said.

The source added that regulators are still trying to get to the bottom of what happened and hope to come to some conclusions in the next four to six weeks.

Top officials at the bank regulators are expected to face intense scrutiny next week when they appear before the Senate Banking Committee.

Lawmakers have already railed against regulators for supposedly being in the dark about the trades and will likely press them on whether they really have a handle on what goes on at the big banks.

The criticism echoes the conversation during the 2007-2009 financial crisis when the four federal bank regulators were blamed for not recognizing that Wall Street had dangerously ratcheted up risk and become so intertwined that the bursting of the housing bubble could bring the financial system to its knees.

After that searing experience, the regulators increased the number of examiners embedded at the biggest firms, including JPMorgan.

The Federal Reserve Bank of New York, which is the primary regulator of JPMorgan's holding company, has some 40 embeds at that bank's U.S. offices, while the Office of the Comptroller of the Currency, which regulates its banking activities, has about 70 in New York, Chicago and Delaware.

The Federal Deposit Insurance Corp has another four on-site supervisors at JPMorgan.

However, no examiners were embedded at JPMorgan's Chief Investment Office in London that executed the failed hedging strategy.

UK regulators do not dispatch full-time on-site regulators. The U.S. embeds are largely clustered on one floor in JPMorgan's midtown Manhattan office, the source familiar with the matter said.

And regulators only became aware of the trading exposure in April around the time news reports said that a UK-based trader at the bank, dubbed the "London Whale," was playing a dominant role in certain markets.

A Fed spokesman declined comment. Bryan Hubbard, a spokesman for the OCC, has said he cannot speak specifically about JPMorgan, but noted it is the OCC's responsibility to ensure that banks have effective risk management. But he added that it is not their job to approve specific risk models, loans or investments.

Hubbard did say that examiners are looking at risk-management strategies at other big banks to "validate our understanding" of inherent risks.

BLAME GAME

JPMorgan and its chief, Jamie Dimon, have talked repeatedly about the trading strategy, which could ultimately cost the bank $5 billion or more, and have issued multiple mea culpas.

The bank regulators have been less willing to take on blame.

The heads of the Securities and Exchange Commission and the Commodity Futures Trading Commission told Congress last week that they were not the primary regulators of JPMorgan.

William Dudley, president of the New York Fed, said last week: "Supervision is about ensuring that banks have sufficient capital and liquidity to handle large shocks ... It's not to prevent the banks from making mistakes, in any dimension."

Sheila Bair, who left as chairman of the Federal Deposit Insurance Corp last year, has been tougher in assigning blame.

"I think the Office of the Comptroller of the Currency and the New York Fed both share responsibility here as I understand it. This is being done inside the insured bank so the OCC also bears responsibility here," she said in an interview with Reuters earlier this month.

She said that for years she fought the OCC and New York Fed over how much banks should be allowed to rely on value-at-risk (VaR) models, an estimate of losses that could occur on a particular trade or portfolio of trades.

Dimon first announced that the CIO unit had changed its VaR model when he announced the trading losses on May 10. The rest of the bank's divisions apparently kept to more conservative modeling to measure the risk of trades.

"They can certainly look at risk management systems and the VaR model is part of that system," Bair said.

EMBEDS

The source familiar with the matter said that, before the JPMorgan trading loss came to light, there had been ongoing talks about how the embed system works.

The person noted that, after the financial crisis, the Fed relocated many of its "risk" professionals at the Fed building to the banks themselves, but generally there are separate floors for the embeds.

"We're not sitting, looking over people's shoulders, which is why we might want to change the name 'embed'," the source said, also noting that some of the current embeds have urged the Fed not to restructure the supervision process too much.

An embedded regulator at one major U.S. bank who was not authorized to speak publicly said it would not necessarily be productive for examiners to be watching the bankers' every move.

"At the end of the day, the bankers can't always be on edge that regulators are playing 'gotcha' games," the embed added.

(Additional reporting by Karen Brettell in New York, Dave Clarke in Washington and Huw Jones in London; editing by Karey Wutkowski, Alwyn Scott and Andre Grenon)

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