JP Morgan, Essay Example

There are many potential angles to analyze the JP Morgan case in which the Chief Investment Office (CIO) lost more than $2 billion dollars (and counting) “hedging” credit exposure. This review will put forth the thesis that it resulted from a risk management failure that was then amplified by two corporate governance failures: 1) CEO Jaime Daimon, while approving the initial hedge, did not understand the structure of the bet made; 2) The composition of J.P. Morgan’s Risk Committee that was not composed of an individual to properly manage the risk.

Of all the details that have emerged from this strange case, Jaime Daimon’s failure to understand the structure and exposure of the hedge stands out. First, the Wall Street Journal reported that although Daimon knew of the CIO’s hedge on credit default swaps spreads, he did not know what exact bets were placed: Daimon first sensed trouble when he saw stories regarding the “London Whale” that was trying to corner the credit default swap market. Actually, Daimon knew roughly of the unit’s total exposure- but the value at risk (VAR) model vastly understated the down side of potential losses leaving Daimon in the dark. This was foremost a failure in risk management to put such confidence in the tarnished VAR measure that had been impugned throughout the financial crisis. Even after the initial reports surfaced, however, Daimon did not come clean with investors stating the publicity was simply a “tempest in a tea pot”- this shows, profoundly poor judgment that Daimon has ultimately apologized for.

Second, one might (rightly) question where the board of directors was during this time? In particular, where were the hard hitting questions from J.P. Morgan’s risk policy committee on this exposure? Looking at the risk policy committee, while the three members all have elite backgrounds and are lawyers, none of them have experience in running a bank or in risk management. This does not pass the putative sniff test: risk management is one of the most arcane and complex subjects in banking; lawyers without advanced degrees in finance will have little or no idea what is being modeled for them nor understand the risks for the firm. This is a clear corporate governance failure, but one not typically identified in analysis of this event.