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JPMorgan Chase CEO Dimon: Bank wasn't gambling

(MoneyWatch) JPMorgan Chase (JPM) CEO Jamie Dimon apologized Wednesday for large financial losses the company suffered earlier this year, telling lawmakers that the banking giant had failed to manage risks in a key trading unit. Yet he also sought to diminish the scale of the incident, saying that no client, customer, or taxpayer money was lost.

"All of our lines of business remain profitable and continue to serve consumers and businesses," he said in prepared remarks before the Senate Banking Committee.

In a sign of the public focus on Wall Street's conduct in wake of the 2008 financial crisis, a handful of protestors from a group called Occupy our Homes briefly disrupted the proceedings even before the hearing had begun by standing and yelling "stop foreclosure now." A man also shouted, "Jamie Dimon's a crook," and, "These guys are not the job creators, they're the job destroyers," before the group were escorted out of the meeting room by police.

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Seemingly unruffled by the disturbance, Dimon testified that trades by Chase's so-called Chief Investment Office, or CIO, earlier this year were designed only to offset other financial risks within the company, rather than boost profits through "proprietary" trades.

"The hedge was intended to improve our safety and soundness, not make it worse," he said, asserting that restricting hedging activities would heighten financial risks and possibly result in banks reducing lending.

In a testy exchange with Sen. Bob Menendez, D.-N.J., over whether the CIO's trading activities amounted to "gambling," Dimon replied bluntly, "I don't believe so, no."

The executive also denied a suggestion by Sen. Jeff Merkeley, D.-Ore., that Chase operates more like a hedge fund than a government-insured depository institution. "We're not a hedge fund," Dimon said.

But Dimon did say that Chase will likely seek to recover, or "claw back," pay from some executives responsible for the trading losses. "When the board finishes its review, which is the appropriate time to make those decisions, you can expect that we will take proper corrective action, and it is likely there will be clawbacks," he said, noting that bank has to date never forced executives to disgorge pay in this manner.

Addressing lawmakers' questions about the safety of the financial system, Dimon said banks are better managed and capitalized than before the housing crash, denying that Chase's recent trading losses are evidence of broader industry risks. He also expressed doubts about the merits of a proposed restriction on big banks' proprietary trading known as the Volcker Rule, claiming that such trades are hard to distinguish from hedging activities. "Every loan we make is proprietary," Dimon said.

Pressed by Sen. Bob Corker, R.-Tenn., to say if the Dodd-Frank financial reform law passed in 2010 has made the banking system safer, Dimon said, "I don't know."

Chase disclosed last month that it had lost at least $2 billion on securities trades made by CIO. The unit is charged with investing excess capital and with protecting the bank against financial loss by placing trades that offset other risks within the company.

In the days following the loss, which Chase later said could top $3 billion, the company acknowledged that a JPMorgan employee in its London office, Bruno Michel Iksil, had made trades using synthetic derivatives that increased the bank's exposure to a swing in financial markets. The executive in charge of CIO, Ina Drew, resigned from the company in May.

Dimon confirmed Wednesday that the problem at CIO was centered in its portfolio of synthetic derivatives, a type of security used on Wall Street whose value "derives" from the price of other assets. Such securities, especially packaged as "collateralized debt obligations," were involved in many of the heavy losses that Wall Street firms suffered during the housing sector crash that led up to the financial crisis.

While saying in his opening statement that CIO's synthetic derivative holdings were "designed to generate modest returns in a benign credit environment and more substantial returns in a stressed environment," Dimon admitted that the unit's trading strategy had failed. The approach "ended up creating a portfolio that was larger and ultimately resulted in even more complex and hard-to-manage risks," he said.

More specifically, Dimon pinpointed five factors in explaining Chase's loss:

  • CIO's strategy for reducing the size of its synthetic credit portfolio "was poorly conceived and vetted"
  • Traders in the CIO unit did not understand the risks their strategy entailed
  • Chase failed to set trading limits in CIO's synthetic credit holdings that reflected the actual level of risk in the portfolio
  • Key CIO staffers and other Chase personnel failed to properly monitor traders within the unit
  • Senior Chase executives, including managers in the bank's risk-control unit, failed to oversee CIO staff

In expressing regret for Chase's financial losses, Dimon said that "we feel terrible" about losing shareholders' money. The executive also said the company has taken several steps to prevent similar incidents. Those include appointing new leadership in the CIO unit and strengthening the company's risk oversight.

Yet despite Dimon's insistence that the CIO division engaged only in hedging transactions, key questions remain unanswered. Perhaps most important, how was the company defining and recording in its financial accounts the kind of hedges the unit used?

For Wall Street, meanwhile, Chase's failure to identify the risks that built up in the CIO unit between January and April deepens questions about banks' procedures and measures to assess their vulnerability to large financial losses.

In January, for example, the company changed its "value at risk" model, a metric commonly used by Wall Street banks to gauge how much money they could lose in a single day. Dimon conceded that Chase's new model was flawed, but suggested that such estimates are inherently difficult to calculate.

"The future is not the past -- things change," he said. "The old model was better at predicting some of the things that happened in April and May than the new model."