Josh Rosner (@JoshRosner) is co-author of the New York Times Bestseller “Reckless Endangerment” and Managing Director at independent research consultancy Graham Fisher & Co. He advises regulators, policy-makers and institutional investors on banking and financial services (a more complete bio appears at the end of this column).

This is part Intro, the first part of 5; We will be releasing a different part each evening and morning culminating in the release of Rosner’s complete report on Friday morning. On that date, the Senate Permanent Subcommittee on Investigations will release their final report on JPM’s CIO Group (aka the London Whale).

Enjoy.

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INTRO:

On Friday, the Senate Permanent Subcommittee on Investigations will release the final report on the losses associated with failures of internal controls in JPM’s CIO group. We expect that the findings will demonstrate significant failures of senior management and conclude that the Company’s own investigation was incomplete. It is important to remember that those losses, while the largest and most notable, are only one example of many such failures in recent years.

In this report we will focus on the risk management and internal control environment at JPMorgan Chase, a bank whose balance sheet is almost one-ninth the size of the United States economy. JPMorgan’s financial filings, its “Task Force” investigation of losses in the CIO’s office and its recent history of significant regulatory failures demonstrate that shareholders of are continuing to be called upon to pay for the firm’s inability to ensure an acceptable control environment.

We have intentionally chosen not to detail all of the many private or public actions settled or outstanding (which have driven almost $16 billion in litigation expenses since 2009) or, other than the multistate settlement and foreclosure review settlement, the agreed to or unresolved costs of actions related to mortgage putback demands, including those of institutional investors, insurers, the GSEs, FHA, or the costs of foreclosure-related actions. Moreover, the impunity with which the firm is seeking to transfer billions of dollars of Washington Mutual (WaMu) related losses to the FDIC demonstrates their unwillingness to accept the responsibilities for their own management failures.

Even without the inclusion of these items, since 2009, the Company has paid more than $8.5 billion in settlements for the various regulatory and legal problems discussed in this report. These settlement costs, which include a small number of recent settlements of older issues, represent almost 12% of the net income generated between 2009-2012. Banking regulations and laws are intended to protect stakeholders and the public but some portion of these costs may be tax deductible to the company allowing management to transfer to the public the costs of and future risks of these violations.

In addition, JPM’s ability to retain its reputation, its political power and support of investors in the face of financials that lack the details necessary for a proper analysis are reminiscent of another too-big-to-fail institution: Fannie Mae.

We are not suggesting that JPM will meet the fate that Fannie did. But there are notable similarities in the actions taken by these institutions. JPM appears to have taken a page out of the Fannie Mae playbook in which the company perfected the art of cozying up to elected officials, dominating trade associations, employing political heavyweights and their former staffers and creating the image of American Flag-waving, apple-pie-eating, good corporate-citizen, all of which supported an “implied government guarantee” and seemingly lowered their cost of funding. Additionally, rather than being driven by the strength of its operations and management, many of the JPM’s returns appear to be supported by an implied guarantee it receives as a too-big-to-fail institution.

JPM has a reputation of being the best managed of the biggest banks. In our reviews we could not find another “systemically important” domestic bank that has recently been subject to as many public, non-mortgage related, regulatory actions or consent orders. The firm’s pride in a disputable “fortress balance sheet” – which underestimates their off-balance sheet risks appears to have given investors false comfort, after all poor risk management and control failures are almost always the major drivers of capital destruction.

 

 

REPORT:  In this report we will focus on the risk management and internal control environment at JPMorgan Chase, a bank whose balance sheet is almost one-ninth the size of the United States economy. JPMorgan’s financial filings, its “Task Force” investigation of losses in the CIO’s office and its recent history of significant regulatory failures demonstrate that shareholders are continuing to be called upon to pay for the firm’s inability to ensure an acceptable control environment.

There are real risks of further regulatory or legislative changes to required leverage and capital ratios, and that the FDIC’s “single point of entry” approach to the orderly liquidation authority may result in new long-term debt issuance requirements at the holding company. Furthermore, other business risks appear under-appreciated, such as those associated with interest-rate risk management and also the collateral management of derivatives. While these fundamental issues deserve attention, they are not areas of focus in this report but will be addressed in a forthcoming report that considers the fundamental financial realities of “fortress JPM”.

The failures we highlight are not exhaustive but should nonetheless serve to demonstrate the ongoing strains in managing a firm the size of JPMorgan and the benefits that would accrue to shareholders from better oversight and a business plan more focused on core operations.

We have intentionally chosen not to detail all of the many private or public actions settled or outstanding (which have driven almost $16 billion in litigation expenses since 2009) or, other than the multistate settlement and foreclosure review settlement, the agreed to or unresolved costs of actions related to mortgage putback demands, including those of institutional investors, insurers, the GSEs, FHA, or the costs of foreclosure-related actions. Moreover, the firms attempts to transfer billions of dollars of Washington Mutual (WaMu) related losses to the FDIC demonstrates their unwillingness to accept the responsibilities for their own management failures.

Even without the inclusion of these items, since 2009, the Company has paid more than $8.5 billion in settlements for the various regulatory and legal problems discussed in this report. These settlement costs, which include a small number of recent settlements of older issues, represent almost 12% of the net income generated between 2009-2012. Banking regulations and laws are intended to protect stakeholders and the public but some portion of these costs may be tax deductible to the company[i] allowing management to transfer to the public the costs of and future risks of these violations.

In addition, JPM’s ability to maintain its reputation, its political power and support of investors in the face of financials that lack the details necessary for a proper analysis are reminiscent of another too-big-to-fail institution: Fannie Mae.

We are not suggesting that JPM will meet the fate that Fannie did, nor that its actions will result in accounting problems. But there are notable similarities in the actions taken by these institutions. JPM appears to have taken a page out of the Fannie Mae playbook in which the company perfected the art of cozying up to elected officials, dominating trade associations, employing political heavyweights and their former staffers and creating the image of American Flag-waving, apple-pie-eating, good corporate-citizen, all of which supported an “implied government guarantee” and seemingly lowered their cost of funding. Additionally, rather than being driven by the strength of its operations and management, many of the JPM’s returns appear to be supported by an implied guarantee[ii] it receives as a too-big-to-fail institution.

JPM has a reputation of being the best managed of the biggest banks. This has enabled the Company to employ its muscle with elected officials and thwart regulatory efforts. Oft-cited arguments that strong regulatory actions in the midst of a recovery could destabilize the biggest banks appear to have helped minimize penalties for the many internal weaknesses that might otherwise have impacted market perception of the firm’s management relative to its peers.

In our reviews we could not find another “systemically important” domestic bank that has recently been subject to as many public, non-mortgage related, regulatory actions or consent orders. The firm’s pride in a disputable[iii] “fortress balance sheet” – which underestimates their off-balance sheet risks – appears to have given investors false comfort.[iv] Poor risk management and control failures are almost always the major drivers of capital destruction. Today, even the primary regulator to the largest banks recognizes that operational, compliance, strategic and reputation risks are more critical and a greater reason for concern than credit, liquidity, interest rate and price risk[v]. Unfortunately, not a single one of the 19 largest banks met the OCC’s requirements for internal auditing, risk management or succession planning.

 

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Disclosures: Neither Rosner nor Ritholtz have any position, long nor short, in JPM stock.

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[i] Should Companies’ Settlements with Uncle Sam be Tax-deductible? (Some of these fines may be tax deductible)

[ii] Quantifying Structural Subsidy Values for Systemically Important Financial Institutions, p.12 p.4 (See. “Using this and the overall rating bonuses described in the previous paragraph, we can evaluate the overall funding cost advantage of SIFIs as around 60bp in 2007 and 80bp in 2009.”, See also Remember That $83 Billion Bank Subsidy? We Weren’t Kidding

[iii] CAPITALIZATION RATIOS FOR GLOBAL SYSTEMICALLY IMPORTANT BANKS ( FDIC CAPITALIZATION RATIOS FOR GLOBAL SYSTEMICALLY IMPORTANT BANKS (G-SIBs) Financial data as of second quarter 2012 (See: “Adjusted Tangible Equity to Adjusted Tangible Assets Ratio – IFRS estimate (3.12 Percent)”)

[iv] The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It, Anat Admati and Martin Hellwig, Princeton University Press (February 2013), P. 83-87

[v] Big Banks Flunk OCC Risk Tests American Banker, “Big Banks Flunk OCC Risk Tests”, by Barbara A. Rehm DEC 13, 2012

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Josh Rosner is co-author of the New York Times Bestseller “Reckless Endangerment “How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon”, and Managing Director at independent research consultancy Graham Fisher & Co. He advises regulators, policy-makers and institutional investors on banking and financial services. Previously he was the Managing Director of financial services research for Medley Global Advisors, Executive Vice President at CIBC World Markets and a Managing Director at Oppenheimer & Co.

In 2001 Mr. Rosner authored “Housing in the New Millennium: a Home without Equity is Just a Rental with Debt” warning of the risks resulting from structural changes in the mortgage finance system. In 2003 Mr. Rosner was among the first analysts to identify operational and accounting problems at the Government Sponsored Enterprises. In 2005 he was among the first analysts to identify the peak in the housing market. In February 2007, warning of the likelihood of contagion in credit markets Rosner co-authored the Hudson Institute paper “How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?”. In the co-authored May 2007 paper “Where Did the Risk Go? How Misapplied Bond Ratings Cause MBS and CDO Market Disruptions” Rosner identified the problems in structured finance. His “Toward an Understanding: NRSRO Failings in Structured Ratings and Discreet Recommendations to Address Agency Conflicts” was presented in the Winter 2009 Journal of Structured Finance.

Category: Corporate Management, Credit, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “JPMorgan Chase: Out of Control”

  1. [...] Barry Ritholtz blogs about JPMorgan sketchy shenanigans. Shenanigans. [...]

  2. louis says:

    The problem is, and will always be their mind set. Remember they are “richer” than us. They don’t care what any of their shareholders think. They don’t care what the government thinks of them. When the subject of operational risk comes up in meetings do you think they wink at each other or burst out laughing? Buyer beware.

  3. CitizenWhy says:

    But Obama loves JP Morgan hase and its Chairman. Therefore JP Morgan Chase is wonderful.

  4. kek says:

    Wall Street has always been a patsy for Jamie, I don’t get the premium valuation and idol worship.

  5. Angryman1 says:

    Yeah, but they have the biggest cash surplus and can “goof” around alot. They are probably the only bank with a trillion bucks of cold hard cash swimming around.

    BofA and Citigroup are the 2 that are real “walkers”.

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  7. MarkKlose says:

    When cataloging the various regulatory actions & settlements, were there any that were the result of Bear Sterns’ activities that were prior to JPM’s acquisition? If so, I think it would be important to detail those separately.

  8. 873450 says:

    Jamie ‘s failure to reign the London Whale in before it spectacularly beached itself resulted in his bonus cut in half from $20 million to $10 million.

    Isn’t that sufficient punishment?

  9. AHodge says:

    you go josh
    jamie in my book is the lowest
    prostituted or end ran JPMs formerly fortress balance sheet and Riskmetrics culture

    maybe he is just decending to the
    in the swamp level of most of the big guys
    but in the mix of
    1 conscious predatory and crooked, on one side , and
    2 CEO stupid ignorant of the bank below
    he is way more of #1
    he clearly thinks the regulators even when investigating are too stupid to figure it out
    we see this week

    i hear on good authority they atually held both sides of individual deals internal to consolidated JPM
    not perfect authority but id give it maybe 90%
    one side being the Investment Officer whale and the other side an unconsolidated hedge fund
    this would not be a new low in banking, not uniquely bad
    Goldman complained about “many” doing this shit before they shut up about accounting
    if the investigators cant find stuff like that
    then the investigators stand exposed as totally f ing clueless
    and jamie will get away with his lawyered up stonewall as most of them do.

  10. AHodge says:

    to be clear
    JPM held both sides of individual deals at way different prices

  11. AHodge says:

    did i see you quoted on b berg as JPM is like Fannie freddie??as bad
    with due regard for what POS Dimon and FF both are
    and involved in mortgage scamming and accounting frauds
    JPM is not even in the same POS league as those two
    Fannie and Freddie are likely thetwo worst “private” stockholder companies–ever. and by a wide margin
    I should know i owned Fannie stock till last week
    counting on them not liquidating shareholders, govt guearantee for that

    but with DeMarco s joint venture move for these two
    i could not count on govt equity bailout
    of two excrescences that will probably cost a half trillion before done
    jPM is probably not even broke.

    ___

    BR: Josh Rosner’s piece posted last night & this morning

  12. Roanman says:

    The United States Senate shouldn’t have to give a rat’s ass about JP Morgan’s management and/or internal controls and wouldn’t were it not for the fact that “JP Morgan’s balance sheet is almost one-ninth the size of the United States economy”.

    If you break up the banks a lot of problems in this country just go away. Although a lot of the damage caused by the banks will likely linger for years.

    Separate brokerage from proprietary trading from retail deposit taking and mortgage making from research from insurance from M and A and now the success and/or failure of these entities needn’t be of concern to anybody other than shareholders and creditors. Which is as it should be.

    Glass–Steagall worked for generations until the weasels managed to get it repealed. Bring it back and then some.

  13. [...] is part 3 of 5; Yesterday evening, we published the Introduction. We will be releasing a different part each evening and morning culminating in the release of [...]

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  17. [...] itself is less than related litigation expenses — the bank has already paid out more than $8.5 billion in settlements since 2009 related to matters covered in the Levin [...]

  18. [...] Federal Reserve at the height of the 2008 financial crisis. It has been forced to pay out some $8.5 billion in settlements related to its role in the crisis (12 percent of its net income in recent years) [...]