In April 2012, Americans were confronted with a story of Wall Street excess and derivatives disaster now known as the JPMorgan Chase whale trades.
Those trades were essentially a series of bets by traders in the London office of U.S. banking giant, JPMorgan Chase. Their bets grew so large that they roiled the $27 trillion market in complex financial instruments known as credit derivatives. JPMorgan’s CEO Jamie Dimon claimed media reports about the whale trades were “a tempest in a teapot.”
But a month later, the bank admitted the truth: that their bets not only had lost more than $6 billion, but also exposed a litany of problems at what had been considered one of America’s safest banks.
The whale trades were the focus of a recent hearing before the Senate Permanent Subcommittee on Investigations, which I chair. Our hearing was the culmination of a nearly one-year, bipartisan investigation that produced a 300-page report. Our report opens a window into the hidden world of high stakes derivatives trading by big banks. And it reveals one overarching fact: the U.S. financial system may have significant vulnerabilities to high-risk derivatives trading.
Among the most troubling aspects of the whale trades case history is that JPMorgan trades essentially hid the losses from their massive portfolio by misreporting the value of their derivatives. It was only after the media threw a spotlight on the trades that JPMorgan restated its financial results for the first quarter of 2012, admitting extra losses of $660 million.
But to this day, JPMorgan maintains that the mismarked values did not, on their face, violate bank policy or accounting rules. If derivative books can be cooked as blatantly as they were in this case without breaking the rules, then the rules need to be revamped.
The whale trades also demonstrate how easily a Wall Street bank can manipulate and avoid risk controls. The financial industry assures us that it can prudently manage high-risk activities, because they are measured, monitored and limited.
But as our report demonstrates in detail, JPMorgan executives ignored a series of alarms that went off as traders breached one risk limit after another. Rather than ratchet back the risk, JPMorgan personnel changed their risk measures to silence the alarms.
The whale trades also exposed another example of a major Wall Street bank’s misstatements and concealment. Our investigation found that the bank failed to fully disclose its bets to regulators for years, even when they tripled in size in the first three months of 2012. In fact, in January 2012, the bank told regulators, inaccurately, that the portfolio was decreasing in size.
After the whale trades went public, JPMorgan misinformed both regulators and the public about them. Top executives described the whale trades as long-term, risk reducing investments that were fully transparent to risk managers and regulators. None of that was true.
Together, the facts are a reminder of what occurred in the recent financial crisis: We can’t rely on a major bank to resist risky bets, honestly report losses, or disclose bad news, without a strong regulator looking over its shoulder.
Our report recommends a number of policy changes to stop the derivative abuses. They include requiring major banks to disclose to regulators all derivatives trading portfolios like the ones in the whale case, prove claims that their derivative bets reduce risks rather than increase them; stop using derivative pricing practices to hide losses; enforce risk limit breaches by ending risky trades rather than silencing the alarms; and accept tougher capital requirements so that when risky trades go south, taxpayers won’t be on the hook for a bank bailout.
We also called on regulators to speed up implementation of what’s known as the Volcker Rule. I worked with Senator Jeff Merkley of Oregon to include the Volcker Rule in the Wall Street reform law enacted in 2010.
It prohibits federally insured banks from making high-risk bets with their customers’ deposits – just the kind of trades that got JPMorgan in trouble. But regulators have delayed putting the Volcker Rule’s prohibition into effect. Those delays should end.
JPMorgan’s whale trades damaged a single bank. But they expose problems that reach far beyond one London trading desk or one Wall Street office tower. The American people have already suffered one devastating economic assault rooted largely in Wall Street excess and they cannot afford another. When Wall Street plays with fire, American families get burned.
The task of federal regulators, and of this Congress, is to take away the matches. The whale trades demonstrate that task is far from complete.
