Posted: November 19th, 2022

Case Study of JP Morgan

Case Study of JP Morgan

In the year 2011, JP Morgan increased its Synthetic Credit Portfolio SCP from $4 billion to around $51 billion. In November that year, the SCP made a $1 billion credit derivative bet for a gain of $400 billion. Later in December the same year, Bank and Chief Investment Office, CIO Managers decide that improving economy would lessen need for credit protection and thus CEO Jamie Dimon instructed CIO head Ina Drew to reduce the CIO’s Risk Weighted Assets (RWA). On December 22nd, CIO proposed to reduce RWA by manipulating models this was quickly followed by the organization’s quantitative head Patt Hagan developing models that lowered SCP risk results. On January 6th 2012, the SCP trading breaches CS01 risk limit that is spread over up to May the same year when metrics are completely overhauled. Later between the 16th and 20th of January, SCP trading caused a 4 day breach in the bank wide VaR. On 23rd the same month, Dimon and the Chief Risk Officer John Hogan take up measures by approving a temporary bank wide VaR limit increase so as to end breach. This was geared to reduce the CIO’s VaR by 44%.
The SCP losses continued to escalate and CIO traders began to mismark SCP values in an attempt to minimize losses towards the end of January. In February, the losses were marked at $69 million. On 2nd March Comprehensive Risk Measure was used to calculate RWA and indicated that SCP had the possibility of losing $6.3 billion in 2012. Later in mid-March CIO traders acquired $40 billion on credits. At the end of March, a loss of $40 billion is recorded. This information is then made public through the Wall Street Journal.
VAR could not be used as a sufficient tool to prevent extraordinary loss because, the tool does not take into consideration the likelihood of a financial meltdown. This is because the tool gives an illusion of wellbeing by giving a false sense of security among senior managers that all is well in the organisation yet the problems are big. The best risk metric that is appropriate in this case is the current ratio. This is because this tool is able to measure a company’s ability to pay obligations and to gauge its ability to do so.
In the Risk-Weighted Assets, they should include gross exposure since managers need to balance the potential rate of return on all the assets with the amount of total capital that they are required to maintain for the given asset class. If the organisation therefore adopts a diverse pool of such assets the organisation has ability to generate a reasonable amount of return on all the assets as well as meet all capital requirements from the regulator.
It is not appropriate to employ derivatives in a cash management function because, since these avenues do not usually create new avenues for generation of income of the company but in the long run increase the exposures to the company. This means that a company may end up spending too much money to curb issues that would have been easily sorted without involving a lot of ground work.
During the whole situation the bank, shareholders and regulators believed that the problem was under control and thus took up measurements to avert the same. The whole time they believed that the problem was under control and within no time, the organisation would be back to its feet. This reaction was not the best since it did not help matters much and not much was done towards averting the dire situation.
A risk management should be very effective in enforcing limits as well as breaches by creation of VAR, CSBPS and CSW that usually offer a limit on all portfolio composition as well as the type of asset as well as ensuring that they are specific to the particular SCP. There is also need to enhance regulatory compliance so as to increase scrutiny. It would also be of great importance if the organization’s structure was changed. For instance the risk management and investment team all reported to Drew meaning that the responsibility for risk management and trading, rested on her thus creating a conflict of interest also the organizational structure allowed for nepotism as in the case of Goldman and Bary Zubrow. There was also tainting on the independence of reporting since Bank wide risk management depended on CIO’s risk management team reporting the risk of portfolio.
My top three changes in redesigning the risk management policy would be one to make risk management metrics specific to SCP. This is would be an effort to reduce discretion of securities to use as well as the portfolio concentration. Secondly the VAR would be calculated through the Monte Carlo simulation rather than through historical market data. Thirdly I would reorganise hierarchy of reporting whereby the risk management team and the investment team would report to different managers so as to reduce the conflict of interest.
Lessons taken away from this organisation is that there is need for closer scrutiny in how organisations carry out their operations. Meaning that issues faced in the organisation should not be overlooked and thus their effects should be scrutinised and should be rectified as soon as they are noticed so as to avoid disastrous downfalls as well as loss of investment.