JPM and the CIO Organization Structure
Q: Describe three aspects of the CIOs organization and reporting that did not conform to good risk management guidelines. (3 points) 2. In 2012, how did the CIO violate conventional pricing approaches? What justification did they use internally for their pricing? (3 points) 3. What red flags were missed by JPM with respect to models and pricing techniques in the CIO?
“The market can remain irrational longer than you can stay solvent.”Attributed to John Maynard Keynes In the spring of 2011, JPMorgan Chase & Co. (JPM) found itself in a dire situation. The synthetic credit portfolio (SCP) of their Chief Investment Office (CIO) had grown tremendously in market value through the first quarter. While the SCP represented less than 1% of the bank's total assets, it had grown to become more than half of the bank's total risk. To make matters worse, the portfolio was not behaving as they had expected in light of recent credit market moves. By the end of March 2012, the SCP had suffered a mark-to-market loss of $719 million in the year to date. However, the CIO was unable to reduce their exposure by selling because they had become a big holder in the market. Any hint of a portfolio liquidation sale would result in a precipitous decline in value of their positions.
Hedge funds and other sophisticated players in the market had begun to “smell blood”, and a forthcoming article in the Wall Street Journal article (April 2012) was about to put the plight of the SCP squarely in the public eye. Having cultivated a reputatio for sound risk management and business decision making through the worst of the financial crisis, how had JPMorgan managed to get into such a position?
JPMorgan Chase & Co. is one of the largest global financial institutions globally, providing the entire range of financial services to its retail, corporate, and institutional clients. While its roots dated back to the mid- l9'? century, the current incarnation of JPM had taken shape after the
repeal of Glass-Steagall in 1998 and the consequent acquisition of JP Morgan & Co. by Chase Manhattan Bank in 2000. This was followed by the acquisition of Bank One in 2004, whose then CEO, Jamie Dimon, became CEO of the combined entity, the Fed-backed purchase of Bear Steams in March 2008, and the purchase of Washington Mutual later that year. At the end of 2011, it boasted a market cap of $184 billion and assets of $2.27 trillion.
Risk Management of the SCP
Within JPMorgan Chase, the CIO's role is to optimize the management of the bank's excess cash from its extremely large deposit base. The CIO invests this excess cash across the universe of fixed income securities and other income generating assets. At the end of 2011, the CIO was comprised of 140 traders and 288 middle and back office personnel, predominantly spread across New York and London, who managed a total of $350 billion in assets. Since 2005, the CIO had been headed by Ina Drew, who was well regarded by senior management and had their utmost confidence. The chief risk officer (CRO) of the CIO, Irv Goldman, reported to her, as did Achilles Macris, the head of international investments.
Drew and Goldman were based in the New York office, while Macris was based in London. Prior to Goldman's appointment, the CRO role did not formally exist in the CIO. Instead, the senior most risk officer was Peter Weiland, who was chief market risk officer and officially reported to Barry Zubrow, the bank CRO, from 2007 to January 2012, though he reported to Drew on a de facto basis.
The risk management framework for the SCP rested upon three key metrics: Value at Risk (VaR), Credit Spread Basis Point Value (CSBPV), and Credit Spread Widening 10% (CSW 10%). In addition, there were limits on portfolio composition and asset type, but these were based on the CIO portfolio as a whole and not specific to the SCP, which effectively gave the CIO incredibly wide discretion in terms of security selection and portfolio concentration regarding the SCP. Given that the CIO was not one of JPM's client-facing business units, it was not subject to issues of regulatory compliance, and as such it was scrutinized to a lesser degree.At the most basic level, VaR measures the tail risk of an asset or portfolio.
There are two ways to calculate VaR in the financial industry: using historical market data or via a Monte Carlo simulation. To set a VaR limit, a time horizon and confidence level are selected and the set of P&L information generated from either method are used. In the case of JPM, they used historical market data. For example, if a portfolio has a “one month 1% VaR (historical)” of$100,000, that means that based on historical data from the past month, there is a 1% probability that the portfolio loss will exceed $100,000.