JPMorgan Chase & Co.'s trading loss of more than $2 billionpoints to failures in the bank's risk-management practices, U.S.regulators told lawmakers today.

Comptroller of the Currency Thomas J. Curry said the lossesraise “questions about the adequacy and rigor” of the bank's riskoperation, particularly of the unit which experienced the losses,the chief investment office.

“We believe that the issue at JPMorgan Chase is one ofinadequate risk management within the office of the chiefinvestment office,” Curry told lawmakers. The agency is looking tosee if “similar gaps exist in any other area of JPMorgan's riskmanagement architecture,” he said.

The hearing before the Senate Banking Committee was the firstpublic airing of the roles played by the OCC, the Federal Reserve,the Federal Deposit Insurance Corp. and the Treasury Departmentbefore May 10, when JPMorgan Chairman and Chief Executive OfficerJamie Dimon disclosed the trading losses tied to creditderivatives.

“We are looking at whether there were gaps within our assessmentof the risks and the risk controls in place in the CIO office,”Curry told lawmakers.

Senator Tim Johnson, the South Dakota Democrat who leads thecommittee, said losses at the largest and most profitable U.S. bankshows that “no institution is immune from bad judgment.”

Dimon, who is scheduled to testify to the Senate panel on June13 and to the House Financial Services Committee on June 19, isunder pressure from lawmakers and regulators to explain the trades,which he has called “flawed, complex, poorly reviewed, poorlyexecuted and poorly monitored.”

Jennifer Zuccarelli, a spokeswoman for JPMorgan, declined tocomment on the remarks of regulators.

Senator Richard Shelby of Alabama, the top Republican on thecommittee, said after the hearing that Curry's testimony, whichcame as the OCC was still conducting its review of the losses,didn't answer all of his questions.

“Maybe Mr. Dimon will explain what's going on,” Shelby toldreporters. “Sooner or later we need an explanation. Was it managingrisk or was it something else?”

Capital Requirements

Fed Governor Daniel Tarullo said in his prepared testimony thatthe central bank has been assisting in the oversight of JPMorgan's“efforts to manage and de-risk the portfolio in question.”

Tarullo, who pointed to the importance of “robust bank capitalrequirements,” said the Fed, as the primary regulator forJPMorgan's holding company, has been looking to see if there areweaknesses in risk management or control. He said the Fed hasn'tfound similar risks, though the review is “not yet complete.”

Lawmakers, split along party lines, tried to square JPMorgan'slosses with a provision in the Dodd-Frank Act to ban proprietarytrading by banks that benefit from FDIC deposit insurance and Fedborrowing.

Senator Jeff Merkley, an Oregon Democrat and co-author of theso-called Volcker rule, argued that the goal of the ban was toreduce risk, not increase it. He asked Curry whether trades by onetrader in the bank's chief investment office — nicknamed the“London Whale” because his positions grew so large — met thatgoal.

“Do you think that Bruno Iksil, the London Whale who ran JPMC'sEuropean strategic investment unit, woke up each day trying tomitigate the risk from excess deposits invested between loans andbonds?”

Curry said that while it is “premature” to reach any conclusionson whether JPMorgan's trades would have violated the Volcker rule,“the episode will certainly help focus our thinking on theseissues.” As to Iksil's role, Curry responded to Merkley by sayinghe would “not necessarily” conclude that the trader was operatingsolely to mitigate the firm's risk.

The final version of the Volcker rule, which is still beingrevised, should prohibit hedging that “does not reduce risksrelated to specific individual or aggregate positions held by afirm,” Treasury Deputy Secretary Neal Wolin said in his preparedremarks.

The JPMorgan loss shows the need for banks' senior managers tohave effective risk models and accountability for failure, and forregulators to have clear understanding of banks' exposures andrisk-management systems, Wolin said.

Substantive Guidelines'

Tarullo said the Volcker rule will put in place “substantiveguidelines” to distinguish between hedging and proprietarytrading.

“If a firm said we are doing this because it is a hedge theywould be required to explain to themselves, importantly, as well asto the primary supervisor, what the hedging strategy was” and makesure it didn't create new exposures, he said.

Senator Jack Reed, a Rhode Island Democrat, raised the issue ofthe OCC's oversight of how JPMorgan measured its “value at risk,”or VaR. Dimon, in a May 10 call with investors, said the chiefinvestment office used a new model that later proved to be“inadequate.”

SEC Chairman Mary Schapiro said in congressional testimony lastmonth that the agency is “very focused” on determining whetherJPMorgan appropriately disclosed changes it made during the firstquarter to the VaR calculation. A company's VaR is a measure of howmuch the company estimates it could lose on trading on 95 percentof days.

Curry said that while the agency “would likely have been aware”of changes to the company's internal risk models, there is noexplicit regulatory approval requirement to make changes.

Tarullo, who garnered support from lawmakers in both parties forhis emphasis on the needs for stronger capital requirements, saidthat because the euro crisis has been brewing for some time, theFed has been able to “regularize” a system of oversight to trackU.S. financial institution exposures in Europe.

“What we have been able to do is put in place a system thatallows us to check the positions and exposures of individual firms”against aggregate data, he said.

Bloomberg News

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