Skipping the ERM tune-up: pay now or pay later: even the best enterprise risk management systems need regular maintenance--or tune-ups--as conditions in the dynamic business environment are constantly changing, both internally and externally; ignoring warning signals can be costly.

Author:Barton, Thomas L.
Position:Enterprise Risk Management
 
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JPMorgan Chase & Co. was one of L the relatively few big banks to emerge from the financial crisis of the decade of the 2000s in reasonably good shape. However, on April 6, 2012, CEO Jamie Dimon--recognized as one of the most astute bankers and risk managers of the current era--learned that JPMorgan had outsized positions in the credit derivatives marketplace taken by one of its traders.

Dimon supposedly learned of this--not from his bank's vaunted risk management system--but by reading a page one article in The Wall Street Journal. In response, JPMorgan shut down the trader's activities four days later, but the positions remained.

It turns out that the London-based trader, Bruno lksil, aptly nicknamed "London Whale," was known for his typically huge trading positions, positions he had taken as part of his job with the company's Chief Investment Office. What he did was apparently acceptable with his management--he was no "rogue" trader such as Nick Leeson of Barings Bank.

Following press coverage of the episode in April, Dimon was dismissive with his "not to worry" statement. "A tempest in a teapot," he said. Then, in May, JPMorgan reported that losses from the Whale's positions could total $2 billion, and Congress summoned Dimon for testimony. Throughout the episode, Dimon was apologetic and humble; he explained that the losses were caused by the poor design and execution of hedges and the failure to properly monitor them.

A month later, however, in June, loss estimates as high as $9 billion were being suggested in the press, and finally, in July, the bank reported the actual loss of $5.8 billion.

Early in the affair were calls for Dinion's resignation or firing, as both his and JPMorgan's reputations were damaged. The company's market capitalization declined by 20 percent over the period from early May until the end of August--representing a larger market drop than the actual losses, in perhaps the market's way of factoring in uncertainty while letting the accountants add up the actual losses.

Alternatively, the losses appear to be more of a punishment by the market for poor risk management and reflect a lack of confidence in management--almost as if poor risk management is directly factored into the stock price.

In the early 2000s, Chase Manhattan Bank (prior to merging with JPMorgan) was viewed as a best-practice ERM company in a major study by the authors here, Making Enterprise Risk Management Pay Off (conducted on behalf of Financial Executives Research Foundation), which studied extensively and in depth the practices of five companies.

At that time, the bank had a strong ERM system and appeared to have its array of risks well covered. This was borne out by the merged company's relative success in navigating the dangerous currents of the financial crisis. Thus, the company's subsequent huge unexpected--losses and to be vilified for weak risk management in 2012--was surprising to many.

In interviews for that study and other research...

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