Clearing The Bull: JP Morgan And Derivatives Derangement Syndrome (DDS) Part II

In the first article we placed the JP Morgan derivatives loss in context, noting that governments are a far greater danger to our financial health than banks. This article focuses on why more legislation, more regulation, more governance and more controls will not solve the problem.

Contrary to what everyone would have us believe the failures at JP Morgan were not about legislation, regulation governance and controls—history shows that these only work until the next cock-up. They are about the mission and values of the organization, and thus the type of culture within which it operates.

There is nothing to suggest that the positions taken by the trader at JP Morgan were in any way rogue positions. In addition, rumors had already been circulating in the market about the size of the positions being held but these had been dismissed by management. This scenario suggests that while the positions were known to management the real extent of the exposures including the possible loss scenarios were not fully understood.

The reality is that in a situation where you have a complex product and the size of the position relative to the rest of the market is abnormally large, the true extent of the risk exposure can never be properly measured. Further, management may not be in a position to fully understand what is being reported to them simply because they do not have the level of knowledge required.

This is in no way unusual.

Such is the nature of banking and the complexity of the risks involved that it would be impossible to find someone sitting at very senior levels of management who would understand all that was happening on the trading floor—irrespective of how many reports they receive.

The question therefore is why take the risk?

Managers take the risk because in the first instance that is the nature of modern business and innovation. Secondly, they can normally rely on governance, controls and risk management to identify and highlight any exceptions that should concern them. In the case of JP Morgan it appears that these functions identified no such problems with the positions in question.

Unfortunately, this is not uncommon in highly complex businesses. Whether it is banking, scientific research or IT specialists with high-level security access, no risk manager, manager nor senior executive can ever exercise complete control. That is an illusion and the sooner managers realize it the better.

This is precisely why behaviors are and have become so important—it is simply impossible to have controls for every single scenario.

So what we are really dealing with here is not governance and controls but how organizations manage their mission and values and by extension their behaviors. Some would call it the organizational culture.

Since JP Morgan’s governance and control functions basically worked as intended, then it must be JP Morgan’s inability to manage individual behaviors and the organizational culture which was at fault. We know that this was the case because if one of your traders is known as “Voldemort” and the “London Whale”, and that was of no concern, then staff and management must have been complicit in Voldemort’s behavior.

This means that the firm, JP Morgan, has not fully cultivated a behavior and a culture which is consistent with having a measured approach to risk. Its difficulty is a prime example of why organizations must place their mission and values before their governance and controls.

While imposing more legislation, more regulation, more governance and more controls might appease the media and the baying masses, in the long run it will prove of little value. That is until and unless Jamie Dimon and the management of JP Morgan decide that they want to run a culturally different type of organization.

In the interim, given that the real problem here is about behaviors and cultures, the firm should be accepting the resignation of the Head of HR along with that of the other departing managers.


Jonathan Ledwidge is the author of the book Clearing The Bull: The Financial Crisis and Why Banks Need a Human Transformation. Use this link to give your opinion on the performance of banks post the financial crisis.

2 responses to “Clearing The Bull: JP Morgan And Derivatives Derangement Syndrome (DDS) Part II

  1. “Since JP Morgan’s governance and control functions basically worked as intended” This is a very bold statement! It would also seem to be contradicted by JD…..

    • This was no rogue trader. The whole market new about the trade and apparently so too did the management of JP Morgan who dismissed any criticism. If this was an unreported position the trader would hav been fired first up. Whether or not the risk of position and the possible loss scenario was properly assessed was another matter.

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