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JPMorgan Cheating on the Stress Test: Exhibit 46,

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- 1869 days ago -
JPMorgan's "London Whale" episode may boil down to a few senior executives attempting to increase their personal compensation.

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JL A (281)
Saturday May 11, 2013, 11:16 am

JPMorgan cheating on the stress test: Exhibit 46

By: Bartlett Naylor

"Bart Naylor" "Financial policy reform"JPMorgan’s “London Whale” episode may boil down to a few senior executives attempting to increase their personal compensation.

The London Whale episode was a trading travesty in April and May of 2012 during which JPMorgan lost about $6 billion on bets it made with some $300 billion in depositor funds.

The losses spurred congressional action, culminating in the Senate’s Permanent Subcommittee on Investigations’ release of a 300-page report and 500 pages of exhibits showing a widespread miscarriage of bank management, bank supervision and integrity.

Examine what’s labeled as “Exhibit 46” in the 500 pages of subcommittee exhibits. On December 22, 2012, JPMorgan Chief Investment Officer Ina Drew directed subordinates to implement a plan to enable the bank to buy back stock. But carrying out the plan was dependent on convincing regulators that such a step would be financially prudent. In a series of emails about the whale trades, Ina Drew states that she is “trying to work with CCAR submission for firm that is acceptable for an increased buyback plan.”

In conventional terms, the committee report alleges that JPMorgan sought to manipulate how the whale trade would appear to regulators so that JPMorgan could buy back stock – an action which typically boosts a share price and thus leads to higher executive compensation.

Let’s unpack this logic with some care.

CCAR is the Federal Reserve’s Comprehensive Capital Analysis and Review, more commonly known as the “stress test.” Banks much show regulators that they have enough capital in case bad things happen.

Equity capital is to banking what a down payment is to a home buying. A home buyer who seeks to flip a property wants to minimize the down payment. If the buyer can put down $4,000 on a $100,000 house and borrow the rest, he can reap a 250 percent profit on the $4,000 if he soon sells the house for $110,000. As it happens, the largest banks also have about 4 percent in equity capital. When the market turns south — when bank customers stop paying their loans, when the bank begins to lose on its bets — banks may quickly run out of that 4 percent equity capital. (See Stanford Professor Anat Admati’s book, “The Banker’s New Clothes.”)

Prudential regulators typically ask banks to increase their equity capital. On April 25, Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) introduced a bill to require minimum equity funding of 15 percent for the largest banks. Currently, the CCAR stress test determines whether a bank has enough equity funding.

Banks typically like to have less equity capital. What Drew means by “an increased buyback plan” is a plan to reduce shareholders’ equity. This indicates a motivating factor in the bank’s actions. Shareholders often like buybacks, because at the end of the day they are left with a bigger share of the pie. Senior executives also like them, since executive compensation is often based on earnings per share figures. The same earnings on fewer shares means higher earnings per share, which could mean a higher bonus. The detrimental end result of stock buybacks is that they leave the bank (or other corporation) with less equity capital to protect against downturns.

The rest of the email chain shows that the bank’s quantitative analysts hoped to win regulatory approval of the stock buyback by changing the math used to calculate the bank’s minimum capital requirements. One proposal was to change the value of the bank’s assets, including the London Whale bets. The “whale” investment was too big, requiring the bank to show corresponding equity. So JPMorgan manipulated the numbers to make it look smaller. With this and other changes to the bank’s risk and capital models, they proposed lowering the bank’s already dangerously low capital by about $7 billion.

One of the proposals in the email (that the firm eventually adopted) produced a new risk model that turned out to be wrong. Instead of revealing the true risk in the London Whale gambles, the new math disguised it. When investors in the stock market later learned that those trades were producing massive losses, JPMorgan’s stock fell 25 percent.

On April 4, 2012, the company justified the $14 million they paid Drew in 2011 this way: “Ms. Drew successfully accomplished her business and people agenda objectives for 2011 by creating shareholder value through risk management activities across a broad array of market sectors and currencies with the help of a very knowledgeable leadership team that Ms. Drew has developed over a long career in various locations around the globe.”

Thirty-six days later, they fired her.

If “risk management activities,” means cheating to boost executive compensation, that’s a chilling way to run a bank. Exhibit 46 offers an inside glimpse of bank conduct that ought to lead regulators to require more, not less equity capital to protect taxpayers from future bailouts.

Bartlett Naylor is the financial policy reform advocate for Public Citizen’s Congress Watch division.

Arielle S (313)
Saturday May 11, 2013, 1:30 pm
This reminds me of the scene in "Pirates of the Caribbean" where Johnny Depp is accused of cheating - he just shrugs and says, "Pirate!" Only in this case, it's "JPMorgan Chase!" What else can we expect from them by now?

Past Member (0)
Saturday May 11, 2013, 2:25 pm
Maybe hes a distant relative of Henry Morgan the pirate LOL

. (0)
Saturday May 11, 2013, 3:15 pm
The paucity of morals and ethics in the world of the Maximum Short Term Profit god never ceases to amaze me. Are these the people that society revels in as successful? No wonder the majority of our youth have no hope never mind the illusionary value system perpetrated by the 1% on them. Long as it makes you popular I guess. Wait 'til the veil is lifted and reality actually does kick in.

JL A (281)
Saturday May 11, 2013, 5:14 pm
You cannot currently send a star to Arielle because you have done so within the last day.
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Angelika R (143)
Sunday May 12, 2013, 4:18 am
The public is probably less interested in HOW it was done than THAT it was done.
" Exhibit 46 offers an inside glimpse of bank conduct that ought to lead regulators to require more, not less equity capital to protect taxpayers from future bailouts." -"ought to"- LOL. You need a LAW to ENFORCE this! We did implement such a law to avoid that type of risk management. Thx -(though I am pretty tired of reading about JP Morgan etc, it'splain sickening)

Darren Woolsey (218)
Sunday May 12, 2013, 5:02 am
An example of why these banks should be broken up...

paul m (93)
Sunday May 12, 2013, 5:16 am

Noted ,,,Good comments//

JL A (281)
Sunday May 12, 2013, 8:41 am
You are welcome Angelika.
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Lois Jordan (63)
Sunday May 12, 2013, 2:10 pm
Excellent info, thanks, JL. Some news that may cheer some up is that Jamie Dimon, (of JPMorgan), is worried that he may not retain his position. The news on the voting tallies will be available in the next 10 days....article on Huffington Post stated. Keeping my fingers crossed, and hoping we're just not seeing someone bad replaced with someone even worse. Stay tuned....

JL A (281)
Sunday May 12, 2013, 2:12 pm
Thanks for the Dimon news Lois! You are welcome.
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Past Member (0)
Sunday May 12, 2013, 2:18 pm
Is there anything or anyone greedier than the banks and Wall Street?

JL A (281)
Sunday May 12, 2013, 2:24 pm
Good question Robert. You cannot currently send a star to Robert because you have done so within the last day.

Birgit W (160)
Sunday May 12, 2013, 7:13 pm

Dianna M (16)
Monday May 13, 2013, 2:41 pm
There was a cover cartoon on 'The Funny Times' a couple years ago where some pirates were watching a banking ship go down. As the bankers loaded themselves onto lifeboats, one pirate says, "Scuttle yer own ship--AND keep all the booty?"

Pirates are kinder. They'll just kill you. A banker will steal all your assets--then demand a handout (excuse me, a 'bail-out') because "we're too big to fail!"
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