January 8th, 2015 8:50 pm
The Wall Street Journal reports on the Federal Reserve’s internal investigation of JPMorgan’s London trading debacle and reason for the failure of regulators to uncover that mismanaged risk.
Via the WSJ:
Markets
Full Report on ‘London Whale’ Incident Sheds More Light on New York Fed Role
Turf Battles, Crisis-Related Distractions Complicated New York Fed’s Supervision of J.P Morgan
By
Victoria McGrane and
Ryan Tracy
Updated Jan. 8, 2015 7:05 p.m. ET
WASHINGTON—The Federal Reserve Bank of New York’s failure to examine J.P. Morgan Chase & Co.’s investment unit ahead of the bank’s 2012 “London Whale” trading debacle stemmed from turf battles with other regulators, an overreliance on J.P. Morgan’s solid reputation and financial crisis-related distractions.
A full version of the Fed’s Office of Inspector General’s report on its years long investigation into the incident sheds additional light on how the New York Fed stumbled in its oversight of the bank’s chief investment office, where the traders engaging in the problematic derivatives transactions were based.
The Inspector General had previously released only a four-page summary of its report, which said the New York Fed failed to examine the CIO ahead of the trading debacle despite the fact that a team of Fed experts had recommended a “full-scope examination” in August 2009. The New York Fed team never carried that examination out. The Wall Street Journal obtained the full report through an open records request, though passages were redacted.
The report also includes the Fed’s response to the IG, including some resistance by top Fed officials to the IG’s conclusions. Michael Gibson, the Fed’s director of Banking Supervision and Regulation, pinned the “Whale” failures on a lack of resources. “The resource challenges faced by the Federal Reserve System and the FRBNY during this period cannot be underestimated,” he wrote. In light of that, the Fed believes it was “wholly appropriate” to rely primarily on the OCC, he said.
A letter from senior New York Fed officials included in the report said the IG’s findings were “incomplete.” The New York Fed “never knew that there were trading irregularities in the CIO,” and the recommendation that the New York Fed examine the office was a result of staffing changes at J.P. Morgan “and not because of any finding or any other reason,” the letter said. New York Fed staff also communicated regularly with the Office of the Comptroller of the Currency, the letter said.
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Given that the New York Fed was strapped for resources and the OCC and J.P. Morgan were both monitoring the bank’s CIO unit “it is not reasonable to substitute the OIG’s priority judgment, in hindsight, for the New York Fed’s,” the letter said.
The IG’s report said interviews with supervisory staff from both the New York Fed and the Office of the Comptroller of the Currency revealed a poor relationship between the two teams assigned to oversee J.P. Morgan’s CIO unit, according to the report. One New York Fed staffer described the relationship between the two teams as “tense,” and indicated that the leads on both supervisory teams did not cooperate,” the report said.
Some New York Fed officials complained the OCC team was “territorial,” defending their role as the lead regulator over J.P. Morgan’s national bank unit, in which the CIO was housed. In one case, New York Fed examiners tried to join an OCC visit of the CIO unit but weren’t allowed to, the report said.
There were also hints that J.P. Morgan’s reputation as a strong bank colored the New York Fed’s view and treatment of the megabank. The New York Fed “placed too much reliance on JPMC internal audit’s review, which concluded in the first half of 2009,” before a team of experts from across the Fed system recommended a full exam of the unit. Mr. Gibson said in his response that such a conclusion wasn’t fully supported.
The full report goes into further detail about the ways in which the New York Fed was overwhelmed with new responsibilities during and after the crisis, which the IG concludes contributed to its neglect of the CIO unit. Competing priorities for the New York Fed’s J.P. Morgan team included the integration of Bear Stearns, which it purchased in 2008, implementation of new capital rules and the Fed’s new “stress-test” exercise. “These activities strained the availability” of resources, the report said.
In his response to the IG, Mr. Gibson questioned whether the stress tests sapped time from the J.P. Morgan supervisory team, saying much of the work for them isn’t conducted by supervisors assigned to banks like J.P. Morgan, but by other Fed staff.
The IG said J.P. Morgan’s relative strength contributed to the resource problem faced by the New York Fed team in charge of J.P. Morgan. “Given JPMC’s stronger financial condition relative to its peers, [the New York Fed team] also had difficulty making a compelling case for additional resources,” the report said.
The IG said those demands reinforced its conclusion the New York Fed should have tried to reach out to the OCC team, given its resource constraints.
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