In 1998 JPMorgan announced plans to spin off its risk management services division as a separate company to “give the division a more entrepreneurial culture by incentivizing employees with share options.”
Earlier that same year, Banker’s Trust had already spun off its risk management software arm into a jointly owned subsidiary named IQ Financial Services. The RiskMetrics variance model at JPMorgan was created in 1989 by the Chairman of JPMorgan, Sir Dennis Weatherstone, who is reported to have asked for daily reporting and measurement of the risks of his firm.
Fast forward six years to December 2004, Jamie Dimon becomes CEO of JPMorgan Chase through a merger with Bank One, a firm long respected for its risk management expertise. To further cement his growing status, Mr. Dimon, as a member of the New York Federal Reserve Board, was directly involved in decision making for a federal bailout loan to purchase Bear Stearns in 2008.
So why is this important? Jamie Dimon has been heralded as the best risk manager on Wall Street by the popular press and he has enjoyed rock star status because of JPMorgan’s relative performance through the sub-prime mortgage fiasco.
The question is: Has Mr. Dimon simply benefited from the strong risk practices of his predecessors? Has the press and Mr. Dimon’s supporters become the latest victims of the fallacy of availability bias? Mr. Dimon is a survivor but has he simply been able to avoid the odds until this most recent public and ongoing risk failure?
As Congress contemplates the Volker Rule and other regulatory legislation, it is important to not make JPMorgan or Mr. Dimon’s admitted mistake the example for more regulation. It is important for legislators and regulators to understand the limits of making decisions under uncertainty with increasingly complex securities that now dwarf the GDP of all developed countries combined.
The notional value of the largely unregulated derivatives market has been estimated at many times the value of all developed countries combined. As debt exceeds global net worth by a factor of 10 or more we have become risk philosophers and no longer risk managers. We are reduced to explanation on the philosophy of how risk should be managed using controls that have not kept pace with the complexity of instruments that we may no longer fully understand.
Mr. Dimon’s called JPMorgan’s trading strategy “flawed, complex, poorly reviewed, poorly executed, and poorly monitored.” This may be an apt description of the entire derivatives market if left unchecked. Normal risk mitigation measures no longer apply. Global markets may be sitting at the precipice of economic recession at precisely the wrong time when we have lost control of risk management expertise.
With global financial markets increasingly run by algorithmic trading and quantitative analytics based on theories from the field of physics and modeled upon the laws of nature, we are increasingly more vulnerable to the frailties of human judgment.
Risk managers are too often blamed for the shortcomings of not preventing the large loss that happened to occur on Jamie Dimon’s watch. This is not the fault of risk managers. Risk taking is necessary for all human activity; we simply do not fully understand nor can we completely calculate the probability of the odds of a failure. We are surprised when they occur simply because it is hard to measure when risk taking moves from the realm of measureable risk to unknown uncertainty.
Jamie Dimon has given us yet another example of our vulnerability and to educate all responsible for regulating risk and managing risk to think more deeply about the limits of managing uncertainty.
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About the Author
James Bone is president of Global Compliance Associates, a risk advisory firm.
About the AuthorJames Bone’s career has spanned 29 years of management, financial services and regulatory compliance risk experience with Frito-Lay, Inc., Abbot Labs, Merrill Lynch, and Fidelity Investments. James founded Global Compliance Associates, LLC and TheGRCBlueBook in 2009 to consult with global professional services firms, private equity investors, and risk and compliance professionals seeking insights in governance, risk and compliance (“GRC”) leading practices and best in class vendors.
James is a frequent speaker at industry conferences and contributing writer for Compliance Week and Corporate Compliance Insights and serves as faculty presenter and independent consultant for several global consulting firms specializing in governance, risk and compliance, IT compliance and the GRC vendor market. James created TheGRCBlueBook.com to provide risk and compliance professionals with transparency into the GRC vendor marketplace by creating a forum for writing reviews on GRC products and sharing success stories on the risk practices that are most effective.
James is currently attending Harvard Extension School for a Master of Arts in Management with an emphasis in accounting and finance. James received an honorary PhD in Letters from Drury University in Springfield, Missouri and is a member of the Breech Business School Hall of Fame as well as the Missouri Sports Hall of Fame. Having graduated from the Boston University Graduate School of Education, James received his M.Ed. in Management and Organizational Design in 1997 and a Bachelor of Arts in Business Administration from Drury University in 1980.
