While JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon was in Washington preparing to explain his firm’s $2 billion trading loss, Morgan Stanley CEO James Gorman was in New York making the case to investors why it couldn’t happen at his firm.
Gorman, who didn’t mention JPMorgan in his presentation yesterday, highlighted the improvements Morgan Stanley has made in risk-governance since the 2008 financial crisis. Investors and analysts have voiced concerns that JPMorgan’s loss is evidence of risky behavior at all banks, and Morgan Stanley has been forced to address mistakes in its own recent past.
In 2007, Morgan Stanley faced a trading loss almost five times larger than the one JPMorgan disclosed last month. Morgan Stanley posted $9.4 billion of mortgage-related losses in the fourth quarter of that year, driven largely by a proprietary-trading desk led by Howard L. Hubler. The firm also racked up almost $5 billion of losses over four years through 2011 tied to derivatives deals with MBIA Inc. and the investment bank’s attempts to hedge its exposure to the bond insurer.
“Every day one makes a mistake of some size or other,” Gorman said. “We simply can’t make the size mistakes we were making that got us into the trouble in the financial crisis.”
Kristin Lemkau, a JPMorgan spokeswoman, didn’t return an e-mailed request for comment.
Morgan Stanley has fallen 11 percent since JPMorgan announced its loss on May 10, outpacing the 6.1 percent decline of the 81-company Standard & Poor’s 500 Financials Index. Analysts including Charles Peabody at Portales Partners LLC have said JPMorgan’s loss has weakened investor confidence in banks including New York-based Morgan Stanley.
JPMorgan, following the loss disclosure, faced questions about the strength of its board’s risk committee, the consistency of pricing securities throughout the bank and oversight of trading operations. Morgan Stanley confronted some of the same issues during the financial crisis, and Gorman said he included more detail about the firm’s processes in his presentation than he typically would.
“This is what actually drives the engine, and this is what I call Morgan Stanley growing up,” Gorman said. “You have to revert back to systematic process if you’re going to control the kinds of risks that are embedded in these businesses.”
JPMorgan has faced criticism over the makeup of its three-person risk-policy committee, which doesn’t feature anyone who has worked as a banker, regulator or had any experience on Wall Street in the past 25 years.
Gorman cited the credentials of the chairman of his firm’s risk committee, Howard Davies, who led the U.K.’s Financial Services Agency for six years and who Gorman described as “very, very highly qualified.”
“Davies is intimately involved in all large risk positions that we take, and any changes to any limits that we put in place across the organization,” Gorman said.
Gorman also cited a program known as Frame that ensures the firm marks all of its securities at consistent prices, even if the same securities are held in different parts of the bank.
JPMorgan’s chief investment office was valuing some of its trades at prices that differed from those of its investment bank, Bloomberg News reported last month. The discrepancy between prices used by the chief investment office and JPMorgan’s credit-swaps dealer may have obscured by hundreds of millions of dollars the magnitude of the loss before it was disclosed May 10.
Dimon treated the CIO differently from other JPMorgan departments, exempting it from the rigorous scrutiny he applied to risk management in the investment bank, according to two people who have worked at the highest executive levels of the firm and have direct knowledge of the matter.
The division’s London team built up a book of credit derivatives beginning in 2008 that became so large by late 2010 that employees couldn’t unwind it without roiling the markets or incurring large losses, according to current and former executives.
“CIO, particularly the synthetic credit portfolio, should have gotten more scrutiny from both senior management and the firmwide risk control function,” Dimon said in prepared testimony for his appearance today before the Senate Banking Committee.
Morgan Stanley has faced doubts following the JPMorgan loss because it has the second-highest amount of notional credit derivatives among U.S. banks, Peabody said. Morgan Stanley had sold credit-default swaps on $2.35 trillion of debt, and purchased protection on $2.36 trillion, the company said in its first-quarter regulatory filing. Those amounts each included $1.1 trillion of CDS tied to indexes and tranches of indexes.
Many of JPMorgan’s trades were in credit-default indexes and so-called tranches of the index, which concentrates risks tied to corporate debt.
Gorman made the case that a similar-sized position couldn’t be built up at his firm without approval from multiple senior executives. Morgan Stanley has what Gorman calls the “significant transactions committee,” which approves any commitment of more than $10 million other than liquid trading positions.
“We get a lot of things done, a lot more than $10 million,” Gorman said. “It’s just they don’t happen by somebody deciding in their own little group to do it.”