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What Did JPMorgan Execs Know and When Did They Know It?

When banks are in trouble, they often mislead the world about their financials. Maybe JPMorgan disclosed everything properly about its $2 billion loss, but that's what we need to determine.

The Securities and Exchange Commission and the Federal Bureau of Investigation are looking into JPMorgan Chase’s trading debacle — and if you think anything is going to come of that, well, I’m pretty sure that JPMorgan has some derivatives it would love to sell you.

A serious investigation is still necessary. The first lesson of the financial crisis is not that the capital markets were poorly regulated or that the banks were too leveraged or that the government needed better processes for taking over failing institutions.

The first lesson is that when they are in trouble, banks will mislead the world about their financials. And some will lie. Richard S. Fuld Jr. of Lehman Brothers, E. Stanley O’Neal and Charles O. Prince of Citigroup all played down their banks’ exposures before their institutions took vast losses. Were they deliberately misleading? Because of the failures to investigate the financial crisis adequately, we still don’t know.

But we do know that when banks hide their problems, they metastasize and can hurt the economy.

So before we move on to other vital discussions — about tightening the Volcker Rule, preventing the rollback of Dodd-Frank’s derivatives provisions, whether these banks are Too Big to Manage and more — we need to go back to the basics:

What did Jamie Dimon, the bank’s chief executive, and Doug Braunstein, the chief financial officer, know and when did they know it? Were JPMorgan’s first-quarter earnings accurate? Were top JPMorgan officials misleading when they discussed the chief investment office’s investments?

Perhaps JPMorgan was a model of probity, but so far these questions have been given only glancing treatment. The news coverage has largely focused on how the bank took the losses, what went wrong with its risk management and what it’s doing now. The commentary has mostly gone straight to discussing the implications for banking reform.

That’s already a victory for bankers — including Mr. Dimon. The first question on everyone’s mind should be whether any existing laws were broken.

That it hasn’t been asked shows how little true accountability there has been since the financial crisis. No top-tier banker has gone to prison for the many bank failures, the deceptive sales practices or the misrepresentations of the books. As a society, we have thrown up our hands at Too Big to Prosecute financial fraud.

Granted, it’s also because Mr. Dimon is charming. Last week, in his extraordinary conference call, he was refreshingly straightforward and made a big show of contrition. He repeatedly said things chief executives don’t say, calling his bank “stupid” and its conduct “egregious.”

And there has been a measure of internal accountability: JPMorgan cashiered the three top executives responsible for the trading loss.

But we still don’t know enough about the timing of these losses.

The broader public became aware of the trades when Bloomberg News and The Wall Street Journal wrote about the “London Whale” in early April. JPMorgan dismissed concerns then.

Now the bank says that the big losses happened after the first quarter, in late April and early May.

JPMorgan reported its first-quarter earnings on April 13. That’s when Mr. Dimon and Mr. Braunstein played down the problem, including with Mr. Dimon’s now-infamous remark that reports about the trades were a “complete tempest in a teapot.”

JPMorgan was clearly executing a strategy. The bank didn’t want its trader to become a wounded zebra on the savanna, attracting predators. Had the bank owned up to the problem right away, the losses could have ballooned as other investors piled in on the other side to force JPMorgan to let go of its positions at fire-sale prices.

JPMorgan executives spread the word, whispering in the ears of reporters and analysts, that hedge funds on the opposite side of the trade were in trouble. JPMorgan signaled that it wasn’t going anywhere. It had a big balance sheet behind these trades and could hold for a very long time. Its message: Hedge funds, you’re in trouble. Sell now.

“As they started to get some scrutiny, the last thing that they wanted was to admit that the journalists had been right,” said David Murphy, a risk management specialist at Rivast Consulting.

Now we realize the bank was bluffing. And it didn’t work.

Of course, bluffing isn’t illegal. From traders’ and bloggers’ efforts to figure out what JPMorgan’s positions were, it appears that the credit default swap indexes that the London Whale, Bruno Iksil, was speculating in started to have big moves recently. That argues in favor of the idea that the first-quarter earnings were not misstated, the most egregious potential transgression.

But there are some odd aspects. Even on Wall Street, losing $2 billion typically takes a while. The one big “London Whale Trade” — buying and selling credit default swaps on the same index but at different expiration dates — appears to amount to only around $50 billion or $70 billion, and likely accounts for perhaps $600 million to $1 billion at most of the more than $2 billion loss, I’m told.

So there were other trades involved, which have also taken losses. From the losses that have been reported so far, the underlying value of the derivatives contracts was likely to be $250 billion to $300 billion. What were the other trades and when did those losses take place? And were positions being marked correctly?

JPMorgan changed a crucial measure of risk during the quarter. Why? And was that adequately disclosed?

At best, this was a huge management failure. The trades had been initiated months ago and were widely known. Earlier in the year, people inside the bank spoke of Mr. Iksil as “defending his positions.” That carries the implication that he was doubling down, to force the market in the opposite direction. That’s a rookie trading mistake, one presumably approved by his bosses.

It’s only human to have trouble owning up to mistakes. As Mr. Murphy, the risk management specialist, put it: “There’s always management pressure when it’s a big number and it’s material. ‘Are we sure?’ The last thing managers want is a big loss in quarter that then comes back right afterwards. Then they look like total idiots.”

But given the outstanding questions, looking like an idiot is the best-case scenario.

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