JPMorgan Chase Has More than 1,000 Models in Production

This afternoon, I spent some time reviewing the annual shareholder letter from JPMorgan Chase. The most interesting bit to me was this section on Model Risk Management (“Model review”) at the Bank:

More than 300 employees are working in Model Risk and Development. In 2014, this highly specialized team completed over 500 model reviews, implemented a system to assess the ongoing performance of the 1,000+ most complex models in the firm, and continued to enhance capital and loss models for our company.

So there at least 1,000 models currently in production at JPMorgan Chase, which doesn’t include the non-complex models…

I also thought Jamie Dimon’s comments on the Comprehensive Capital Analysis and Review (CCAR) were illuminating:

We believe that we would perform far better under the Fed’s stress scenario than the Fed’s stress test implies. Let me be perfectly clear – I support the Fed’s stress test, and we at JPMorgan Chase think that it is important that the Fed stress test each bank the way it does. But it also is important for our shareholders to understand the difference between the Fed’s stress test and what we think actually would happen. Here are a few examples of where we are fairly sure we would do better than the stress test would imply:

  • We would be far more aggressive on cutting expenses, particularly compensation, than the stress test allows.
  • We would quickly cut our dividend and stock buyback programs to conserve capital. In fact, we reduced our dividend dramatically in the first quarter of 2009 and stopped all stock buybacks in the first quarter of 2008.
  • We would not let our balance sheet grow quickly. And if we made an acquisition, we would make sure we were properly capitalized for it. When we bought Washington Mutual (WaMu) in September of 2008, we immediately raised $11.5 billion in common equity to protect our capital position. There is no way we would make an acquisition that would leave us in a precarious capital position.
  • And last, our trading losses would unlikely be $20 billion as the stress test shows. The stress test assumes that dramatic market moves all take place on one day and that there is very little recovery of values. In the real world, prices drop over time, and the volatility of prices causes bid/ask spreads to widen – which helps marketmakers. In a real-world example, in the six months after the Lehman Brothers crisis, J.P. Morgan’s actual trading results were $4 billion of losses – a significant portion of which related to the Bear Stearns acquisition – which would not be repeated. We also believe that our trading exposures are much more conservative today than they were during the crisis.

The last point is important because the way the scenarios have worked in the recent years for CCAR, the assumption was that there was a one-time (one day to less than a month-long), massive shock to the equity markets (50 to 60% drop in the severely adverse case).

Risk Management at JPMorgan: Relying on Excel Spreadsheets

I spent some time this morning reading the recently published “JPMorgan Chase & Co. Management Task Force Regarding 2012 CIO Losses,” a 129-page report on how and why the Chief Investment Office (CIO) lost more than $6 billion for the company in 2012. The media has been quick to point the finger at Bruno Iksil, the so-called “London Whale” responsible for executing the trades. As Felix Salmon notes, the executive summary on the first 17 pages of the report is well-written and provides the context behind this trading disaster for JPMorgan.

I went through the other portions of the document and wanted to highlight that the Risk Management, particularly in the CIO, wasn’t up to snuff. First, this was a huge red flag:

The Firm’s Chief Investment Officer did not receive (or ask for) regular reports on the positions in the Synthetic Credit Portfolio or on any other portfolio under her management, andinstead focused on VaR, Stress VaR, and mark-to-market losses. As a result, she does not appear to have had any direct visibility into the trading activity, and thus did not understand in real time
what the traders were doing or how the portfolio was changing. And for his part, given the magnitude of the positions and risks in the Synthetic Credit Portfolio, CIO’s CFO should havetaken steps to ensure that CIO management had reports providing information sufficient to fully understand the trading activity, and that he understood the magnitude of the positions and what
was driving the performance (including profits and losses) of the Synthetic Credit Portfolio.

But the big question: why did it take so long for JP Morgan to discover that these trades were losing money for the company? Turns out, it had to do with rudimentary platforms in place to measure/track risk on a daily basis. Alas, they were relying on Microsoft Excel!

During the review process, additional operational issues became apparent. For example, the model operated through a series of Excel spreadsheets, which had to be completed manually, by a process of copying and pasting data from one spreadsheet to another. In addition, many of the tranches were less liquid, and therefore, the same price was given for those tranches on multiple consecutive days, leading the model to convey a lack of volatility. While there was some effort to map less liquid instruments to more liquid ones (i.e., calculate price changes in the less liquid instruments derived from price changes in more liquid ones), this effort was not organized or consistent.

In addition to these risk-related controls, the Task Force has also concluded that the Firm and, in particular, the CIO Finance function, failed to ensure that the CIO VCG (Valuation Control Group) price-testing procedures – an important financial control – were operating effectively. As a result, in the first quarter of 2012, the CIO VCG price-testing procedures suffered from a number of operational deficiencies. For example, CIO VCG did not have documentation of price-testing thresholds. In addition, the price-testing process relied on the use of spreadsheets that were not vetted by CIO VCG (or Finance) management, and required time-consuming manual inputs to entries and formulas, which increased the potential for errors.


If you’re into risk management at all (like I am), the entire report is worth perusing.