The this paragraph”?} The inclusion of newThe this paragraph”?} The inclusion of new

The financial crisis of 2007 / 2008 was driven largely by a
sub-prime lending crisis, which resulted in financial contagion across the
world. The crisis was driven by both internal (poor management decisions) and
external factors (insufficient regulatory oversight). This essay will focus on
the contribution of internal oversight on the financial crisis, with a focus on
JP Morgan.

{This goes very detailed very
quickly – some background sentence or two for context would be helpful. May not
need this paragraph”?} The inclusion of new
institutional economics and stakeholder theory, none of which has been tested
in the context of risk management, is the first attempt to introduce these
theories to empirical research in the field. Both theories are relatively new
and immature.24 Jul 2007Risk Management Theory:
A comprehensive empirical assessment

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{Should explain what the London
whale is here in one sentence} The case of JP Morgan and the London
whale highlighted that corporate governance is a poor tool for addressing the
role of the corporation. One suggestion is that the effort to employ
shareholders as agents of public values and as a result to instruct corporate
decisions with a public responsibility is imprudent
{You may want to detail this point out to specify exactly what was happening}. {You
could add that “shareholders tend to have a shorterm view for return on
capital. This myopic led to greater risk taking
in an attempt to capitalize on cheap credit and a growing value in the housing
market.”} There was an assumption that having shareholders’ interests
aligned with those of non-shareholder stakeholders would have a positive impact
but the end result was that this association was flawed. The demands for
greater accountability resulted in policymakers attempting to restrict the
corporation’s internal decision making structure, for the purpose of improved
corporate governance. The advisory note from Dodd-Frank’s on executive
compensation is an example of this. (Fisch, 2015)

JP Morgan suffered a massive financial loss due to the whale’s
risky trading decisions but it was their shareholders who benefited from this
risk taking. {I would add a little more detail around
what risky trading decisions they made – 1-2 sentences} {another option to
close paragraph, “Given shareholder expectations of return on capital,
they are poorly positioned to act as a sufficient corporate governance
structure. Instead, stronger regulatory oversight such as through the Volcker
rule would be a more appropriate  As a
result, shareholders were positioned poorly to address the incentives that gave
rise to risky operational decisions. Despite assertions of “improved corporate
governance” in the shape of shareholder empowerment it rather aggravated the
problem instead of acting as a solution. The disaster at JP Morgan highlights the
limitations of shareholder governance and they may be best addressed in a
regulatory manner such as through the Volcker rule. (Barr, 2008)

So what was the cause of JPMorgan’s trading loss? It was not
out of control traders, or portfolio models gone bad, or a greedy, an
asleep-at-the-wheel CEO. JPMorgan’s problem was a desire from individuals,
companies and regulators for less risk. People and companies were looking for
safety. So they kept more money at the bank {Not sure
this was a major factor? It was more around people and banks being over
leveraged in order to maximize profit from a growing housing bubble}. The
general assumption of being Too-Big-To-Fail, led to a false sense of security.
JPMorgan over the past 4 years have trebled their portfolio to $1.1 trillion. As
regulators are ensuring other banks to boost their capital by lending less. This
inevitably led to JPMorgan having reserves of extra cash. (Gandal, 2012)

The success of JP Morgan’s CEO Dimon’s stemmed from his close
attention to risk. It was reported that JP Morgan held monthly meetings during
which the heads of all the business units provided updates on their individual
areas. These meetings covered items from
systems, products, competition and customer complaints to whether ATMs are
working or sales forces are growing but was driven by a culture of truth. At a
bank the size of J.P. Morgan, Dimon’s meetings are a treasure trove of
information that can be shared among its divisions. “He
knows where the risk is in his institution. As such, J.P. Morgan avoided a lot
of the major mistakes that were made by other banks,” Pershing’s Ackman
said. “Some bank executives delegated risk management, but he oversaw this
personally.” (Barr, 2008)

Source JP Morgan Chase & Co


(Buehler, et al., 2008)


So with such an emphasis on risk management and integrity
how where these trading losses accrued? A backdrop of deficient accounting
controls in the CIO {explain acronym} which
included spreadsheet miscalculations which resulted in large valuation errors
and the use of subjective valuation techniques that made it easier for the
traders to mismark the CIO portfolio.

In an attempt to mitigate their exposure JPMorgan senior
management rewrote the CIO’s valuation control policies in advance of the firm
filing with the SEC its first quarter report for 2012. The senior management
knew that the firm’s Investment Banking unit had used differing pricing
mechanisms for the CIO and Investment Banks derivatives which led to increased
losses of over $750 million {Maybe call out here that
individual business units were optimizing for their own benefit and potentially
not sharing the full risk exposure to the larger org.}  In addition there was a failure by
senior management to inform their own internal audit committee of said findings
which in turn affected their ability to deliver accurate reporting. (Taylor, 2013)


On analysis of the unit’s numbers and it is evident that
there are other issues besides hedging. Back in 2008, for instance, JPMorgan’s
Chief Investment Office had a portfolio of $113 billion. If we look at the
graph below it is evident that despite a reduction in the number of loans
during the 2008-2010 period should have had a correlating reduction in hedging
in the CIO. However on analysis the CIO’s portfolio almost tripled. (Gandal, 2012) {Did the type of loan change… were they more exposed in
sub-prime… so less loans but more risky loans?}