Stop Burning Money: Learning From JPMC’s Financial Mistakes


If you’re a long time reader of this blog, you know that for some time we’ve been discussing project management in the largest possible sense. For many, project management is all about managing the schedule and budget of a project. My view is that the project budget and schedule are merely outputs of a much more involved process. The basic tools of project management are very similar to the tools of many other offices: procurement, audit, business improvement, etc. But, in a well-managed firm the threads of all of these different departments come together in the PMO Project Portfolio. Firms, especially financial firms, are now so large and interconnected that individuals and departments can control billions of dollars of assets and leave almost no “footprint” on the firm (i.e. process documentation, business objectives, scope of responsibilities, stakeholder buy-in, etc.). Last week, we heard that JPMC (the world’s largest bank) ran a “loss prevention department” that lost $2 billion. How did that happen? How do you prevent it in the future?

The short version of the story goes like this. JPMC manages many billions in their security portfolios. To limit the risk in these groups, JPMC created a hedging group to limit the possibility of losses on that portfolio. How does a hedging strategy work? It can get very complicated, but essentially it is about putting together a basket of assets that moves in the opposite direction of the assets you are trying to protect. These assets are almost always leveraged (borrowed money used to “amplify” profits). That means that if your primary asses go down, the hedge fund goes up…. Which provides the profits to protect your primary assets.  In a recent blog we went over the details of hedging and how it has led several of the last market collapses. That’s not to say that any one hedge fund is necessarily bad, but all hedges have an Achilles heel. They work perfectly, except for the day when they go through the floor. Each Achilles heel is different and depends on the math behind the fund: it could be a sudden rise or dip in the economy, or a sudden drop in the Asian real estate markets, or loss of confidence in a type of financial instrument. All of these changes have happened, and as a result we had market and economic collapses in the 80s and 90s.

When these strange activities really get going, the next step is that the biggest of these funds keeps increasing its “bet” until it is astronomical in size. If that’s a bad bet, then the firm and even the entire economy can take a fatal hit. We have heard that the damage was $2 billion (this may rise), but the bet was much larger… $100 billion. The bet was only slightly wrong, and lost 2% (i.e. $2 billion). It could easily have been 5 or 10 billion, or more. However, this time, something very different happened. The CEO of JPMC, Jamie Diamond, did something we haven’t seen in a long time. Before he was required to, he publicly reported this problem… BEFORE HE WAS LEGALLY REQUIRE TO REPORT IT! This is one of the reasons that Mr. Dimon has been called America’s best CEO of banking. It took real guts to do this, rather than trying to “fix” the problem with even riskier trades to cover the problem… which has been a recurring problem with other banks. However, if Jamie Dimon is the best CEO of a bank, and JPMC I the best bank in the world, then we have to assume that the JPMC problem is neither unique nor the worst example of what we can expect in the future.

According to Dimon, “There were many errors, sloppiness and bad judgment. These were egregious mistakes, they were self-inflicted.” On “Meet The Press” (5/13/12), Dimon added that JPMC had many billions invested in security portfolios and needed to build a group to hedge the risk for their portfolios; unfortunately, the strategy for that group was, “badly vetted, badly monitored.”

Dallas Federal Reserve Bank President Richard Fisher, said the biggest banks do not have adequate risk management. “What concerns me is risk management, size, scope… At what point do you get to the point that you don’t know what’s going on underneath you? That’s the point where you’ve got too big.” For once, we see commonality between the banks and the regulators. Even when every department produces management reports, these big firms do not have transparency in their operations.

The PMO’s project portfolio is more than a list of projects. It is a crystal ball into the thinking of individual departments. If the PMO is truly global, there should be a section in the folder for each department. When there is a gap in the portfolio, a department with no projects, that’s a sign that this department either is not very connected to the rest of the firm, does not see itself as having any need for improvement, or does not wish to expose it’s operation to the firm.

  • Not connected: There are a lot of reasons for a department to not take the time to work with the PMO. Big deals, high pressure meetings, highly paid staff with better things to do. But these are the same reasons why the department may not be well connected with regulatory and control department. Today, there is a lot of talk about whether bank regulation works, if JPMC had this problem. However, much regulation occurs after the fact. Because of reporting requirements, Dimon found out about this loss. But if there was more exposure of the working of the hedge process, other stakeholders might have raised questions or escalated the issues.  For example, did the fund change its philosophy and did this change lead to the loss? If so, what about changes to their trading systems, training, etc. There are rumors that this loss prevention department was changing its shift to profit making. Did that happen without a project?
  • No problems: When a department does not believe that it has any problems to fix, it invariably has a lot of problem. Perhaps more importantly, it has been able to fool itself into not seeing its flaws. Or believing that only it’s managers are capable of identifying or fixing their problems. This is a high risk thought process. But it’s not uncommon. If we look at a lower-risk industry, we can learn something important. Take supermarkets. Every supermarket is a bit different. The demographics of the neighborhood change, and the physical space varies between supermarkets. Every supermarket manager needs to make compromises to maximize profitability. Managers compete fiercely against each other for the honor of top store manager. While the financial reward will not be as great as a top fund manager, it matters a lot for a supermarket manager. Yet, the head office frequently rotates managers because of “store blindness.” After being in one location for a while, managers have lived with their weaknesses for so long, that they become blind to them. This condition is progressive, creating an ever expanding blind spot where effective management cannot occur. It is no different in banking.
  • Resists exposure: We all know that some manager are more helpful and others are less helpful in developing projects. But managers that are completely absent should set off a red flag. Especially if they are responsible for high-value  assets. High-value and high-risk  operations should be the most connected operations within the firm. They need to have regular contact with stakeholders in other departments, including regulators. The project portfolio should provide insight into the intentions of the that department. Active resistance to exposure can be a culmination of the other influences (everything is OK, I have no reasons to be connected, I don’t need help from other department, etc.).  However, it could also be that the operations of this department are too proprietary, too confidential to be exposed to the entire PMO. If this is the case, I would argue for a sub-department… the Confidential Projects PMO.  This would be a smaller group that only works on projects with high levels of confidentiality.  Big financial firms must flow information from business units to many other groups (IT, compliance, legal, HR, etc.), so there are few legitimate reasons for not injecting PMO disciplines into the top levels of business thinking.

Irony truly rules the world. JPMC created a group to prevent losses in portfolio trading, which pursued a high level risk strategy that has cost the firm $2 billion… so far. Yet this highly leveraged strategy could have cost JPMC much more. You can be sure that JPMC is combing through the firm to find out if other departments have gotten out of control. Expect high-level resignations and executives who suddenly have an urge to spend more time with their families. Will other firms take this as a cue to ensure that departments with the highest risks and most valuable assets are fully connected to the rest of the firm, including the PMO? Will financial firms take advantage of the position of the PMO, and the analytic skills of their project managers, to analyze the project portfolio to find signs of risk behavior and operational blindness? Probably… they will. But not until we have a much bigger and more visible blow-up. And when that blows-up happens, expect a blow by blow examination on this blog site… and that’s my Niccolls worth for today!

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One Response to Stop Burning Money: Learning From JPMC’s Financial Mistakes

  1. Neil says:

    The way hedging strategies work is that they are able to use the securities from their clients (OPM) to speculate and dictate the markets openly without any supervision or disclosure and benefit from it. Then they turn around and pay their top officers unreal amount of money in bonuses and in case their stategy went bad then the taxpayers bail them out. So only the stockholders or the taxpayers are at risk not the banks ! what a country !
    I know this as I have worked for these wall street banks.

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