A few blogs ago we talked about how undisclosed risk in any operation or project can completely change the game. What used to be the right choice may now the wrong one, when you don’t know the whole story. The $2 billion loss at JPMC… or is it $3 billion loss… or should we count the $20 billion in lost equity value… is all about undisclosed risk. Simply, a program was set up by JPMC’s Chief Investment Office to run a hedge fund to insurance against risk-related losses on JPMC’s equity portfolios, valued at as much as $400 million. You can argue if that’s a good or bad strategy, but it is logical to want to reduce that risk. However, rather than reducing risk, it was increased, and money was lost. Something was changed.
The source of the problem, the “Gemba” in Kaizen/Lean quality management world, was that this “insurance” program changed, apparently without authorization or notification. Senior revenue producers, especially in the finance world, may think it’s peculiar to speak in terms of project management or quality control when looking at the actions of senior managers. Yet, without this discipline, problems happen. Carefully examine the discussions between JPMC and the government, and you see that this “insurance” program looks more like a profit center. That’s a big change with a lot of implications for the business model. An acceptable risk to protect assets is not the same as an acceptable risk to make a profit. The Chief Investment Office either made or was on the way to make this transition without a transition program to support the changed role.
According to Bloomberg BusinessWeek, “JPMorgan altered the risk model in mid-January without telling investors…” Back in May the New York Times stated, “JPMorgan’s office, with a portfolio of nearly $400 billion, had become a profit center that made large bets and recorded $5 billion in profit over the three years through 2011.” The change in roles may have accelerated after January 2012, but the Chief Investment Office was at least dabbling (if a $5,000,000,000 profit can be considered dabbling) with a more risk oriented role for years. It’s not clear if all the money or just some came from this hedge fund, but the role of the OFFICE seemed to move steadily towards riskier and more profitable models. Even if the intention was still to protect assets, we shouldn’t be surprised that the thinking of this office was in transition and would eventually apply that thinking to all assets under its control. When billions of dollars of revenue started to appear in this office, didn’t anyone question how this financial alchemy was possible?
What we’re seeing is a combination of events. First, when money starts to flow in a financial firm, people tend to get out of the way. I don’t think that requires many explanations, and it’s why there is so much discussion about controls… and whether these controls should be imposed by the financial firms or the government. Even Jamie Dimon agrees that there must be more control, “Mr. Dimon said that there should be specific limits on the types of trades that failed. In this case, however, he said, not enough limits were erected.” However, there is another factor, one that is pretty difficult to understand. Let’s call it the “invisible Gorilla.” YouTube created a buzz a while back with a video about people passing around a ball. The video instructs you to watch the people in the video and count the number of times the ball is passed. Half way through the video (which runs less than a minute) a guy in a gorilla suit walks across the stage. You are now asked, “How many times was the ball passed (16 times)? You are then asked if you saw the Gorilla. About 40% (mostly the people who got the ball passing number right) say, “What Gorilla?”
The human brain is VERY bad at multi-tasking, regardless of what the average teenager thinks. This video highlighted the problem with texting and driving at the same time. People are bad multi-takers because we don’t really multi-task. Instead we selectively ignore information. Individuals who can hyper-focus well, type “A” personalities like Wall Street senior managers, can perform complex tasks breathtakingly well and still ignore a “Gorilla” staring then right in the eyes. Add to that the prejudice we have that individuals who make millions of dollars a year have brains that can handle situations that confuse the rest of us. While some people are better at some tasks, asking a single brain to multi-task (which causes mistakes), hyper-focus (which causes blind spots), and take responsibility for income generation with confidential investments (which limits controls, inputs and awareness of events by others) we create a risky mix of human frailties. That’s why project management and quality control needs to be more involved in top level banking activities. These methodologies take these shortcomings into account and offset them with areas of human strengths.
I don’t know if Wall Street is ready to hear this, think about how long it’s taken us to realize how bad we are at driving and doing anything else. Still, I think that we need to rely more on structured processes that create the visibility that senior managers need. At least, that’s my Niccolls worth for today!