The federal government charged two former JPMorgan Chase JPMorgan Chase employees, Javier Martin-Artajo and Julien Grout, for their involvement in a multi-billion dollar loss at the bank last year. Prosecutors accused the two men of conspiring to falsify books and records, falsifying filings made with the Securities and Exchange Commission, and wire fraud. In essence, the complaint filed by prosecutors blames Grout and Martin-Artajo for covering up losses incurred by the bank.
This prosecution was the first criminal action associated with the event. The question is: will it help reform Wall Street‘s risk management and curb the types of reckless behavior that contributed to the 2008 financial crisis? Or will the case’s narrow focus on an alleged cover up of a massive trading loss fail to make a bigger impact on the financial sector?
The problems at JPMorgan started in its Chief Investment Office, a unit with more than 100 traders and $300 billion in assets. In early 2012, trades made by the unit in various credit default swaps began to drop. As the losses mounted, JPMorgan painted a rosy picture of the situation, telling regulators and investors through statements and SEC filings that the losses were far lower than what had actually occurred. At the end, the extent of the losses added up $6 billion, far higher than the initial estimates JPMorgan disclosed.
In a detailed account, the government accuses Grout and Martin-Artajo for artificially deflating the losses JPMorgan incurred and of hiding the losses from their superiors at the bank. It is a bit surprising that the primary person involved in the ill-fated trades, the so-called “London Whale” Bruno Iksil, was not charged. But the bigger question is will this action help lead to changes that will prevent losses caused by poor internal controls and faulty risk management going forward?
The primary causes of the 2008 financial crisis had little to do with the types of actions detailed in the charges made by the government. Instead, reckless bets, short-sighted incentive structures, a misunderstanding of risk, and the inability to understand the risks associated with complex financial instruments like CDOs all contributed to the imbroglio. When compounded by the panic stricken chain reaction that underlies just about every market crash, the end result was the worst recession since the 1930s. Outright fraud, theft, or cheating – the type of behavior we think of when we conjure up memories of Bernard Madoff or one of the many financiers found guilty of insider trading in recent years – was not widespread. The lack of chargeable offenses is what frustrated so many Americans who wanted those responsible for the crash to pay for the damage they caused to the economy.
The reforms instituted after 2008 primarily through the enactment of the Dodd-Frank Reform Act were supposed to curb the reckless behavior of the nation’s largest financial institutions, primarily the ones that were “too big to fail” because they would be bailed out by the government if they were on the verge of collapsing.
Unlike some of its peers, JPMorgan had not suffered major losses during the financial crisis. Its performance earned its CEO, Jamie Dimon, widespread praise. The $6 billion loss undermined this perception and exposed the scary proposition that if the bank renowned for its risk management could lose so much money in a short period of time, how would other financial institutions fair.
The allegations made by the government – fraud, concealment of facts, falsification of losses both internally and to the outside world – are certainly worthy of prosecution. But they don’t address the underlying problem: how did a firm renowned for its risk management fail to stop a multi-billion dollar loss in the first place? The timing of the loss in the wake of a crisis still fresh in everyone’s memory made the event that much more shocking. The government’s case doesn’t address these underlying risks in the financial sector and until regulators really get to the heart of the problem, such losses are likely to occur again in the future.