A financial journalist delved into the causes for a major trading scandal at US investment bank JP Morgan - and guess what he discovered?
Last year, the supposedly robust and fortress-like JP Morgan surprised regulators and the market by reporting that an employee in its chief investment office had racked up trading losses of $6.2bn. The culprit Bruno Iksil became known as the “London Whale” because of the scale of his trading.
As usual, the episode set off a whelter of internal and external investigations culminating in hearings before the US senate this week.
ExcelZone picked up the trail from Smurf on Spreadsheets and followed it to Zerohedge.com, where Tyler Durden looked at the background in more detail. One of the initial warning signs was a huge leap in the bank’s VaR figures in the first quarter of 2012.
According to the bank’s SEC 10-Q filing, “The increase in CIO average VaR was due to changes in the synthetic credit portfolio held by CIO as part of its management of structural and other risks arising from the Firm's on-going business activities.”
Durden urged readers to keep that last statement in mind as he delved into an internal task force report that explained the circumstances behind the VaR reporting discrepancy. Previously, the bank had relied on a Basel II.5-based spreadsheet model for the CIO’s VaR reporting, but stopped doing so in 2012 after errors were discovered in the model, including an operational error in the calculation of the relative changes in hazard rates and correlation estimates.
The taskforce explained: “Specifically, after subtracting the old rate from the new rate, the spreadsheet divided by their sum instead of their average, as the modeller had intended. This error likely had the effect of muting volatility by a factor of two and of lowering the VaR... It also remains unclear when this error was introduced in the calculation.”
So JP Morgan’s skyrocketing VaR was down to a grossly incorrect Excel formula that misreported the bank’s VaR by 50% for years. The official 10-Q explanation “conveniently missed to mention that, oops, we made a rookie, first year analyst error”, noted Durden.
What does that say about all the other banks that are not as closely supervised by the Federal Reserve, he added. “Or how about Europe's far more troubled banks?”
