Federal Reserve Governor Daniel Tarullo said the central bank is helping oversee JPMorgan Chase & Co.’s management of a portfolio that lost $2 billion in a credit-derivatives position.
“The Federal Reserve has been assisting in the oversight of JPMorgan’s efforts to manage and de-risk the portfolio,” Tarullo said in comments prepared for testimony tomorrow before the Senate Banking Committee in Washington.
JPMorgan has been under tougher regulatory scrutiny since Chief Executive Officer Jamie Dimon said May 10 that the firm’s chief investment office suffered the loss. He later called it “a Risk 101 mistake.” Regulator probes began after traders in the London office, which manages the bank’s excess cash, made wrong-way bets on illiquid credit derivatives.
Shares of the New York-based company (JPMORGAN:US) have fallen about 21 percent since May 10, and several federal agencies, including the Securities and Exchange Commission and the Office of the Comptroller of the Currency, are looking into the matter.
Tarullo said the Fed anticipates working with the OCC and the Federal Deposit Insurance Corp. “to identify the changes in risk measurement, management and governance that will be necessary to improve risk-control practices surrounding the firm’s trading activities and to address trading strategies that led to these losses.”
“The Federal Reserve has been looking at other parts of the holding company to determine if governance, risk management and control weaknesses -- similar to those exposed by this incident -- are present elsewhere,” he said, adding that the Fed’s review is not yet complete.
Tarullo, a former law professor and aide to President Bill Clinton, is the Fed’s lead governor on bank supervision. Since taking office in January 2009, he has overhauled the Fed’s bank oversight and piloted the implementation of the Dodd-Frank Act, the most sweeping change to financial regulation since the 1930s.
The Fed governor has also sharpened the central bank’s focus on the largest U.S. financial institutions with stress tests, capital plan reviews, and the creation of the Large Institution Supervision Coordinating Committee, a multi- disciplinary task force that draws on the central bank’s economists and quantitative analysts to hunt down systemic risk.
The LISCC “ also has focused its attention on potential implications for financial stability in the United States from stresses arising in Europe,” Tarullo said in his remarks.
Tarullo emphasized that large banks must maintain sufficient capital buffers to absorb losses, and limit their risk to the overall financial system to avoid a repeat of the financial crisis that he said was the worst since the 1930s.
“It is critical that we complete the implementation of capital and other prudential measures to prevent another crisis and protect taxpayers from having again to recapitalize financial firms,” he said. The economic recovery “is far from complete,” he added.
The Fed governor has used the stress tests and capital plan reviews as a goad to assure banks balance dividend payments and stock buybacks with plans to boost and maintain capital.
“The best way to safeguard against taxpayer-funded bailouts in the future is for our large financial institutions to have capital buffers commensurate with their own risk profiles and the damage that would be done to the financial system if such institutions were to fail,” Tarullo said.
He said “recent events” are a reminder that “substantial amounts of high-quality capital is the best way to ensure that significant losses at individual firms are borne by their shareholders, and not by depositors or taxpayers.”
The 19 largest banks participating in these exams have increased their tier one common capital levels to $759 billion in the fourth quarter of last year from $420 billion in the first quarter of 2009. That raised the ratio of capital to risk- weighted assets to 10.4 percent from 5.4 percent. The biggest banks paid out 15 of net income in common dividends in 2011 compared with a payout of 38 percent net income in 2006, according to the Fed.
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