WASHINGTON, DC – At a Senate Banking Committee hearing today investigating JPMorgan Chase & Company’s $2 billion trading losses in the bank’s Chief Investment Office (CIO), U.S. Senator Jack Reed (D-RI) sharply questioned CEO Jamie Dimon about accountability, risk management, bank supervision, and Wall Street reform. 

JPMorgan’s Chief Investment Office managed as much as $375 billion in assets and was supposed to help the bank manage credit risk.  But after large derivative bets by a trader nicknamed "the London whale" went bad and roiled a sector of the markets, JPMorgan lost at least $2 billion, with the full extent of the losses still unknown.

As one of the architects of the landmark Wall Street reform law, Senator Reed has worked to strengthen financial regulation and improve federal oversight of banks and securities firms.  Reed is a strong proponent of the Volcker rule, which would prevent banks like JP Morgan with government-insured deposits from engaging in proprietary trading and limit their investments in private equity and hedge funds.  While a version of the Volcker rule was included in the historic 2010 Wall Street reform law, the Federal Reserve has yet to finalize it and attempts have been made by the financial industry to water it down.  Reed wants a strong Volcker rule to be implemented as soon as possible to prevent other big banks from using taxpayer-backed funds from engaging in the kind of proprietary trading that led to JPMorgan’s massive loss.

Today, in response to Reed’s questioning, Dimon testified that a fully implemented Volcker rule once put in place “may very well have stopped parts of what this portfolio morphed into.”

A partial transcript of today’s hearing follows:

CHAIRMAN JOHNSON: Senator Reed?

SEN. JACK REED: Well, thank you very much, Mr. Chairman.

I think this is a very important hearing because the issues that have been raised go right to the capability of large, complex international financial institutions to manage risk. And complementing that is the ability of regulators to oversee the manner in which risk is being managed by those corporations. And I think it also is a strong case in my view for a very clear, but very strong Volcker rule. And also our standing up finally a director at the Office of Financial Research; I know I've been talking to Chairman Johnson and also Ranking Member Shelby about that.

But let me ask a question. This goes to risk management. The -- in your proxy materials risk management seems to be the responsibility out of the Office of Risk Management, which is an individual different than the CIO. Was this individual, and I know there were several changes, monitoring and supervising the CIO, the chief investment officer, on a regular basis? Did he or she prove the change in modeling for the VAR?

DIMON: So, every business we have has a risk committee. Those risk committees and the head of risk in those businesses report to the head of risk of the company, and there are periodic conversations between the risk committees and the head of risk of the company and our senior operating group about the major exposures we're taking. And obviously that chain of command didn't work in this case either because we missed a bunch of these things.

So you can blame it on anyone in that chain that if we'd been paying a little more attention to why there weren't more granular limits here we could have actually have caught this and stopped that at this point. There's an independent model review group that looks at changes in models, and we do change models all the time. Models are constantly being changed for new facts.

I just caution, models are backward looking. You know, the future isn't the past. And they never are totally adequate in capturing changes in businesses, concentration, liquidity, or geopolitics or things like that. So we're constantly improving them.

I also don't think -- we don't run the business on models. Models are -- they're one input. You should be looking at lots of other things to make sure you're managing your risk properly.

REED: Did you share with or did the OCC inquire about the change in the modeling? And I -- and for the record, this change was just in the -- the office of investment, correct? It wasn't...

DIMON: There was a change in the office of investment in January. A new model was put in place and we took it out and put the old model back in some time...

REED: Why didn't you change the model firm-wide?

DIMON: Well, the firm has hundreds of models. This model was very specific to that synthetic credit portfolio. It wasn't...

REED: Let me get back to my question with OCC. Were they aware of the change? Did you bring it to their attention?

DIMON: I don't know. You know, we generally are open kimono with the regulators and tell them what they want to know. They often look in models. Some models they actually do in extensive detail. I don't know particularly in this one.

REED: If the -- according to the proxies, the chief investment officers are responsible for measuring, monitoring, reporting and managing the firm's liquidity, interest rate, and foreign exchange risks and other structural risks, which basically essentially -- at least the implication is their job is risk management, not generating profits by investing deposits.

It seems that their model -- their BAL (ph) model was loosened up considerably, giving them the opportunity to engage in more risky activities. Is that your conclusion looking backwards?

DIMON: Yeah, half. In January, the new model was put in place that allowed them to take more risk and it contributed to what happened. I -- we don't as of today believe it was done for nefarious purposes. We believe it was done properly by the independent model review group. There may be flaws in how it was implemented, but once we realized that the new model didn't more accurately reflect reality, we went back to the old model.

REED: Now let me ask, it appears, you know, from looking at some published reports that essentially these credit default swaps were first made to protect your loans outstanding, particularly in Europe. And that was in the 2007-2008 time period, which is a classic hedging. You have extended credit to corporations. Those credits go bad. You want to be able on the other side to ensure yourself against that.

But then in, well, 2011 and '12 at some point, the bet was switched. And now you started, rather than protecting your credit exposures, taking the other side of transaction, selling credit protection, which seems to me to be a bet on the direction of the market unrelated to your actual sort of credit exposure in Europe, which looks a lot like proprietary trading designed to generate as much profit as -- as you could generate, which seems to be consistent, again, with -- if this is simply a risk operation and you're hedging a portfolio.

How can you be on both sides of the transaction and claim that you're hedging?

DIMON: I think I've -- I think I've been clear, which is the original intent I think was good. It was just morphed into -- I'm not going to try to defend. Under any name, whatever you call it, I will not defend it. It violated common sense in my opinion. I do believe the people doing it thought that they were maintaining a short against high-yield credit that would benefit the company in a crisis. I think -- and we now know they were wrong.

REED: But that leaves us in the situation of how do we build in -- because it's our responsibility -- build in rules and regulations that prevent, as you would say, well intentioned, extremely bright people who are doing things that are very detrimental?

First of all, you've lost several billions of dollars, which this activity was located in the bank. And frankly, it was deposits that are ensured by the federal government. And second, you've lost a significant amount of your market value to your shareholders.

And the irony to me is that if there was a good Volcker rule in place, they might not have been able to do this because it clearly doesn't seem to be hedging customer risk or even the overall exposure to the bank's portfolio.

DIMON: I don't know what the Volcker is. It hasn't been written yet. It's very complicated. It may very well have stopped parts of what this portfolio morphed into.

REED: So there is the possibility, in fact, if it's done correctly as proposed, which we -- I hope it is, that it would have -- could have avoided this situation.

DIMON: It's possible. I just don't know.

REED: Thank you very much.