JPMorgan Chase faced intense criticism Friday for claiming that a surprise $2 billion loss by one of its trading groups was the result of a sloppy but well-intentioned strategy to manage financial risk.
More than three years after the financial industry almost collapsed, the colossal misfire was cited as proof that big banks still do not understand the threats posed by their own speculation.
"It just shows they can't manage risk — and if JPMorgan can't, no one can," said Simon Johnson, the former chief economist for the International Monetary Fund.
Late Friday, the Wall Street Journal reported that JPMorgan had instructed traders several months ago to find a way to reduce the bank's exposure to market fallout from Europe's deepening financial crisis. Instead of shrinking the risk, the Journal reported, their complicated bets backfired into losses of as much as $200 million a day in late April and early May.
The Journal wrote, "While attention has focused on large positions taken by a trader nicknamed 'the London whale,' he and other traders were carrying out instructions from a bank executive'' according to people familiar with the situation.
JPMorgan is the largest bank in the United States and was the only major bank to remain profitable during the 2008 financial crisis. That lent credibility to its tough-talking CEO, Jamie Dimon, as he opposed stricter regulation in the aftermath.
But Dimon's contention that the $2 billion loss came from a hedging strategy that backfired, not an opportunistic bet with the bank's own money, faced doubt on Friday, if not outright ridicule.
"This is not a hedge," said Sen. Carl Levin, D-Mich., chair of a subcommittee that investigated the crisis. He said the trades were instead a "major bet" on the direction of the economy, as published reports suggested.
Dimon, 56, told NBC News he did not know whether JPMorgan had broken any laws or regulatory rules. He said the bank was "totally open" to regulators. The head of the Securities and Exchange Commission, Mary Schapiro, told reporters that the agency was focused on the JPMorgan loss but declined to comment further.
The Journal's report said U.S. and British regulators are examining what went wrong, who is responsible and whether JPMorgan should have told investors about the losses sooner.
JPMorgan's disclosure recharged a debate about how to ensure that banks are strong and competitive without allowing them to become so big and complex that they threaten the financial system when they falter. The loss did not cause anything close to the panic that followed the September 2008 failure of the Lehman Brothers investment bank. But it shook the confidence of the financial industry.
Within minutes after trading began, JPMorgan stock had lost almost 10 percent, wiping out about $15 billion in market value. It closed down 9.3 percent.
Fitch Ratings downgraded the bank's credit rating by one notch, while Standard & Poor's cut its outlook on JPMorgan to "negative," indicating a credit-rating downgrade could follow.
Dimon gave few details about the trades Thursday beyond saying they involved "synthetic credit positions," a type of the complex financial instruments known as derivatives.
Enhanced oversight of derivatives was a pillar of the 2010 financial overhaul law, known as Dodd-Frank, but the implementation has been delayed repeatedly and will not take effect until the end of this year at the earliest.
JPMorgan's trades show that the derivatives market remains too opaque for regulators to oversee effectively, said Rep. Barney Frank, D-Mass., one of the law's namesakes.
"When a supposedly responsible, well-run organization could make such an enormous mistake with derivatives, that really blows up the argument, 'Oh, leave us alone, we don't need you to regulate us,' " he said.
"This just tells you that we are a long, long way from getting our arms around this whole 'too big to fail' issue," said Cliff Rossi, a former top risk executive for Citigroup, Countrywide and other big financial companies.
Immediately after the 2008 crisis, there was broad public support for an overhaul of bank regulations.
The Obama administration called for consolidation of regulators and oversight of the multitrillion-dollar marketplace for derivatives.
Regulators are still drafting hundreds of rules under the 2010 law. As Wall Street has returned to record profits, and executives to million-dollar bonuses, banks have fought to soften those rules.
In particular, the industry has fought hard against a few provisions that might have prevented the problems at JPMorgan.
One is the so-called Volcker rule, which will prohibit banks from trading for their own profit. The rule is still being written, and the Federal Reserve has said it will begin enforcement in 2014.
JPMorgan said that its bets were made only to hedge against financial risk. Dimon conceded that the strategy was "egregious" and poorly monitored. But analysts, former bank executives and many lawmakers disagreed.
"This is an exact description of proprietary trading-style activity," Sen. Jeff Merkley, D-Ore., told reporters Friday. "This really is a textbook illustration of why we need a strong Volcker rule firewall."