Lawmakers Question Why Regulators in the Dark on JPM Trades

WASHINGTON – The heads of the U.S. government’s two financial-market watchdogs did not learn of trades that led to sharp losses at JPMorgan Chase until they were reported by the media, the agency chiefs told Congress on Tuesday.

Lawmakers appeared surprised by the remarks from Mary Schapiro, who heads the Securities and Exchange Commission, and Gary Gensler, chairman of the Commodity Futures Trading Commission, at a Senate Banking Committee hearing.

“So you really didn't know what was going on, or the problem with the trade, until you read the press reports like all of us?” asked Republican Sen. Richard Shelby.

“That's what I've said, yes, sir,” Gensler responded.

The trades that led to JP Morgan's growing losses were first reported by Bloomberg News in early April, nearly a month before the bank reported $2 billion in losses on its deteriorating credit derivatives positions.

The SEC is now investigating whether JPM’s disclosures were both accurate and timely, Schapiro testified. And the CFTC has opened a separate investigation into the trades themselves, according to Gensler.

The regulators’ testimony illustrated that there are still key gaps between what different regulatory agencies can see inside large financial institutions, three and a half years after the collapse of insurer AIG made that problem apparent.

Schapiro noted that none of the transactions in question occurred inside JP Morgan’s U.S. broker-dealer, which is regulated by the SEC. Rather, the trades took place in a U.K. branch of JP Morgan’s commercial bank, which is regulated by the Office of the Comptroller of the Currency, and in another London- based unit.

“So the SEC did not have any direct oversight or knowledge of the transactions,” Schapiro said.

The CFTC has the authority to monitor credit derivatives market – where the trades in question were made – for fraud and manipulation, according to Gensler. But he added that the agency does not yet regulate JP Morgan as a swaps dealer because it has not finalized the rules that the Dodd-Frank Act mandated in that area.

Those comments prompted Shelby to ask, “So you're saying it's a no man's land?”

“Currently the American public is not protected in that way,” Gensler responded.

The gaps in regulatory oversight were not the only context in which the JPMorgan trades drew comparisons to the AIG fiasco. Democratic Sen. Jeff Merkley compared the way in which JPMorgan took a position on corporate debt to AIG’s failed bet on the U.S. mortgage market.

“And pretty soon, they were in the position of doing what AIG did, which was to sell lots of insurance very cheaply, and then when the bets went bad, they had to pay off,” Merkley said.

Merkley was one of the authors of the Volcker Rule, the 2010 measure that bans proprietary trading by banks, and he and other committee Democrats used Tuesday’s hearing to push the regulators for a tough implementation of that provision.

Much of the debate over the Volcker Rule involves where the regulators should draw the line between forbidden proprietary trading and allowable hedging, a question that has gained a much higher public profile because of the losses at JPMorgan.

Schapiro argued that the law establishes strong criteria that must be met before a trade meets the exemption for hedging.

“So I think there's strong language there, and what we need to do is take what happened at JPMorgan and view it through the lens of those criteria and see how that helps to inform the rulemaking going forward,” she said.

Gensler, who has been an advocate for a tough implementation of the Volcker Rule, noted that the law requires a hedge to be a firm’s specific risk from individual or aggregate positions. He also suggested that the draft rules should be reconsidered in light of what has happened at JP Morgan.

“And this experience reminds us maybe we have to go back and make sure it really is tied to specific aggregate positions,” he said. “It's not sort of like, ‘Well, we think revenues will go up,’ or … ‘We like the European debt markets these days.’”

Democrats on the Banking Committee argued that the JPMorgan situation shows why it was important in Dodd-Frank to address the threat posed by large financial institutions.

“Because if JPMorgan lost $2 billion, or some reports suggest likely more, through these trades, what's to stop them from losing $10 billion the next time?” Democratic Sen. Robert Menendez asked. “Or even worse, to stop another less- capitalized bank from taking losses so large that it could bring it down?

Committee Republicans countered that the difficulty in distinguishing a hedge from a proprietary trade shows the futility of the Democrats’ approach to financial regulation.

GOP Sen. Pat Toomey argued that the regulators have an impossible task under Dodd-Frank.

“And the task is to micromanage the activities of these institutions. That's what Dodd-Frank attempts to do, says we're going to limit systemic risk by controlling everything you can do in great, minute detail,” Toomey said.

“The better solution is require more capital so that we can let people do what they want to do, let the people in the marketplace make the decisions they will make, and then let them live with the consequences.”

Tuesday’s hearing was the first of three in which members of the Banking Committee will grapple with the JPM losses. Banking regulators will testify on June 6, and JPMorgan CEO Jamie Dimon will testify at a later date.

Dimon could also be called to testify before the House Oversight Committee. Democrats on that panel asked Tuesday that the committee’s Republican chairman, Rep. Darrell Issa, hold a hearing with Dimon.