The Senate Banking Committee Discusses Dodd -Frank Implementation, the Volcker Rule and JPMorgan’s Trading Loss
AT TODAY’S SENATE BANKING COMMITTEE HEARING, top regulators from the Treasury Department, Federal Reserve (Fed), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC) and Consumer Financial Protection Bureau (CFPB), discussed the implementation of the Dodd-Frank Act, the Volcker Rule and the multi-billion dollar trading loss at JPMorgan Chase.
Although the stated purpose of the hearing was to update Congress on the implementation of the Wall Street reform law, Committee members continued its probe into the trading loss at JPMorgan, focusing on the OCC’s failure to detect JPMorgan’s risk-taking and discussing ways to prevent trading losses of this magnitude. The hearing also served as a prelude to next week’s Committee hearing where Jamie Dimon, the CEO of JPMorgan Chase, is set to testify about the trading loss and his criticisms of the Dodd-Frank Act.
In his opening statement, Chairman Tim Johnson (D-S.D.) discussed the implications of JPMorgan’s trading loss, which he believes reinforces the importance of regulation, oversight, and enforcement. He said regulators need to increase capital requirements, improve leverage standards, and sharpen focus on the largest and riskiest institutions because “no financial institution is immune from bad judgment.” He acknowledged that there should be separate standards for banks of different sizes, saying a “one size fits all approach is not appropriate.” In closing, he disagreed with calls for deregulation and said more scrutiny of institutions is necessary to restore confidence.
Ranking Member Richard Shelby (R-Ala.) expressed concern about the implications of JPMorgan’s loss on taxpayers. He said taxpayers “basically guarantee” JPMorgan’s deposits and they deserve to know if this loss will threaten the bank’s health or cause serious systemic problems. He identified a number of policy issues he believes will have a negative impact on the economy, including the possibility of a bailout for short term creditors and regulators’ authority to designate companies as systemically important. He said such a designation seems like an implicit guarantee that the institution will not be allowed to fail at any cost.
Neal Wolin, Deputy Secretary of the U.S. Department of the Treasury, focused his testimony on the implementation of Dodd-Frank. He said the legislation addresses key financial system failures through constraints on risk-taking and leverage, the creation of an orderly liquidation authority, oversight of derivatives, stronger consumer protection, and greater transparency. Wolin discussed the success of the Financial Stability Oversight Council (FSOC) in designating utilities and companies for enhanced prudential standards and facilitating research and information-sharing through the development of a report on financial market and regulatory developments. He also highlighted increased research and monitoring from two offices created by Dodd-Frank, the Federal Insurance Office and the Office of Financial Research.
He said the lessons learned from the JPMorgan losses will be important to the Volcker Rule discussion, which he said explicitly exempts risk-mitigating hedging activities that benefit customers. In closing, Wolin stressed the importance of ensuring that no exceptions are allowed to undermine the impact of Dodd-Frank.
Daniel Tarullo, Member of the Board of Governors of the Federal Reserve, opened his testimony by stressing the centrality of strong capital standards to a strong financial system. He said a bank with a “strong capital position can absorb loss from unexpected sources… [ensuring] losses are borne by the bank and not by taxpayers.” He said he is pleased that the Fed is in the final stages of implementing more rigorous capital regulations, and believes that these regulations, in conjunction with stress tests, capital surcharges, and comprehensive reviews, will form a complementary set of requirements to increase market discipline and oversight. He praised the intentions of Dodd-Frank Sections 165 and 166, and the Volcker Rule, to enhance prudential standards, and noted the necessity of tailoring the application of these standards to differently sized banks. Tarullo also highlighted the Fed’s progress creating a data driven, horizontal approach to improving supervision.
In his opening statement, Thomas Curry, Comptroller of the Currency, gave a broad overview of the OCC’s implementation of Dodd-Frank regulations and its response to JPMorgan’s recent losses. He said the OCC has recently approved replacing credit ratings with investment grades as well as proposals to implement Basel III, and reviewed comment letters in regards to the Volcker Rule and Dodd-Frank in general. He said the OCC has worked to translate reforms into a fair banking system by increasing awareness of the risks that banks face, ensuring that risk is well-managed, raising expectations for management, and increasing capital reserves and liquidity governance.
Noting that his office is the primary regulator and prudential supervisor of JPMorgan Chase, Curry said OCC examiners met with JPMorgan’s management team to discuss transaction activity in April, when the state of its investment position “deteriorated rapidly.” He said the OCC is currently compiling a two-pronged review of supervisory activities, focusing on the adequacy of risk controls at JPMorgan and how to apply the lessons learned from this loss to enhance risk management for other banks. Curry said the OCC is also evaluating the functions of the Chief Investment Officer, and will pursue “formal and informal remedial measures” if necessary. He also assuaged fears of contagion or losses to customers, pointing to the bank’s strong capital position and indicating that losses will only affect JPMorgan’s earnings.
In his opening statement, Martin Gruenberg, Acting Chairman of the FDIC, stressed the importance of resolution for systemically important financial institutions. He said the FDIC has taken several steps to achieve this goal, including creating an Office of Complex Financial Institutions to monitor risk, conducting resolution planning, and coordinating with regulators overseas. He said the FDIC has also completed basic rulemaking processes necessary for identifying systemic risk, including working with foreign regulatory authorities in the UK under Section 210 of Dodd-Frank and establishing the authority to designate systemically important institutions. Gruenberg noted that Dodd-Frank rules may affect community banks and discussed changes to the deposit insurance program intended to benefit smaller banks, including permanently increasing the insurance limit and reducing aggregate premiums paid by smaller banks by redefining the base used for deposit insurance assessments. He added that the FDIC is also holding roundtables with community bankers and researching the evolution of community banking.
In his testimony, Richard Cordray, Director of the CFPB, provided updates on the steps the CFPB has taken to increase its supervision of financial institutions and implement Dodd-Frank regulations. He said the bank supervision program is well underway, and examiners are working to ensure compliance with the law. Cordray said the CFPB is also working with state regulators to avoid potential problems with inconsistent federal and state regulation. Additionally, Cordray discussed the CFPB’s role on the FSOC, commenting on the effectiveness of mutual participation in identifying risks. In closing, he acknowledged the issues that community banks are facing, stating that although the CFPB does not examine banks worth less than $10 million, they are working to eliminate uneven standards through their oversight of non-bank firms.
Question and Answer
The JPMorgan Trading Loss
Johnson and Sen. Charles Schumer (D-N.Y.) asked Curry if the JPMorgan trading loss was a failure in risk management and what should be done differently to prevent this type of loss in the future. Curry said the OCC believes the loss was a result of “inadequate” risk management in the Chief Investment Office. He said the OCC’s investigation into the loss has focused on JPMorgan’s deviation from standard risk management practices in that office and across the firm.
Following up, Schumer asked Tarullo if the Federal Reserve is reviewing the risk management infrastructure of the other banks it oversees. Tarullo said one of the virtues of enhanced prudential standards is that it requires “horizontal comparison and review” to be effective, which means that the Fed will examine each institution’s risk management infrastructure and compare them.
Johnson asked Wolin if the JPMorgan trading loss posed a systemic risk and what effect the loss would have on future Dodd-Frank rulemakings. Wolin acknowledged the size of JPMorgan’s loss, but said it did not pose any systemic risks to the financial system. He said the conclusions that will be drawn from the trading loss at JPMorgan will serve as “important insights” for regulators as they draft a range of Dodd-Frank rulemakings, including the Volcker Rule, risk management practices, and enhanced prudential standards.
Schumer noted that hedge funds were able to identify the JPMorgan trades that went bad because of their “irregular impact” on the market for credit derivatives. He asked Tarullo if it is possible to build an early warning system that alerts regulators if a single firm accumulates a significantly large position in a single product or market. Tarullo said regulators do have a type of early warning system though their supervisory processes because they are monitoring market indicators to identify risky trading trends. He added that a major obstacle to identifying the trades that JPMorgan was making is the disparity in man power between JPMorgan and the regulators.
Johnson, Shelby and Sen. Jack Reed (D-R.I.) asked if the OCC reviewed JPMorgan’s risk management and internal controls before the trading loss, and what kind of presence they had at the bank. Curry said a major focus of the OCC’s supervision and oversight activities is risk management, noting that they review the risk management controls of each department in the firms they regulate. He said the OCC is able to draw on a “reserve of skilled individuals” that have expertise on a range of relevant issues, noting that it has 65 “core examiners” at JPMorgan, five of which are in the London office.
Curry said the OCC began its investigation of the loss in April and is currently investigating if there are any gaps in its assessment of the risk controls in JPMorgan’s Chief Investment Office. Further, Curry said the OCC is closely monitoring how JPMorgan is mitigating additional risk from the bad investment. However, he said that reviewing risk management controls is only one way that the OCC determines risks within an organization, pointing out that capital levels, capital reserve levels and liquidity measures are also used.
Following up, Shelby asked Curry when the OCC will finish its investigation into the trading loss. Curry said they are working to complete the investigation “as quickly as possible.” When pressed by Sen. Robert Menendez (D-N.J.) for a more specific time frame, Curry said he hopes to complete the investigation in the “next several weeks, and no more than a few months.”
Shelby also asked Curry to describe the trade that triggered the multi-billion dollar loss at JPMorgan. Curry said determining the intent of the trade is one of the focuses of their investigation. He said the investment strategy that led to the loss was “very complicated” and they are looking to determine if the strategy was meant to mitigate risks in JPMorgan’s investment portfolio or generate profits.
Sen. Michael Bennet (D-Colo.) asked Curry to provide more detail on the OCC’s investigation. Curry said the OCC is taking a “two-pronged” approach. The first prong consists of identifying the nature of the hedge or trading activity in question, the trading activity’s financial risk to the firm and how the JPMorgan plans to reduce its exposure to further losses. He said the second prong is identifying if there were risk management gaps in the Chief Investment Office and across the firm, as well as how the lessons learned at JPMorgan can be applied to the OCC’s oversight of other institutions.
Sen. Mark Warner (D-Va.) asked Curry if he thinks the trades that led to JPMorgan’s losses would have violated the Volcker Rule. Curry said it is important to note that the OCC does not have all of the facts yet and is still in the process of conducting its investigation. However, he said that the loss was a result of a risk management failure, regardless of whether the trades violated the Volcker Rule or not.
Menendez and Sen. Sherrod Brown (D-Ohio) asked Curry if the OCC “screwed up” by allowing the bad JPMorgan trades to happen. Curry said the OCC is seeking to answer that question through its investigation. He noted that the investigation is not just an investigation of JPMorgan’s risk management practices, but also a self-review of the OCC’s oversight and monitoring techniques.
Dodd-Frank Implementation
Johnson and Reed asked Wolin if regulators are better coordinated and prepared to deal with external threats to financial stability and economic growth since the passage of Dodd-Frank and what steps are being taken to respond to the European debt crisis. Wolin said “there is no question” that the establishment of the FSOC has given Treasury and the various banking regulators an opportunity to more effectively monitor the situation in Europe and its implications for the US economy and financial institutions. Tarullo added that because the debt crisis in Europe has been a threat for a sustained period of time, regulators have been able to implement a system that allows them to monitor financial institutions’ exposure to Europe, and are working with those institutions to unwind that exposure.
Warner asked Gruenberg and Tarullo if they have the tools needed to evaluate the living wills that have been submitted and what standards will be used to judge the effectiveness of the wills. Gruenberg said living wills are evaluated under the standards of the bankruptcy code, and must credibly result in the effective unwinding of an institution. Gruenberg said the FDIC is working with banks as they develop their living wills and that the plans of the largest banks will be submitted for review in July.
Tarullo added that it is not possible to tailor “a lot of different resolution plans to a lot of different adverse scenarios,” which is why the review of such plans must include basic questions about the ongoing structure of the firm.
Sen. Mike Crapo (R-Ind.) expressed his concern that Dodd-Frank will reduce credit availability in the housing market though the proposed rules on qualified mortgages (QM) and qualified residential mortgages (QRM). He asked Cordray about the CFPB’s decision to reopen the comment period for the QM proposal and if he plans to convene the Small Business Panel to discuss the impact of the proposed rules. Cordray said one of the reasons the CFPB reopened the QM comment period is because the CFPB has recently obtained a significant amount of data from FHFA that “gives us [CFPB] a better window into the mortgage market.” He assured Crapo that they will draft a QM and QRM rule that is based on sound data and does not unduly restrict access to credit.
Cordray added that because the QM rule was originally proposed by the Fed, the Small Business Panel has not been convened to review the proposal, noting that if the Small Business Panel were to review the rule, the CFPB would miss the statutory deadline to release the rule. Following up, Crapo asked Gruenberg, Curry and Tarullo if they intend to wait for the CFPB to finish its definitions of QM and QRM before moving ahead with their risk retention rules. Gruenberg, Curry and Tarullo all indicated that they will wait for the CFPB before moving forward on its risk retention plans.
Crapo asked Tarullo if the Fed is considering utilizing models other than the exposure method, to measure counterparty risk given recent questions about the exposure method’s accuracy. Tarullo said the Fed’s risk modeling methodology is one of the topics that can be commented under proposed rules 165 and 166. He said a number of alternatives have been suggested but noted that the challenge is finding a methodology that tries to track actual risk exposure, but is not dependent on modeling within firms.
The Volcker Rule
Sen. Bob Corker (R-Tenn.) asked each witness to define “risk mitigating, hedging activities in connection with, and related to, individual or aggregated positions or contracts.” In regard to whether a particular trade is subject to the Volcker Rule or not, Wolin said it is important to ask if the trade is associated with an individual or aggregate position. If it is, Wolin said the trade or hedge is OK, if not, than it is not permissible under Treasury’s interpretation of the statute.
Tarullo and Curry said, statutorily, the Volcker Rule is aiming to establish “substantive guidelines” for distinguishing between hedging individual or aggregated positions and proprietary trading, and put in place risk management reporting and documentation requirements that explains the hedging strategy, how it correlates with current investment positions and how they will ensure the hedge will give rise to new kinds of exposures.
Gruenberg agreed with Tarullo’s characterization of the Volcker Rule, adding that the Volcker Rule would help establish a set of controls to monitor the type of investments banking organizations are engaging in.
Sen. Jeff Merkley (D-Ore.) asked Curry particularly pointed, rapid-fire questions regarding JPMorgan’s trading loss. Curry was clearly flustered by the line of questioning and regularly punted answers. In closing, Merkley asked if the OCC will support “closing the loopholes that allow Wall Street banks to maintain hedge fund style operations.” Curry said it is one of the issues that the regulatory agencies are seeking to address with the Volcker Rule.
In response to Merkley’s line of questioning, Sen. Pat Toomey (R-Pa.) made the point that bad loans, not proprietary trading activity led to all of the bank failures resulting from the 2008 crisis. He expressed his concern that the current regulatory environment does not address the real risks to the economy and advocated for the use of capital standards as the “essential tool to reduce systemic risk.”
Sen. Jerry Moran (R-Kan.) pointed out that a number of the witnesses said the loss at JPMorgan “informed” their position with regard to the Volcker Rule and asked the witnesses to elaborate. Curry said he means that the OCC’s experience reviewing JPMorgan’s risk management operations has better informed regulators on the types of oversight structures and mechanisms that need to be in place to ensure compliance with the Volcker Rule.
For testimony and a webcast of the hearing, please click here.
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AT TODAY’S SENATE BANKING COMMITTEE HEARING, top regulators from the Treasury Department, Federal Reserve (Fed), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC) and Consumer Financial Protection Bureau (CFPB), discussed the implementation of the Dodd-Frank Act, the Volcker Rule and the multi-billion dollar trading loss at JPMorgan Chase.
Although the stated purpose of the hearing was to update Congress on the implementation of the Wall Street reform law, Committee members continued its probe into the trading loss at JPMorgan, focusing on the OCC’s failure to detect JPMorgan’s risk-taking and discussing ways to prevent trading losses of this magnitude. The hearing also served as a prelude to next week’s Committee hearing where Jamie Dimon, the CEO of JPMorgan Chase, is set to testify about the trading loss and his criticisms of the Dodd-Frank Act.
In his opening statement, Chairman Tim Johnson (D-S.D.) discussed the implications of JPMorgan’s trading loss, which he believes reinforces the importance of regulation, oversight, and enforcement. He said regulators need to increase capital requirements, improve leverage standards, and sharpen focus on the largest and riskiest institutions because “no financial institution is immune from bad judgment.” He acknowledged that there should be separate standards for banks of different sizes, saying a “one size fits all approach is not appropriate.” In closing, he disagreed with calls for deregulation and said more scrutiny of institutions is necessary to restore confidence.
Ranking Member Richard Shelby (R-Ala.) expressed concern about the implications of JPMorgan’s loss on taxpayers. He said taxpayers “basically guarantee” JPMorgan’s deposits and they deserve to know if this loss will threaten the bank’s health or cause serious systemic problems. He identified a number of policy issues he believes will have a negative impact on the economy, including the possibility of a bailout for short term creditors and regulators’ authority to designate companies as systemically important. He said such a designation seems like an implicit guarantee that the institution will not be allowed to fail at any cost.
Neal Wolin, Deputy Secretary of the U.S. Department of the Treasury, focused his testimony on the implementation of Dodd-Frank. He said the legislation addresses key financial system failures through constraints on risk-taking and leverage, the creation of an orderly liquidation authority, oversight of derivatives, stronger consumer protection, and greater transparency. Wolin discussed the success of the Financial Stability Oversight Council (FSOC) in designating utilities and companies for enhanced prudential standards and facilitating research and information-sharing through the development of a report on financial market and regulatory developments. He also highlighted increased research and monitoring from two offices created by Dodd-Frank, the Federal Insurance Office and the Office of Financial Research.
He said the lessons learned from the JPMorgan losses will be important to the Volcker Rule discussion, which he said explicitly exempts risk-mitigating hedging activities that benefit customers. In closing, Wolin stressed the importance of ensuring that no exceptions are allowed to undermine the impact of Dodd-Frank.
Daniel Tarullo, Member of the Board of Governors of the Federal Reserve, opened his testimony by stressing the centrality of strong capital standards to a strong financial system. He said a bank with a “strong capital position can absorb loss from unexpected sources… [ensuring] losses are borne by the bank and not by taxpayers.” He said he is pleased that the Fed is in the final stages of implementing more rigorous capital regulations, and believes that these regulations, in conjunction with stress tests, capital surcharges, and comprehensive reviews, will form a complementary set of requirements to increase market discipline and oversight. He praised the intentions of Dodd-Frank Sections 165 and 166, and the Volcker Rule, to enhance prudential standards, and noted the necessity of tailoring the application of these standards to differently sized banks. Tarullo also highlighted the Fed’s progress creating a data driven, horizontal approach to improving supervision.
In his opening statement, Thomas Curry, Comptroller of the Currency, gave a broad overview of the OCC’s implementation of Dodd-Frank regulations and its response to JPMorgan’s recent losses. He said the OCC has recently approved replacing credit ratings with investment grades as well as proposals to implement Basel III, and reviewed comment letters in regards to the Volcker Rule and Dodd-Frank in general. He said the OCC has worked to translate reforms into a fair banking system by increasing awareness of the risks that banks face, ensuring that risk is well-managed, raising expectations for management, and increasing capital reserves and liquidity governance.
Noting that his office is the primary regulator and prudential supervisor of JPMorgan Chase, Curry said OCC examiners met with JPMorgan’s management team to discuss transaction activity in April, when the state of its investment position “deteriorated rapidly.” He said the OCC is currently compiling a two-pronged review of supervisory activities, focusing on the adequacy of risk controls at JPMorgan and how to apply the lessons learned from this loss to enhance risk management for other banks. Curry said the OCC is also evaluating the functions of the Chief Investment Officer, and will pursue “formal and informal remedial measures” if necessary. He also assuaged fears of contagion or losses to customers, pointing to the bank’s strong capital position and indicating that losses will only affect JPMorgan’s earnings.
In his opening statement, Martin Gruenberg, Acting Chairman of the FDIC, stressed the importance of resolution for systemically important financial institutions. He said the FDIC has taken several steps to achieve this goal, including creating an Office of Complex Financial Institutions to monitor risk, conducting resolution planning, and coordinating with regulators overseas. He said the FDIC has also completed basic rulemaking processes necessary for identifying systemic risk, including working with foreign regulatory authorities in the UK under Section 210 of Dodd-Frank and establishing the authority to designate systemically important institutions. Gruenberg noted that Dodd-Frank rules may affect community banks and discussed changes to the deposit insurance program intended to benefit smaller banks, including permanently increasing the insurance limit and reducing aggregate premiums paid by smaller banks by redefining the base used for deposit insurance assessments. He added that the FDIC is also holding roundtables with community bankers and researching the evolution of community banking.
In his testimony, Richard Cordray, Director of the CFPB, provided updates on the steps the CFPB has taken to increase its supervision of financial institutions and implement Dodd-Frank regulations. He said the bank supervision program is well underway, and examiners are working to ensure compliance with the law. Cordray said the CFPB is also working with state regulators to avoid potential problems with inconsistent federal and state regulation. Additionally, Cordray discussed the CFPB’s role on the FSOC, commenting on the effectiveness of mutual participation in identifying risks. In closing, he acknowledged the issues that community banks are facing, stating that although the CFPB does not examine banks worth less than $10 million, they are working to eliminate uneven standards through their oversight of non-bank firms.
Question and Answer
The JPMorgan Trading Loss
Johnson and Sen. Charles Schumer (D-N.Y.) asked Curry if the JPMorgan trading loss was a failure in risk management and what should be done differently to prevent this type of loss in the future. Curry said the OCC believes the loss was a result of “inadequate” risk management in the Chief Investment Office. He said the OCC’s investigation into the loss has focused on JPMorgan’s deviation from standard risk management practices in that office and across the firm.
Following up, Schumer asked Tarullo if the Federal Reserve is reviewing the risk management infrastructure of the other banks it oversees. Tarullo said one of the virtues of enhanced prudential standards is that it requires “horizontal comparison and review” to be effective, which means that the Fed will examine each institution’s risk management infrastructure and compare them.
Johnson asked Wolin if the JPMorgan trading loss posed a systemic risk and what effect the loss would have on future Dodd-Frank rulemakings. Wolin acknowledged the size of JPMorgan’s loss, but said it did not pose any systemic risks to the financial system. He said the conclusions that will be drawn from the trading loss at JPMorgan will serve as “important insights” for regulators as they draft a range of Dodd-Frank rulemakings, including the Volcker Rule, risk management practices, and enhanced prudential standards.
Schumer noted that hedge funds were able to identify the JPMorgan trades that went bad because of their “irregular impact” on the market for credit derivatives. He asked Tarullo if it is possible to build an early warning system that alerts regulators if a single firm accumulates a significantly large position in a single product or market. Tarullo said regulators do have a type of early warning system though their supervisory processes because they are monitoring market indicators to identify risky trading trends. He added that a major obstacle to identifying the trades that JPMorgan was making is the disparity in man power between JPMorgan and the regulators.
Johnson, Shelby and Sen. Jack Reed (D-R.I.) asked if the OCC reviewed JPMorgan’s risk management and internal controls before the trading loss, and what kind of presence they had at the bank. Curry said a major focus of the OCC’s supervision and oversight activities is risk management, noting that they review the risk management controls of each department in the firms they regulate. He said the OCC is able to draw on a “reserve of skilled individuals” that have expertise on a range of relevant issues, noting that it has 65 “core examiners” at JPMorgan, five of which are in the London office.
Curry said the OCC began its investigation of the loss in April and is currently investigating if there are any gaps in its assessment of the risk controls in JPMorgan’s Chief Investment Office. Further, Curry said the OCC is closely monitoring how JPMorgan is mitigating additional risk from the bad investment. However, he said that reviewing risk management controls is only one way that the OCC determines risks within an organization, pointing out that capital levels, capital reserve levels and liquidity measures are also used.
Following up, Shelby asked Curry when the OCC will finish its investigation into the trading loss. Curry said they are working to complete the investigation “as quickly as possible.” When pressed by Sen. Robert Menendez (D-N.J.) for a more specific time frame, Curry said he hopes to complete the investigation in the “next several weeks, and no more than a few months.”
Shelby also asked Curry to describe the trade that triggered the multi-billion dollar loss at JPMorgan. Curry said determining the intent of the trade is one of the focuses of their investigation. He said the investment strategy that led to the loss was “very complicated” and they are looking to determine if the strategy was meant to mitigate risks in JPMorgan’s investment portfolio or generate profits.
Sen. Michael Bennet (D-Colo.) asked Curry to provide more detail on the OCC’s investigation. Curry said the OCC is taking a “two-pronged” approach. The first prong consists of identifying the nature of the hedge or trading activity in question, the trading activity’s financial risk to the firm and how the JPMorgan plans to reduce its exposure to further losses. He said the second prong is identifying if there were risk management gaps in the Chief Investment Office and across the firm, as well as how the lessons learned at JPMorgan can be applied to the OCC’s oversight of other institutions.
Sen. Mark Warner (D-Va.) asked Curry if he thinks the trades that led to JPMorgan’s losses would have violated the Volcker Rule. Curry said it is important to note that the OCC does not have all of the facts yet and is still in the process of conducting its investigation. However, he said that the loss was a result of a risk management failure, regardless of whether the trades violated the Volcker Rule or not.
Menendez and Sen. Sherrod Brown (D-Ohio) asked Curry if the OCC “screwed up” by allowing the bad JPMorgan trades to happen. Curry said the OCC is seeking to answer that question through its investigation. He noted that the investigation is not just an investigation of JPMorgan’s risk management practices, but also a self-review of the OCC’s oversight and monitoring techniques.
Dodd-Frank Implementation
Johnson and Reed asked Wolin if regulators are better coordinated and prepared to deal with external threats to financial stability and economic growth since the passage of Dodd-Frank and what steps are being taken to respond to the European debt crisis. Wolin said “there is no question” that the establishment of the FSOC has given Treasury and the various banking regulators an opportunity to more effectively monitor the situation in Europe and its implications for the US economy and financial institutions. Tarullo added that because the debt crisis in Europe has been a threat for a sustained period of time, regulators have been able to implement a system that allows them to monitor financial institutions’ exposure to Europe, and are working with those institutions to unwind that exposure.
Warner asked Gruenberg and Tarullo if they have the tools needed to evaluate the living wills that have been submitted and what standards will be used to judge the effectiveness of the wills. Gruenberg said living wills are evaluated under the standards of the bankruptcy code, and must credibly result in the effective unwinding of an institution. Gruenberg said the FDIC is working with banks as they develop their living wills and that the plans of the largest banks will be submitted for review in July.
Tarullo added that it is not possible to tailor “a lot of different resolution plans to a lot of different adverse scenarios,” which is why the review of such plans must include basic questions about the ongoing structure of the firm.
Sen. Mike Crapo (R-Ind.) expressed his concern that Dodd-Frank will reduce credit availability in the housing market though the proposed rules on qualified mortgages (QM) and qualified residential mortgages (QRM). He asked Cordray about the CFPB’s decision to reopen the comment period for the QM proposal and if he plans to convene the Small Business Panel to discuss the impact of the proposed rules. Cordray said one of the reasons the CFPB reopened the QM comment period is because the CFPB has recently obtained a significant amount of data from FHFA that “gives us [CFPB] a better window into the mortgage market.” He assured Crapo that they will draft a QM and QRM rule that is based on sound data and does not unduly restrict access to credit.
Cordray added that because the QM rule was originally proposed by the Fed, the Small Business Panel has not been convened to review the proposal, noting that if the Small Business Panel were to review the rule, the CFPB would miss the statutory deadline to release the rule. Following up, Crapo asked Gruenberg, Curry and Tarullo if they intend to wait for the CFPB to finish its definitions of QM and QRM before moving ahead with their risk retention rules. Gruenberg, Curry and Tarullo all indicated that they will wait for the CFPB before moving forward on its risk retention plans.
Crapo asked Tarullo if the Fed is considering utilizing models other than the exposure method, to measure counterparty risk given recent questions about the exposure method’s accuracy. Tarullo said the Fed’s risk modeling methodology is one of the topics that can be commented under proposed rules 165 and 166. He said a number of alternatives have been suggested but noted that the challenge is finding a methodology that tries to track actual risk exposure, but is not dependent on modeling within firms.
The Volcker Rule
Sen. Bob Corker (R-Tenn.) asked each witness to define “risk mitigating, hedging activities in connection with, and related to, individual or aggregated positions or contracts.” In regard to whether a particular trade is subject to the Volcker Rule or not, Wolin said it is important to ask if the trade is associated with an individual or aggregate position. If it is, Wolin said the trade or hedge is OK, if not, than it is not permissible under Treasury’s interpretation of the statute.
Tarullo and Curry said, statutorily, the Volcker Rule is aiming to establish “substantive guidelines” for distinguishing between hedging individual or aggregated positions and proprietary trading, and put in place risk management reporting and documentation requirements that explains the hedging strategy, how it correlates with current investment positions and how they will ensure the hedge will give rise to new kinds of exposures.
Gruenberg agreed with Tarullo’s characterization of the Volcker Rule, adding that the Volcker Rule would help establish a set of controls to monitor the type of investments banking organizations are engaging in.
Sen. Jeff Merkley (D-Ore.) asked Curry particularly pointed, rapid-fire questions regarding JPMorgan’s trading loss. Curry was clearly flustered by the line of questioning and regularly punted answers. In closing, Merkley asked if the OCC will support “closing the loopholes that allow Wall Street banks to maintain hedge fund style operations.” Curry said it is one of the issues that the regulatory agencies are seeking to address with the Volcker Rule.
In response to Merkley’s line of questioning, Sen. Pat Toomey (R-Pa.) made the point that bad loans, not proprietary trading activity led to all of the bank failures resulting from the 2008 crisis. He expressed his concern that the current regulatory environment does not address the real risks to the economy and advocated for the use of capital standards as the “essential tool to reduce systemic risk.”
Sen. Jerry Moran (R-Kan.) pointed out that a number of the witnesses said the loss at JPMorgan “informed” their position with regard to the Volcker Rule and asked the witnesses to elaborate. Curry said he means that the OCC’s experience reviewing JPMorgan’s risk management operations has better informed regulators on the types of oversight structures and mechanisms that need to be in place to ensure compliance with the Volcker Rule.
For testimony and a webcast of the hearing, please click here.