Money and Banking (ECON UN3265)

Lecture 24

Tri Vi Dang

Columbia University

Spring 2022

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I. Money and Banking since the II. Policy, Regulations and Responses
18th Century of the Banking Industry

I.1. Evolution of the Banking II.1. Central Bank Policies

System

I.2. Bank Holding Companies II.2. New Regulation and Unintended

Liquidity Consequences

I.3. New Forms of Money and II.3. Market Making and Risk
Banking Management of Banks

I.4. The Financial Crisis in 2008 II.4. Most Recent Trends

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 Lecture 24

II.2. New Regulation and Unintended Liquidity Consequences

G. Case: Risk Retention Rule and the Rise of MOA and CMOA

II.3. Market Making and Risk Management of Banks

A. Bank Risk Management

B. Value at Risk (VaR)
C. Case: JPM London Whale
D. Case: JPM Risk Limits and Hedging versus Proprietary Trading

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 II.2.G Case: Risk Retention Rule and the Rise of MOA and CMOA

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Remark

This section provides another example that shows how regulation leads to new
innovations and new investment opportunities.

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Risk Retention Rule in Securitization

Amended from section 15G of the Securities Exchange Act of 1934 and
required under section 941 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act

Originally proposed on March 29, 2011

Re-proposed on August 28, 2013

Finalized October 22, 2014

Effective December 24, 2015 for ABS backed by residential mortgage loans
and December 24, 2016, for all other securitizations

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Rationale

Six Agencies: OCC, Federal Reserve Board, SEC, FDIC, FHFA, and HUD

“jointly prescribe regulations” requiring securitizers to retain a portion of the

credit risk of any securitized transaction

“Congress intended the risk retention requirements mandated by section 15G

to help address problems in the securitization markets by…provid[ing]
securitizers an incentive to monitor and ensure the quality of the securitized
assets underlying a securitization transaction, and, thus, help align the interests
of the securitizer with the interests of investors” (Credit Risk Retention,
SEC.gov)

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Final Rule: Retention Options

A securitizer may retain “an eligible vertical interest, an eligible horizontal

residual interest, or any combination thereof as long as the amount of the
eligible vertical interest and the amount of the eligible horizontal residual
interest combined is no less than 5 percent.” (Credit Risk Retention, SEC.gov)

Vertical Interest: retaining at least 5% of the face value of each tranche and
represents an interest in the entire structure of the securitization transaction

Horizontal Interest: retaining at least 5% of the face value of the entire issue,
typically in the most subordinate tranche, and represents a “first-loss position”
on the entire asset pool

Combined Interest: Achieved through a variety of combinations and is

commonly referred to as an L-shape interest

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Risk Retention Implementation

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Who Must Retain Interest?

Securitizer/Sponsor:

“either an issuer of an asset-backed security or a person who organizes and

initiates a securitization transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate or third-party”

Majority-Owned Affiliate:

“an entity (other than the issuing entity) that, directly or indirectly, majority
controls, is majority controlled by or is under common majority control with,
such person” and where majority control means “ownership of more than 50
percent of the equity of an entity or ownership of any other controlling
financial interest in the entity, as determined under GAAP”

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CLO Risk Retention Opposition & the LSTA

The Loan Syndication and Trading Association (LSTA) filed a lawsuit against
the SEC and Federal Reserve shortly after the final rules were passed. The
industry and LSTA cite the following in support of repeal or moderation of
rules for CLOs:

CLOs are an important source of financing for American companies.

Long-term nature of CLOs makes them a stabilizing force during economic

downturns.

CLO managers earn a performance fee. Thus, their incentives are already
aligned with investors.

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CLOs performed well during and since the financial crisis with not a single
AAA or AA tranche suffering a loss and a historical impairment rate of just
0.2%.

CLOs are not the “originate-to-distribute” model risk retention aims to correct.

An exemption for “Qualified” CLOs should be established (as it is for certain

ABS), in which CLO manager should only retain 5% of the equity tranche.
Criteria would include:

i) asset quality, ii) portfolio diversification, iii) capital structure, iv) alignment
of interests of the manager and investor, v) regulation of the manager, and vi)
transparency and disclosure”

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Evolution of the CLO Market

CLO 1.0
Originally issued in the 1990s, the first vintage of CLOs invested in leveraged
loans, high yield bonds, and other structured products (e.g. CDS). They were
invented to facilitate increased lending and focused on generating income.

CLO 2.0
Following the financial crisis in 2008, CLOs featured stronger credit support
(greater subordination, less leverage, tighter collateral tests, etc.) and a shorter
reinvestment period.

CLO 3.0
In response to the Volker Rule and a new regulatory environment, CLOs since
2014 have been “Volkerized” to remove all non-loan assets from collateral
pools.

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Innovations of Risk Retention Vehicles and Third-Party Investors

Needing to obtain financing to meet requirements, CLO managers have joined

forces with a variety of investors, including PE firms and hedge funds, to
produce some of the most creative risk retention solutions.

Three standard risk retention vehicles have emerged: the MOA, CMOA, and
CMV.

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CLO Performance

Low Loss Rates

Loss rates of US CLO tranches are low.

According to Moody’s, only 59 out of 6606 CLO tranches they rated since
1993 have suffered principal impairment (none of CLO 2.0).

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Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 27
Remark

Regulation may generate new investment opportunities.

See also section I.3.N on CLO asset managers.

Section I.3.O shows that there are no adverse selections and Wildcat CLOs.

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 II.3.A. Bank Risk Management

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Remark

Risk management is vital for a bank or any other financial institution.

This section uses JP Morgan (JPM) to illustrate the main principals of bank
risk management.

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Example

With $2.266 trillion in total assets at December 31, 2011, but only $184 billion
of total stockholders’ equity, JPM needed to accurately measure and closely
monitor the risks that it took.

A decrease of 8.1% in the value of assets would eliminate entire equity.

In such a case JPM would be bankrupt.

In December 2014, JPM had 2.571 trillion total assets and $232 billion book
equity.

A 10% decline in total assets would wipe out JPM’s equity.

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Risk factors and governance

Cognizant of the risks facing it as a highly leveraged financial institution, JPM

devoted 43 pages of its 2011 Form 10-K annual report to the SEC describing
the firm’s risk management practices, beginning by noting “risk is an inherent
part of JPMorgan Chase’s business activities.”

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Risk Policy Committee

The Risk Policy Committee “provides oversight of the CEO’s and senior
management’s responsibilities to assess and manage the Firm’s credit risk,
market risk, interest rate risk, investment risk, liquidity risk, and reputational
risk, and is also responsible for review of the Firm’s fiduciary and asset
management activities”.

JPM used a formal framework to link the firm’s appetite for risk with its return
targets, capital management, and other controls.

The Risk Policy Committee approved the risk appetite policy on behalf of the
Board.

Chief Executive Officer Jamie Dimon established JPM’s overall risk appetite
and also approved the risk appetite that the head of each of the bank’s lines of
business had set for their unit.

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JPM identified the following nine major risks that affect the bank.

Liquidity (i.e. short term funding, cash and liability)

Credit (i.e. counterparty default)

Market (i.e. asset price movement)

Interest Rate (i.e. interest rate movement)

Country

Private Equity

Operational

Legal and Fiduciary

Reputation
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The following four corporate functions provided oversight.

Risk Management
coordinates and communicates with each line of business through the line of
business risk committees and chief risk officers to manage risk

Legal and Compliance

oversight for legal risk

Chief Investment Office (CIO)

responsible for measuring, monitoring, reporting and managing the Firm’s
liquidity, interest rate and foreign exchange risk, and other structural risks”

Corporate Treasury
same responsibilities as the CIO
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Remark

JPM separated its Chief Investment Office (CIO) from its Treasury unit in
2005, with CIO becoming a separate unit within the bank.

By year-end 2011, CIO had 428 employees based in New York and London,
consisting of 140 front office traders and 288 middle and back office staff.

CIO is responsible for liquidity management.

The next sections discuss the CIO unit and the $6 billion loss incurred by its
$350 billion synthetic credit portfolio.

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 II.3.B. Value at Risk (VaR)

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Remark

The Board of Governors of the Federal Reserve System

regulates bank holding company,

Office of the Comptroller of the Currency (OCC)

regulates national bank subsidiaries.

In April 2011, the Board of Governors of the Federal Reserve System and the
OCC issued joint “Supervisory Guidance on Model Risk Management” for the
banks under their supervision.

The Basel bank capital regulatory framework encourages banks to develop

internal risk models, since banks may be required to hold less capital if using
an internally-developed model than if using a standard model.

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Value at Risks (VaR)

Value at Risk (VaR) was developed by JPM in the early 1990s and has since
become one of the most common methods employed by financial institutions
to measure and monitor market risk by using data about the volatilities of and
correlations among financial securities to measure potential loss.

JPM defines “market risk” as the “exposure to an adverse change in the market
value of portfolios and financial instruments caused by a change in market
prices or rates”.

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Definition

VaR is an estimate of the most that one or more financial instruments could
lose in value over a fixed time period (e.g., one day) with a given level of
confidence (e.g., 95%).

OCC defines Value at Risk as follows:

“Value-at-Risk (VaR) means the estimate of the maximum amount that the
value of one or more positions could decline due to market price or rate
movements during a fixed holding period within a stated confidence interval.”

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JPM defines VaR as follows:

“VaR is calculated using a one day time horizon and an expected tail-loss
methodology, and approximates a 95% confidence level.

This means that, assuming current changes in market values are consistent
with the historical changes used in the simulation, the Firm would expect to
incur losses greater than that predicted by VaR estimates five times in every
100 trading days, or about 12 to 13 times a year.

However, differences between current and historical market price volatility

may result in fewer or greater VaR exceptions than the number indicated by
historical simulation.”

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Remark

Financial institutions use VaR models to calculate regulatory capital and for
internal risk management.

Though the OCC allows banks under its supervision to develop their own VaR
models used for regulatory purposes, it provides detailed guidance on how
these VaR models should function.

Furthermore, the OCC must approve the regulatory VaR models that the banks
create.

However, the OCC does not review or approve VaR models used by banks for
internal risk management.

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VaR used by JPM

JPM uses numerous VaR models to calculate the market risk of individual
positions, products, and trading desks, with different models typically used to
calculate regulatory capital and for internal risk management.

JPM’s most important VaR calculation for internal risk management is the one
used in quarterly 10-Q and annual 10-K filings.

This so-called “10-Q VaR” is based on a one-day holding period and a 95%
confidence level and is a Level 1 risk limit.

Since JPM calculated 10-Q VaR using a 95% confidence level, it expected
losses greater than those predicted by the model 5 times in every 100 trading
days, or about 13 times per year.

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Example (JPM’s VaR for CIO unit)

On 12/31/2009, the VaR = $76 million.

There is a 5% that the loss exceeds $76 million at one trading day.

Or only 5 times in 100 trading days, would the loss exceed $76 million.

In 2009, the average VaR = $103 million.

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Risk Limits

JPM risk management staff would compare actual VaR usage to the maximum
VaR limit set by senior management.

At January 1, 2012, JPM’s firm-wide 10-Q VaR limit was $125 million, and
CIO’s equivalent limit was $95 million, reflecting that much of JPM’s market
risk came from the CIO.

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 II.3.C. Case: JPM London Whale

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Remark

JP Morgan held a $350 billion synthetic credit portfolio (London Whale) in

2012 and subsequently suffered a loss of $6 billion.

JPMorgan Trader’s Positions Said to Distort Credit Indexes

Bloomberg, 04/06/2012
http://www.bloomberg.com/news/articles/2012-04-05/jpmorgan-trader-iksil-s-heft-is-said-to-distort-credit-indexes

Making Waves Against 'Whale'

WSJ, 04/10/2012
http://www.wsj.com/news/articles/SB10001424052702304587704577336130953863286

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Excess deposits

JPM provides a wide variety of financial services, yet its commercial bank
subsidiaries continue to engage in the basic banking functions of taking
deposits and making loans.

The amount of deposits held by JPM on behalf of its customers was

consistently greater than the amount of money loaned by the bank.

JPM had $1.128 trillion of deposits payable to customers at December 31,

2011, but only $724 billion of loan balances receivable, resulting in excess
deposits of about $400 billion.

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Managing excess deposits

JPM had not loaned out excess deposits, so the bank needed a way to
profitably yet safely invest these excess deposits.

This task was assigned to the CIO unit, and it was the unit’s primary
responsibility.

CIO invested the bank’s excess deposits in Treasury bonds and other
investment grade (i.e., high quality) fixed income securities, including
corporate, municipal, and asset-backed bonds.

This conservative investment approach was consistent with how other banks
managed excess deposits, and the average credit rating for CIO’s investments
was AA+.

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By December 2011, CIO managed a $350 billion portfolio of fixed income
securities, an amount that was approximately double JPM’s total stockholders’
equity of $184 billion at that date.

CIO had various additional objectives, including funding JPM’s retirement

plans, as well as hedging the risks associated with interest rates and mortgage
servicing rights on behalf of other units within the bank.

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Synthetic credit portfolio

One of CIO’s other objectives was to partially hedge JPM’s credit risk.

Like other lenders, JPM is exposed to credit risk (also known as default risk),
which is the risk that someone who has borrowed money from the bank is
unwilling and/or unable to repay the money when due.

Trade of credit derivatives were approved in 2006.

The Synthetic Credit Portfolio managed by CIO was intended generally to

offset some of the credit risk that JPMorgan faces, including in its CIO
investment portfolio and in its capacity as a lender.

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The Unit: Chief Investment Office

JPM separated its Chief Investment Office (CIO) from its Treasury unit in
2005, with CIO becoming a separate unit within the bank.

By year-end 2011, CIO had 428 employees based in New York and London,
consisting of 140 front office traders and 288 middle and back office staff.

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Main actors

Ina Drew, who was JPM’s Chief Investment Officer, was also head of CIO
from its start as a separate unit in 2005 until her retirement in May 2012 one
month after the CIO trading losses had become public.

Her subordinate Achilles Macris ran the CIO London office in his capacity as
International Chief Investment Officer. Javier Martin-Artajo directly oversaw
the SCP as Head of Europe and Credit & Equity, and reported to Macris.

Bruno Iksil, the “London Whale”, was the senior trader of the SCP and
reported to Martin-Artajo.

Julien Grout was a junior trader who in turn reported to Iksil.

JPM fired Macris, Martin-Artajo, and Iksil in July 2012, while suspending
Grout (who then subsequently resigned).

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Martin-Artajo and Grout were indicted in absentia by the US Department of
Justice in August 2013.

Iksil had entered into a non-prosecution agreement with the US government

and accordingly was not charged.

In an internal memo dated March 31, 2014, JPM said that it would recombine
the CIO and Treasury units, which is how asset-liability management function
is traditionally structured at most banks.

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Credit index

A credit index tracks a specific basket of credit instruments, and a credit

tranche tracks a specific portion of a credit index.

The main products traded by Iksil were based on the CDX.NA.HY and
CDX.NA.IG indices administered by the Markit Group Limited (Markit).

Iksil bought protection on the CDX.NA.HY, which is a credit index of 100

companies located in North America and classified as High Yield (i.e., higher
risk) based on their credit rating.

He sold protection on the CDX.NA.IG, which is a credit index of 125

companies located in North America and classified as Investment Grade (i.e.,
lower risk).

Iksil also carried out similar trades on European credit indices.

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Evolution of strategy

In December 2011, Dimon and Braunstein instructed CIO to reduce the size of
the SCP during 2012, so that JPM could reduce its Risk-Weighted Assets
(RWA) as the bank prepared to adopt the impending Basel III bank capital
regulations.

However, Martin-Artajo, Iksil, and Grout were also expected to minimize the
trading costs of decreasing RWA, while still maintaining the chance to profit
from unexpected corporate bankruptcies.

In an attempt to balance these multiple competing objectives, Iksil suggested

in late January 2012 that SCP expand a strategy first implemented in 2011 to
buy credit protection on (higher risk) high yield companies, while funding
some of the premiums by selling protection on (lower risk) investment grade
companies.

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The resulting rapid increase in trading caused the net notional size of the SCP
portfolio to triple from $51 billion at year-end 2011 to $157 billion by March
31, 2012, and brought Iksil to the attention of Bloomberg and the Wall Street
Journal.

The trading strategy was not successful, as changes in credit spreads caused
the value of protection owned by SCP to decrease more rapidly than did the
value of protection that the traders had sold.

Although Drew ordered the SCP traders to halt this strategy on March 23,
losses continued to mount as the credit derivative positions were unwound,
ultimately reaching $6.2 billion by December 2012.

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 II.3.D. Case: JPM Risk Limits and Hedging versus Proprietary Trading

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Remark

This case highlights that senior risk managers might have not intervened
properly when traders exceeded their risk limits.

Large part of the firm-wide risks came from the synthetic credit portfolio
(SCP).

When risk limits were exceeded, senior managers increased risk limits.

Or they changed risk models to reduce risks.

Remark

Risk management is also fundamental in hedge funds.

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Remark

All major financial institutions use various risk limits and metrics, often based
on mathematical models, to measure and monitor the risk of their lending and
investing activities.

The amount of risk taken is measured on a daily or weekly basis using various
risk metrics, and these amounts are compared with the relevant limits.

If a risk limit is exceeded, JPM policy requires that such breaches be reported
to senior management in a timely fashion, and that the affected line of business
reduce the size of its trading positions or consult with senior management on
the appropriate action.

In practice, these risk limits and the accompanying metrics and models
provided little or no restraint on the risk that was taken by CIO.

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Risk Limits

JPM risk management staff would compare actual VaR usage to the maximum
VaR limit set by senior management.

At January 1, 2012, JPM’s firm-wide 10-Q VaR limit was $125 million, and
CIO’s equivalent limit was $95 million, reflecting that much of JPM’s market
risk came from the CIO.

On January 9, JPM VaR was $123 million and CIO VaR was $88 million,
already rapidly approaching their respective limits.

On January 16, caused CIO exceeded its own $95 million VaR limit and was
the main contributor to the breach of the $125 million firm-wide VaR limit.

Both of these VaR breaches continued until January 19.

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As required by firm policy, Dimon and the other members of the JPM
Operating Committee were notified each day that the firm-wide VaR limit was
exceeded.

However, Drew did not order the CIO traders to reduce the size of the risky
positions within the SCP book in response to the limit breaches.

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Change to new VaR model

Irvin Goldman, the recently appointed CIO Chief Risk Officer, e-mailed his
superior Hogan that the most important solution to stop the breaches was the
new VaR model that CIO planned to implement by the end of January.

On January 23, Dimon and Hogan approved a temporary increase in the firm-
wide VaR limit from $125 million to $140 million until January 31.

Ms. Drew likewise temporarily raised the CIO VaR limit from $95 million to
$105 million.

On January 30, JPM’s Model Review Group (part of the risk management
function) approved CIO’s new VaR model.

With the new model reducing CIO VaR by half from the initially reported
$132 million to only $66 million.

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Breaching other risk limits

In addition to exceeding department-wide and firm-wide VaR limits, CIO

personnel disregarded several other risk limits and metrics during the early
months of 2012.

Comprehensive Risk Measure

The Comprehensive Risk Measure (CRM) is a dollar measure of potential loss.

Though calculated in a similar way, CRM results in a much larger measure of
potential loss than 10-Q VaR, because CRM is based on a one-year time
horizon and a 99.9% level of confidence,

CIO calculated CRM on a weekly basis, as required by regulators.

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CIO CRM increased rapidly in January 2012, from $2.0 billion on January 4,
to $2.3 billion on January 11, and then to $3.2 billion by January 18, an
increase of over 60% in two weeks.

Soon thereafter, JPM’s Quantitative Research team had technical difficulties

and was not able to calculate CIO CRM again until February 22, at which
point it had almost doubled to $6.3 billion.

When Peter Weiland, CIO head of market risk, learned of the $6.3 billion
CRM figure in early March, he dismissed it as “garbage”.

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Credit Spread Widening 01

At JPM, the risk metric known as Credit Spread Widening 01 (CS01)

measured the expected dollar profit or loss if the spread on a credit derivative
widened by one basis point.

For example, how much would JPM profit from the change in fair value of
protection that it had purchased on a high yield CDS whose spread widened
from 500 to 501 basis points, or how much would JPM lose from the change in
fair value of protection that it had sold on an investment grade CDS whose
spread widened from 200 to 201 basis points?

CS01 was also referred to as Credit Spread Basis Point Value (CSBPV).

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CIO calculated CSBPV for each of its fixed income securities and credit
derivatives, summed these, and compared the total to the aggregate risk limit
of $12 million.

Those securities and derivatives subject to mark-to-market accounting had a $5

million CSBPV limit.

In response to these breaches, CIO market risk personnel began suggesting in

early February that the mark-to-market CSBPV limit be raised from $5 million
to $20 million, $25 million, or even $30 million.

Though these proposed limit increases were not granted, Drew also did not
require traders to reduce risk.

Weiland also faulted CSBPV, just as he criticized the results of the CRM
metric.

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Credit Spread Widening 10%

The Credit Spread Widening 10% (CSW10%) metric measures the expected
profit or loss to a portfolio if the spread on each credit position simultaneously
widened by 10% of its current amount.

For example, how much would JPM profit from the change in fair value of
protection that it had purchased on a high yield CDS whose spread widened
from 500 to 550 basis points, or how much would JPM lose from the change in
fair value of protection that it had sold on an investment grade CDS whose
spread widened from 200 to 220 basis points?

In contrast with their general disregard for CRM and CSBPV, both Drew and
Weiland felt that CSW10% was useful in measuring and monitoring risk.

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Weiland thought CSW10% “better reflect[ed] the risk of the portfolio in
material market moves”, and Drew looked to CSW10% as the “overriding”
risk limit.

In fact, after SCP first breached CIO’s mark-to-market CSW10% limit of

plus/minus $200 million on March 22, Drew halted trading of the SCP the very
next day.

However, the various long and short derivative positions in the SCP book still
existed, and losses escalated and risk limits continued to be exceeded as a
result, even as the trading book was being dismantled.

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Liquidating SCP book

In late April 2012, JPM senior management ordered a team of derivatives

experts from the Investment Bank to analyze each of the approximately 130
positions within the SCP book.

After its review, most SCP credit derivatives were transferred during the
second quarter to the Investment Bank, which closed out these positions
throughout the remainder of the year.

SCP-caused trading losses ultimately reached $6.2 billion by December 31,

2012.

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 81

Reforms

In response to a November 2012 OCC Supervisory Letter identifying

deficiencies in CIO risk management, as well as the January 2013 JPM Task
Force Report on the CIO losses, JPM implemented a number of reforms, some
of which are directly pertinent to the bank’s use of risk limits, metrics, and
models.

JPM reviewed and revised market risk limits across all lines of business,
adding more granular limits.

For example, CIO had 260 risk limits by January 2013, including
concentration limits and portfolio-specific limits for the first time.

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 82

Settlement

In 2013, banking regulators in the US and the United Kingdom announced a

global settlement with JPM, penalizing the firm a total of approximately $1
billion.

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 83

Remark

This case highlights that risk management is based on judgments and

enforcement of the senior risk managers.

There are potential tensions between hedging and profit making.

JPM CIO unit was responsible for investing excess deposits in low-risk high-
quality bond holdings,

CIO purchased default protection using credit derivatives to partially hedge

JPM’s exposure to credit risk that arose from the bank’s lending activities.

While the CIO was in charge of a number of different portfolios, one important
issue surrounding the SCP (synthetic credit portfolio) specifically was whether
the portfolio evolved over time from a purely hedging function to also
incorporate proprietary trading.

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 84

Internal audit

JPM completed the initial internal audit review of what it termed “CIO Global
Credit Trading” in November 2007.

In the final audit report, the business overview began by noting that CIO
“credit trading activities commenced in 2006 and are proprietary position
strategies executed on credit and asset back indices.”

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 85

Task force

A report issued January 2013 by the internal JPMorgan Chase Management Task
Force (JPM Task Force) stated “The Synthetic Credit Portfolio managed by CIO was
intended generally to offset some of the credit risk that JPMorgan faces, including in
its CIO investment portfolio and in its capacity as a lender.” (JPM Task Force 2013, 2)

However, the SCP traders could produce no documentation of what these credit risks
were, what hedges would be used, or how to test hedge effectiveness. (US Senate
Report, 4)

In other US Senate testimony, JPM officials acknowledged that the CIO never
documented SCP’s purpose or intended manner of working, nor did the CIO ever issue
a policy delineating SCP hedging parameters or strategies.

Senior JPM executives have stated that the SCP would not have required such
procedures and documents, since it was not intended as a dedicated hedge, but rather
as a macro hedge to protect the bank as a whole against credit risk during another
financial crisis or other stress event.
Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 86
Credit Suisse Gave Archegos Big Leverage for Collateral
Bloomberg, 05/03/2021

Credit Suisse lent the family office of Bill Hwang funds allowing bets with leverage of
up to ten times, and only asked for collateral worth 10% of the sums borrowed,
according to a person familiar with the business.

The leverage offered by the Swiss bank was in some cases double what other brokers
gave Hwang, helping to push the loss to some $5.5 billion after the fund imploded in
March. That compares with a $2.9 billion hit to Nomura Holdings Inc and lesser sums
or no loss at all for lenders including Deutsche Bank AG that offered Hwang prime
brokerage services.

https://www.bloomberg.com/news/articles/2021-05-03/credit-suisse-gave-archegos-big-leverage-for-little-collateral

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 87

Bank losses linked to Archegos top $10bn after latest results
Guardian, 04/27/2021

The impact stems from Archegos’s failure to meet a margin call in March. The
resulting fire sale of assets, which initially included high-profile US media stocks,
flooded the market and resulted in lower returns for investment banks that were trying
to unwind the hedge fund’s position and recoup their losses.

The margin call, which is usually triggered when the total value of assets held in a
firm’s prime brokerage account falls below an acceptable level, required Archegos to
top up its account with extra cash or collateral.

When it failed to meet that demand, the investment banks tried to minimise potential
exposure to losses by selling shares and other assets from the Archegos’ accounts.

But lenders like Credit Suisse have taken a hit after failing to recoup losses through
the sell-off.

https://www.theguardian.com/business/2021/apr/27/nomura-and-ubs-latest-banks-to-reveal-impact-of-archegos-collapse

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 88

Here’s how much the big banks have lost so far from the Archegos collapse
Fortune, 04/27/2021
https://fortune.com/2021/04/27/heres-how-much-big-banks-have-lost-so-far-from-the-archegos-collapse/

Banks Are Making It Harder for Hedge Funds to Leverage Their Bets After
Archegos
Bloomberg, 05/06/2021
https://www.bloomberg.com/news/articles/2021-05-06/archegos-fallout-crimps-hedge-fund-leverage-as-banks-curb-risks

Unrecognized Lessons of the Archegos Collapse

Bloomberg, 05/17/2021
https://www.bloomberg.com/opinion/articles/2021-05-17/archegos-collapse-some-unrecognized-lessons

Archegos Fiasco Spurs Regulators to Demand Banks’ Answers Soon

Bloomberg, 05/21/2021
https://www.bloomberg.com/news/articles/2021-05-21/archegos-fiasco-spurs-regulators-to-demand-banks-answers-soon

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 89

Readings

Zeissler, Bennett, and Metrick (2014): JPMorgan Chase London Whale Z: Background
& Overview Yale Program on Financial Stability Case Study 2014-2Z-V1.
http://som.yale.edu/sites/default/files/files/001-2014-2Z-V1-REVA.pdf

Zeissler, Bennett, and Metrick (2014): JPMorgan Chase London Whale D: Risk
Management Practices, Yale Program on Financial Stability Case Study 2014-2D-V1.
http://som.yale.edu/sites/default/files/files/001-2014-2D-V1-JPMorgan-D-REVA.pdf

Zeissler, Arwin and Metrick (2014): JP Morgan Chase London Whale C: Risk Limits,
Metrics, and Models, Yale Program on Financial Stability Case Study 2014-2C-V1.
http://som.yale.edu/sites/default/files/files/001-2014-2C-V1-JPMorgan-C-REVA.pdf

Zeissler, Arwin and Metrick (2014): JPMorgan Chase London Whale G: Hedging
versus Proprietary Trading, Yale Program on Financial Stability Case Study 2014-2G-
V1.
http://som.yale.edu/sites/default/files/files/001-2014-2G-V1-JPMorgan-G-REVA.pdf

Money and Banking, Tri Vi Dang, Columbia University, Spring 2022 90