Lessons in risk for JPMorgan Chase chief

Jamie Dimon, the head of America’s largest bank, took a risk Wednesday in testifying before Congress. In May, his high reputation for managing risk at JPMorgan Chase was tarnished after he revealed the bank had lost more than $2 billion in risky trading.

Could he now restore faith in the ability of financial institutions to reduce the fear of big losses – for consumers, investors, and even taxpayers?

It helped that Mr. Dimon was open and honest. “We made a mistake. I’m absolutely responsible. The buck stops with me,” he told the Senate Banking Committee. He admitted a lapse in his oversight of a bank department handling a complex portfolio that “morphed into something that, rather than protect the firm, created new and potentially larger risks.”

And for him, the big lesson was that “no matter how good you are at managing risk, you can never be complacent.”

But his testimony was revealing about the nature of risk today, not only in the world of high finance but for other kinds of risks, such as cyberthreats, environmental tragedies, or terrorism. Risk has become more globalized, diffuse, and diverse. Threats are not as obvious. The amount of information can be overwhelming.

Managers must deal more with potentialities of an unknown threat than the deterrence of a known one. They need constant feedback loops for a kind of information that is always changing.

Dimon said the bank’s sophisticated computer models, designed to minimize financial risk, are only backward looking. They aren’t always adequate in looking to the future, where the risk of an eventuality lies.

Yet Congress seeks certainty that financial markets won’t fail, a near-zero tolerance for another financial disaster like that in 2008-09. It hopes that more regulations and more regulators can second-guess the risk decisions of people like Dimon.

This clash of worldviews, between one that demands certainty and one that manages the risks of imagined scenarios, is best represented in the struggle to define the so-called Volcker rule, a key plank of the 2010 Dodd-Frank financial reform law. The rule is aimed at reducing the risks in a bank’s use of federally insured deposit money.

Congress left it to regulators to determine what would be a risky financial instrument. Should a hedge fund cover an entire pool of investments or just a single transaction? Is the hedge fund only for reducing risk or for making a profit?

Such questions aren’t easy to answer in high finance. Even experts like Dimon can make $2 billion mistakes.

Reducing fear is the goal of risk management, and that requires bankers to be honest, open, and humble about their goal of serving others. Most of all, risk can be managed if one is always learning from one’s mistakes.

That point was made clear from the JPMorgan chief’s testimony.