Authors: Gillian Tett
In March 2000, David Li, a researcher at J.P. Morgan, published a groundbreaking paper presenting a method he had devised for estimat
ing the degree of correlation based on a well-established statistical technique known by the formidable name of the Gaussian copula model. This was essentially a way of estimating the degree of dependencies of different kinds among a group of variables. He applied it to CDOs of corporate debt, and his concept quickly spread until almost every bank, ratings agency, and investment group adopted it for their own model. Indeed, some bankers liked to joke that the Gaussian copula was like the combustion engine of the CDO world: enabling them all to craft more and more CDOs faster and faster.
In many ways, Li’s work was a boon for the industry. As the
Wall Street Journal
pithily pointed out, the launch of Li’s Gaussian copula model meant that bankers had a method not only to weigh a “bag of apples” (i.e., companies) but also to predict the likelihood they would all rot. That gave bankers the ability to trade different pieces of CDO risk with much more confidence—so much so, in fact, that a new business developed called “correlation trading,” which made investment bets based on how the correlation inside a CDO or between CDOs might move. But the model also introduced new risks. The more that banks all relied on Li’s Gaussian copula approach, the more they were creating a
new
form of correlation risk. Because everyone was using the same statistical method of devising their CDOs to contain risk, in the event of economic conditions that defied that modeling, huge numbers of CDOs would suffer losses all at once. As Alex Veroude, the manager of a CDO for Gulf International Bank, explained, “The problem is that all the structures now are designed the same way, with the same triggers. That means that if there is a storm, all the boats in the water will capsize.”
Worse still, the fundamental philosophy behind the Gaussian statistical technique did not appear to be well suited to cope with a situation where the boats might all capsize, en masse. Like any model, it was only as good as the data that was fed into the “engine,” and that data was usually based on what had happened in the past. If something completely unexpected ever occurred—an event that was
not
in the data set—the model would not work. Good statisticians tried to avoid that problem by working with as much data as they could. However, the credit world was so new that there was not always that much data available. How could the
trajectory of a CDO squared be judged from past data when that “past” was just two years old? Or, for that matter, a subprime-linked derivative that had never been widely traded? How could the models forecast what might happen if a true investor panic got under way, creating a selling chain reaction that had never been seen before? As David Li himself said about the model he had fashioned, “The most dangerous part is when people believe everything coming out of it.”
But even if some observers of the boom were highly skeptical about just how well the risks had really been measured, few had any motive to stop it. No one could argue with the returns. The revenues of the largest investment banks grew 14 percent between 2003 and 2004, to hit $184 billion, producing $61 billion profit. Citigroup, Goldman Sachs, Morgan Stanley, and Deutsche Bank all reported particularly good numbers, with Goldman leading the pack with revenues of more than $16 billion. Some of that was due to the banks’ traditional businesses of equity market underwriting, share trading, and merger advice recovering from the internet crash, but a key component of the growth was the credit boom. Between 2003 and 2004, the total market capitalization of major global banks rose by $900 billion to $5.4 trillion, a record high.
Amid this heady bonanza, however, one bank was notably
not
celebrating: JPMorgan Chase. By 2004, the bank that had kick-started the credit investment boom was, ironically, lagging badly behind the new pack of players, in large part because the J.P. Morgan management had opted out of the mortgage-based CDO and CDS business. Analysts were unimpressed with the bank’s results, and the stock price was languishing. An injection of new energy was urgently needed, and the bank was about to get quite a shock to the system.
I
n January 2004, JPMorgan Chase was swept again into the global banking merger mania. This time, the partner was Chicago-based Bank One. On January 14, William Harrison, the CEO of JPMorgan Chase, announced a deal to purchase the bank for $58 billion, one of the biggest deals ever in the financial sector.
The rationale behind the purchase, at least as it was presented by Harrison, was that JPMorgan Chase wanted to expand its retail footprint across the whole of America. Bank One was the sixth largest retail bank in the country and had a formidable network in the Midwest, as well as being the largest single issuer of VISA cards. With 2,300 branches in seventeen states, the JPMorgan Chase–Bank One merged entity would be almost as big as the Citigroup behemoth. The only other close competitor was Bank of America, which was in the process of merging with FleetBoston to create yet another superbank.
Savvy as the deal may have been, some analysts suspected that Harrison was trying to dig himself out of a hole. As the losses from Enron, WorldCom, and other JPMorgan Chase clients had piled up and the bank’s stock price tumbled, he had come under mounting pressure, and Harrison was not a man to go quietly. He needed a way to deflect the criticism and boost the share price, and the Bank One deal did precisely that. When the deal was announced, analysts—as well as the JPMorgan Chase staff—seized on the fact that the merger brought with it the brash financier Jamie Dimon, who had famously helped to build the Citigroup financial empire back in the 1990s.
In early 2004, Dimon was running Bank One, and under the terms of the merger he would technically be junior to Harrison. Dimon was named chief operating officer and president, while Harrison held the post of CEO. But the deal also stipulated that when Harrison, who was sixty, retired in two years, Dimon would take over. Until then, Dimon would be paid 90 percent of whatever Harrison earned, a deal that analysts guessed would give Dimon a pay package of around $20 million a year. “Everybody eventually reports to me, but Jamie [Dimon] is the president, COO,” Harrison smoothly explained. “He [Dimon] is running the retail side of the bank, and he’s also running the finance and risk management function…it was a good way to segment responsibilities.”
Wall Street was almost ghoulishly fascinated. The two leaders were near opposites. Dimon was a hard-talking, fast-acting New Yorker—the “boy wonder from Queens,” as
Fortune
magazine dubbed him; Harrison was described by the same magazine as a “courtly Southern gentleman.” The only thing they clearly shared was a history of frenetically forging bank mergers.
Dimon had built his career by joining with Sandy Weill to gobble up Salomon Brothers, Citibank, and others to forge the Citigroup empire. He
also
had a long history of ousting the heads of the companies he took over. Inside JPMorgan Chase, the rumor mill speculated about just how long Harrison would survive. “Everybody’s talking about Dimon being the CEO,” a reporter pointed out to Harrison shortly after the deal was announced. “Does it bother you?…Do you feel that in some regard you’re stalled for the next two years?” Harrison blithely batted the question away.
At the time of the merger, Dimon was only forty-seven, a good thirteen years younger than Harrison. But he had already generated more legends than Wall Street financiers twice his age. He grew up in Queens, New York, in a family of Greek immigrants from Smyrna. His grandfather worked as a small-time broker, and Dimon’s father, Theodore, took a similar job on Wall Street, eventually working for Salomon Brothers. As a child, Dimon spent summers working in his father’s and grandfather’s offices. His father’s well-paid job also afforded Dimon a good education. He attended Browning School, a smart prep school on the Upper
East Side, then majored in psychology and economics at Tufts University and completed his studies with an MBA from Harvard.
On graduation from Harvard in 1982, at the age of twenty-six, he was offered jobs at Goldman Sachs and Morgan Stanley, but he turned down those elite positions in favor of joining league with Sandy Weill. A friend of Dimon’s father, Weill was an aggressive, up-and-coming financier who was working at American Express. Dimon’s choice was an extraordinarily bold punt. Weill was a highly controversial figure on Wall Street and something of an outsider. But he was also forceful, entrepreneurial, and highly ambitious, qualities Dimon admired.
When Weill was ousted from American Express a couple of years later, the two men embarked on an extraordinary acquisition spree. First, they teamed up to purchase Commercial Credit, a floundering consumer loan company, which they used as a vehicle for grabbing several other firms. Finally, in the late 1990s they implemented their biggest coup of all, acquiring Travelers Insurance to create the Citigroup conglomerate, just as the Glass-Steagall rules were being swept away.
The streak was a stunning triumph, but their story took a Shakespearean turn. Outsiders often described their relationship as being like father and son, since it appeared emotionally intense. Journalists also tended to assume that it was Weill pushing through the deals. Dimon, though, vehemently disputed that Weill was a father figure. He regarded the older man as a
manager,
and not a very good one at that. He also insisted that he was as responsible as Weill for developing strategy, if not more so. His close friends at Citigroup, such as Steve Black, were apt to agree.
As the 1990s wore on, the relationship between Weill and Dimon steadily deteriorated, marred by numerous fights. One such clash started in 1995 after Dimon refused to promote Weill’s daughter, Jessica Bibliowicz, who was working at Citigroup. Eventually the atmosphere soured so badly that Dimon left Citigroup. A sixteen-year partnership came to an abrupt end.
For more than a year, Dimon hung in limbo, without a job. He disappeared from view to such an extent that some Wall Street commentators suggested that his career had been completely derailed. Then in 2000 he
accepted the job of running ailing Bank One. It was one of the smartest strategic moves Dimon ever made.
Bank One, like Chase Manhattan, was the unwieldy product of three Midwest banks that had been carelessly cobbled together during the 1990s merger mania. When Dimon arrived in Chicago, the company was almost bankrupt, weighed down with internet-related loans that were imploding and an exceedingly bloated cost structure. In short order, Dimon fired the old management, installed new bankers, including some from Citigroup, slashed expenses by 17 percent—$1.5 billion—and transformed the loan book. He also radically reorganized the retail banking operation to make it more customer-friendly. By 2003, the bank was reporting a $3.5 billion profit, up from a $511 million loss in 2000. The turnaround was sweet revenge. Then the fates played into his hands again.
As the reverberations of the internet bust and the Enron and WorldCom scandals pounded Wall Street, Citigroup was hit hard, and Sandy Weill’s reputation was badly damaged. In October 2003, he resigned. Miles away from New York, in Chicago, Dimon was one of the few senior bankers who emerged from those years with a reputation that was not just intact but soaring. Harrison’s decision to reach out to Dimon and Bank One was an exceedingly canny move, analysts agreed. If anyone could restore the reputation and confidence of the damaged JPMorgan Chase brand, it was Dimon.
The only question that was critically unclear was how Dimon would actually go about restoring the bank’s fortunes. Would he go head-to-head with the Citigroup behemoth he had been instrumental in creating? Or did he have something completely different up his sleeve?
Shortly after arriving at JPMorgan Chase, Dimon flew across the Atlantic to become acquainted with the European operations of the bank, including the impressive derivatives empire Bill Winters had built. Winters was now the most senior remaining member of the old Hancock group.
The bankers in London were extremely curious to meet Dimon—and distinctly apprehensive, too. After three years of bitter infighting with the Chase side of the bank, the Heritage Morgan team there (as the
former J.P. Morgan bankers were called) was deeply wary of anything in the vein of Chase. Some had decidedly low expectations of Dimon. “Not another retail banker from Hicksville, USA!” one muttered to colleagues before Dimon’s arrival. In the years before he had arrived at JPMorgan Chase, rumors circulated that suggested Dimon was no fan of investment banking. This was partly because back in the late 1990s, Dimon ran Salomon Smith Barney, the investment banking arm of Citigroup, and shut down the US proprietary trading desk. The furious Salomon bankers promptly concluded that Dimon hated traders. Dimon vociferously denied that, pointing out that he had chosen to merge with an investment bank when he and Weill were building up Citigroup. The rumors, though, made some J.P. Morgan bankers wary: they wondered what Dimon would do with their derivatives powerhouse.
The London-based bankers had nervously prepared a briefing for Dimon about their successes and sent it to him in advance of his trip. By 2004, they had plenty of good news to highlight. Their derivatives business was rapidly expanding, as was their underwriting business. The bank was also in the process of forging a joint venture with Cazenove, the blue-blooded British investment bank, which promised to offer JPMorgan Chase a powerful platform for expanding its advisory and underwriting work in Europe.
Tony Best, a former member of the old J.P. Morgan derivatives team, fully expected to spend the morning of Dimon’s arrival discussing the briefing he had sent him. Nobody ever dared to assume that a bank head would have had time to actually read a briefing, and the first part of such meetings was usually spent reviewing them. Dimon was different. “I’ve read the paper,” he announced abruptly, in his nasal Queens accent, and then asked highly specific questions that indicated he had indeed absorbed the details of the report. He made it a point of pride to always memorize as much of a preparatory paper as he could before a meeting. “You gotta do homework; I always do my homework,” Dimon liked to say.
For almost an hour, Dimon debated the state of the European derivatives market with Best and others. It soon became clear that—contrary to the prior rumors—he knew the minutiae of complex finance. The brainstorming was intense. Then, at the end, the discussion took a completely
unexpected turn. “Do you know what you are paying for these telephones?” he asked, pointing at the phone on the desk. They responded with baffled silence. Investment bankers dealing with the esoteric world of derivatives weren’t concerned with phone matters. “I will tell you!” Dimon declared. He loved posing aggressive, rhetorical questions to an audience, to keep them uneasily on their toes. “The average price of a phone in the London office right now is $22. I have checked and it should be $9. So, listen, I am going to call five vendors and get them to make me a better price. We gotta fix the plumbing first, and then we can worry about everything else!”
Oh my god,
some of the Heritage J.P. Morgan bankers thought. They had never experienced anything like Dimon before. In a sense, he seemed to be confirming their worst fears. Or was he? It was clear to Best that Dimon was phenomenally bright: not only had he memorized details about the British telephone system, but he also clearly understood the credit world, with its complex acronyms. “He’s not like any leader I have ever met before,” Best confessed to a colleague. The gossip about what Dimon would do with the bank grew intense.
In reality, Dimon’s plans were both highly complex and exceedingly simple. Though almost none of the Heritage Morgan bankers realized it at the time, Dimon had arrived at JPMorgan Chase with an extensive knowledge of how the old J.P. Morgan worked. That stemmed from a little-known friendship Dimon had forged more than a decade earlier with former CEO Dennis Weatherstone. Back in the early 1990s, J.P. Morgan was a lead banker to Commercial Credit, the unruly financial group that Weill and Dimon had taken over as the first step on their road to creating Citigroup. As a result, Weatherstone had become acquainted with them, and he soon made a point of traveling to the bank’s headquarters down in Baltimore on a regular basis, a reflection of Weatherstone’s old-fashioned respect for client relationships.
Weatherstone took a particular shine to Dimon, perhaps because he had also started out as something of an outsider. At one stage, Weatherstone even suggested to Weill that he should mentor Dimon, which Weill
brushed off. Weatherstone, though, did act as an informal mentor, having long chats with Dimon. “I adored Dennis Weatherstone—absolutely adored him!” Dimon later recalled. “Sandy Weill never gave me a piece of advice at all; he just did not do mentoring. But I guess that Weatherstone was a mentor to me in a way, since he really took me under his wing.”
During the course of those conversations, Dimon gained respect for the values Weatherstone stood for. “They were a good, ethical lot at the old J.P. Morgan. They really believed in trying to do the right thing, in trying to serve clients,” Dimon recalled. However, by the mid-1990s, Dimon was also increasingly unimpressed with the commercial results of the bank. He appreciated the bank’s impressive history and formidable franchise, but he also thought the bank was dangerously arrogant and insular. Subsequently he also became highly critical of the way the merger with Chase had been carried out, generating so much dysfunctional infighting. “My first impression of [JPMorgan Chase] was that it was completely undisciplined—there was a lot of politics,” Dimon recalled. “There was not a lot of good there, apart from the investment bank, which had some great embedded businesses. But that was also just really undisciplined. No discipline at all.”
In Dimon’s eyes, that lack of discipline was nothing short of a cardinal sin. It was a stance born from a more profound set of attitudes towards the craft of banking. Contrary to his reputation, Dimon had not arrived at JPMorgan Chase ignorant of how the inner details of high finance worked. He had an extremely curious mind that was exceptionally good at absorbing data, with near-photographic powers of recall. He took it as a point of pride to spend time each month studying new topics. “I love studying reports, new ideas, just love it! You gotta keep challenging yourself,” he liked to say. Along the way, that mind had enabled him to grasp a vast amount of information about how advanced market instruments worked.