Lessons from JP Morgan Chase

This is how the cover story of the current issue of Fortune starts out:

It was the second week of October 2006. William King, then J.P. Morgan's chief of securitized products, was vacationing in Rwanda, visiting remote coffee plantations he was helping to finance. One evening CEO Jamie Dimon tracked him down to fire a red alert. "Billy, I really want you to watch out for subprime!" Dimon's voice crackled over King's hotel phone. "We need to sell a lot of our positions. I've seen it before. This stuff could go up in smoke!"

A classic Dimon manic moment, the call is significant for two reasons. First, it marked the beginning of a remarkable strategic shift that helped J.P. Morgan, virtually alone among the big diversified banks, sidestep the worst of a historic credit crisis. Second, it sheds light on Dimon's distinctive management style - a blend of Cartesian analysis and inspirational leadership that, despite some bad bets in the home mortgage market, has moved J.P. Morgan to the front of the pack in global banking.

But this isn't another story about sub-prime, securitization, and structured finance.  It's about building a leadership team:

Dimon relies on a trusted team of talented lieutenants who share his zeal for sifting piles of data to spot trouble before it happens and vigilantly control risk, even when that means sacrificing growth and losing market share to rivals. Says J.P. Morgan director Bob Lipp, the former Travelers chairman who's worked with Dimon for two decades: "This is the best team on Wall Street."

Dimon and his team are on top today because they took a daring stance at the height of the credit bubble. J.P. Morgan mostly exited the business of securitizing subprime mortgages when it was still booming, shunning now notorious instruments such as SIVs (structured investment vehicles) and CDOs (collateralized debt obligations). With the notable exception of Goldman Sachs, J.P. Morgan's main competitors - including Citigroup, UBS, and Merrill Lynch - ignored the danger signs and piled into those products in a feeding frenzy.

The stock price, while down 21%  from March 31, 2007, is down far less than Bank of America (-37%) or Citigroup (-59%), and JP Morgan Chase's market cap is now virtually equivalent to that of Bank of America and some 25% higher than Citi.  Meanwhile, they've enjoyed lower writedowns on the notorious CDO's.  For the period 1Q2007 through 2Q2008, here are the figures:

• JP Morgan:  $1.9-billion in CDO writedowns
• Bank of America:  $8.0-billion
• Citi:  $27.7-billion

And let's not even mention Bear Stearns, Lehman Brothers, or Merrill Lynch.  The beauty of having a relatively valuable currency (the stock) in this environment is the ability to do even more deals, beyond the Bear Stearns takeover.  "Sure, it's hard to make a deal when your stock has dropped," [Dimon] says. "But so have the stocks of the targets. We have the capital and the people to do a deal, if it makes sense."

Wasn't the Bear Stearns takeover a risk?

Not by the numbers: Bear had $11.5-billion in cash on its books, which should be enough to offset the costs of the acquisition, and JP Morgan also picked up Bears' headquarters building at 48th and Madison worth, conservatively $2-billion (with a mortgage of $670-million).

So who are these guys?

Here are some of the characteristics (emphasis supplied):

• "Dimon's all-stars who make up the 15-member operating committee are a mix of longtime loyalists, J.P. Morgan veterans, and outside hires. Dimon doesn't look for people who went to the right schools or have prestigious résumés. To make it on Dimon's team you must be able to withstand the boss's withering interrogations and defend your positions just as vigorously. And you have to live with a free-form management style in which Dimon often ignores the formal chain of command and calls managers up and down the line to gather information."
  
  
• The environment of being able to push back with your ideas is at the core of this culture.  A classic example, albeit in some ways a small but symbolic one, is this:  "When he first came from Bank One, Dimon vociferously defended using the Chase "octagon" symbol as a trademark across the company. [Jay] Mandelbaum [head of strategy and marketing]  convinced Dimon that the octagon was a symbol of retail banking that didn't match J.P. Morgan's exclusive image. His lieutenants joke that Dimon now claims dropping the octagon from the J.P. Morgan side of the business was his idea."
  
  
• But an atmosphere of free-wheeling ideas is not always without sharp elbows:  "If you get your feelings hurt, you can't work here," says [Steve] Black [co-head of the investment bank]. "Jamie will apologize, then do the same thing two weeks later. He can't help himself."
  
  
• Getting bad news to the surface is another component.  Says Todd Maclin:  "Jamie and I like to get the bad news out to where everybody can see it:  To get the dead cat on the table."
  
  
• At the team's monthly day-long management meetings, candor is the currency du jour: " Dimon will throw out a comment like "Who had that dumb idea?" and be greeted with a chorus of "That was your dumb idea, Jamie!" "At my first meeting, I was shocked," says Bill Daley, 60, the head of corporate responsibility and a former Secretary of Commerce. "People were challenging Jamie, debating him, telling him he was wrong. It was like nothing I'd seen in a Bill Clinton cabinet meeting, or anything I'd ever seen in business.""
  
  
• However, you need to be as detail-oriented as Dimon.  Says Jes Staley, head of investment management, who battled Dimon for a year and ultimately won (on the question of whether JP Morgan should sell other firms' investment products to their customers—Staley argued they should only sell in-house products):  "He understands the details completely, he loves to debate and disagree, yet he'll let you do it." Staley adds a caveat: "As long as you know what's in Appendix 3 of your report as well as he does."

What does all this add up to?

I would argue:  The shockingly free flow of information.

Remember the October 2006 "ditch subprime" call?  What set Dimon off?

Every month, recall, Dimon reviews every aspect of the business in great detail ("Appendix 3" is not a joke).  And in October 2006, during the regular monthly review of the retail bank's operations, the head of mortgage servicing said that late payments on subprime loans were rising at an alarming rate.  Moreover, data showed that loans originated by competitors like First Franklin and American Home were performing three times worse than J.P. Morgan's subprime mortgages. "We concluded that underwriting standards were deteriorating across the industry," says Dimon.

But what about the CDO's the bank still held?  Weren't they all AAA rated?

Yes, they were, but the price of credit default swaps on even AAA-rated CDO's told a different story: 

Winters and Black [investment bank co-heads] saw that once they bought credit default swaps to hedge the AAA CDO paper J.P. Morgan would have to hold, the fees from creating CDOs would vanish. "We saw no profit, and lots of risk, in holding subprime paper on our balance sheet," says Winters.

The combined weight of that data triggered Dimon's call to King in Africa. "It was Jamie who saw all the pieces," says Winters.

Not only did Dimon instruct the bank to start selling its CDO's (including more than $12-billion subprime mortgages that JP Morgan had originated), he took action across the entire institution.  Trading desks were ordered to dump loans on their books, and to stop making markets in subprime loans for customers.  The private bank, that manages money for wealthy clients, started advising them to sell.  The corporate treasury department started hedging and placing bets that credit spreads would widen (profiting by hundreds of millions of dollars when that turned out to be precisely the case). 

Think there was no push-back?  Guess again:

Dimon's stance was radical: He was skirting the biggest growth business on Wall Street. "Our employees wanted to know why we were being so conservative," says Black. "We lost a lot of structured credit people to hedge funds." J.P. Morgan also lost ground to competitors. It sank from third to sixth in fixed-income underwriting from 2005 to 2007, and the main reason was its refusal to play in subprime CDOs, which its rivals were gorging on. "We'd get the quarterly reports from our competitors and see that they'd added $100 billion to their balance sheets," says Dimon.

So, to recap:

• Promote an environment of radical candor.
• Listen—truly listen—to those with other ideas.
• Assimilate information from every corner of the firm (unfiltered, need I add?).
• Synthesize it.
• And don't be afraid to take radically unpopular action, including walking away from seemingly lucrative business your competitors are milking.

Memories may be short, but financial services, let us never forget, are cyclical.  Just ask Jamie Dimon.