[ by Howard Haykin ] The Federal Reserve Bank of New York, vowing to overhaul its supervision of the nation's largest banks, replaced virtually all of its 40 or so examiners at JPMorgan Chase in mid-2011.  The objective was to enhance the team's expertise and to prevent cozy relationships from developing between Fed examiners and bank executives. It turned out to be a bad decision. Either the concept or the execution was flawed, and the Fed inadvertently let down its guard.  Its new corps of front-line examiners reportedly lacked a deep knowledge of JPMorgan's operations for a brief yet critical time, which contributed to the examiners' failure to adequately police JPMorgan's trading activities. Forced to play catch-up, ... the examiners struggled to understand the inner workings of a powerful investment unit, those officials said.  By the time they got up to speed, it was too late.  In May, JPMorgan disclosed a multi-billion dollar trading loss in the investment unit. They "couldn't ask tough questions," said a former official who was based at JPMorgan, highlighting a fundamental challenge of policing big banks, even after the crisis.  As regulators increased the number of examiners and tried to upgrade their capabilities and sophistication, the transition was not always smooth.  Faced with a higher level staff turnover during a several month period, regulators tried their best to retain knowledge of the bank's activities.  But they could not do enough - given the fact that the bank has more than $2 trillion in assets. It simply was not possible comb through every significant loan document or trade.  So, they took alternative measures, relying primarily on a bank's own analysis of its risk, a broad portrait that can mask problems.

As it turned out, the Fed staff served in an oversight role, peering over the bank's shoulders, and not as examiners, as the Fed had intended them to be - that, according to Bart Dzivi, who served as special counsel to the Federal Crisis Inquiry Commission.

Struggles Spread to Examiners from Office of the Comptroller of the Currency. The New York Fed's shake-up ended up aggravating a continuing struggle between JPMorgan executives and regulators from the Office of the Comptroller of the Currency, which supervises banks. For years, the agency, with dozens of its own examiners at JPMorgan, worried that the bank had been miscalculating how much money it could lose in extreme situations, according to the current and former officials. Examiners challenged the executives who stonewalled, and the conflict left agency supervisors with an incomplete picture of the bank's risk.  That was unfortunate, because their oversight covers the Chief Investment Office, and their reviews typically would include "risk management policies and controls that govern both the C.I.O and the rest of the bank.  That information will be used to determine what supervisory actions and changes are appropriate." Then there was a point in early 2012, when JPMorgan briefly stopped providing examiners with an important risk estimate for the chief investment office, the group at the center of the recent trading losses, the current and former officials said.  Executives told examiners not to worry. Hopefully, the JPMorgan trading losses will receive fresh scrutiny, and this information will begin to come out on Friday, when the JPMorgan reports its numbers. For further details, go to:  [Dealbook, 7/11/12].