JPMorgan's Whale Makes a $2 Billion Trading Loss

Not much to the Bloomberg article below. My summary and comments:
  • JPMorgan's position on the CDX market is so sizable it's moving the market
  • Senior management (and obviously the genius trader who built that position) didn't understand the risk
  • In order to make a $2 billion loss, you need to have a massive position, in the dozens of billions, so $100 billion seems likely.
  • Unwinding that trade will be very costly to JPM, so new losses will stack up. Partly due to the size of the bet, and partly because the market will not forgive this major mistake, and hedge funds will now work on arbitraging JPM on this trade.
  • They tweaked their VaR methodology to show less risk were they shouldn't. This is a consequence of greed and of incompetence, but could also be qualified as fraudulent activity.
And here's the Bloomberg report:
(Bloomberg) May 10, 2012 — JPMorgan Chief Executive Officer Jamie Dimon said the firm suffered a $2 billion trading loss after an “egregious” failure in a unit managing risks, jeopardizing Wall Street banks’ efforts to loosen a federal ban on bets with their own money. 
The firm’s chief investment office, run by Ina Drew, 55, took flawed positions on synthetic credit securities that remain volatile and may cost an addtional $1 billion this quarter or next, Dimon told analysts yesterday. Losses mounted as JPMorgan tried to mitigate transactions designed to hedge credit exposure. 
There were many errors, sloppiness and bad judgment,” Dimon said as the company’s stock fell in extended trading. “These were grievous mistakes, they were self-inflicted.”
The chief investment office was thrust into the debate over U.S. efforts to ban proprietary trading when Bloomberg News reported last month that the unit had taken bets so big that JPMorgan, the largest and most profitable U.S. bank, probably couldn’t unwind them without losing money or roiling financial markets. Dimon, 56, had transformed the unit in recent years to make bigger and riskier speculative trades with the bank’s money, five former employees said
Dimon had defended the unit as a “sophisticated” guardian of the bank’s funds on an April 13 conference call, calling news coverage “a complete tempest in a teapot.” On May 2, he led fellow Wall Street CEOs in a closed-door meeting to lobby the Federal Reserve about softening proposed U.S. reforms that might crimp their profits.

Yesterday, he said the timing of the trading blunders “plays right into the hands of a bunch of pundits out there” who are pushing for a strict version of the proprietary trading ban named for former Federal Reserve Chairman Paul Volcker
Given Dimon’s resistance to the ban and new regulations, “he’s got a lot of egg on his face right now,” said Craig Pirrong, a finance professor at the University of Houston. “Any chance they had of getting a relative loosening of Volcker rule, anything of that nature, that’s out the window.” 
The chief investment office’s push into risk-taking was led by Achilles Macris, 50, according to three former employees, Bloomberg News reported on April 13. He was hired in 2006 as its top executive in London and led an expansion into corporate and mortgage-debt investments with a mandate to generate profits for the New York-based bank, they said. Dimon closely supervised the transition from its previous focus on protecting JPMorgan from risks inherent in its banking business, such as interest-rate and currency movements, they said.

“I wouldn’t call it ‘more aggressive,’ I would call it ‘better,’” Dimon told analysts yesterday. “We added different types of people, talented people and stuff like that.” Until recently, they were careful and successful, he said. 
“It’s classic Wall Street hubris, which we’ve seen so many times before,” said Simon Johnson, a former chief economist at the International Monetary Fund who now teaches at the Massachusetts Institute of Technology. “What’s particularly ironic here is that Jamie presents himself, and is believed by others to be, the king of risk management.” 
Bloomberg News first reported April 5 that London-based JPMorgan trader Bruno Iksil had amassed positions linked to the financial health of corporations that were so large he was driving price moves in the $10 trillion market. 
The $2 billion loss occurred in London under multiple traders, according to an executive at the bank, who spoke on the condition of anonymity. Dimon wasn’t immediately told about their shift in strategy and didn’t know the magnitude of the losses until after the company reported earnings April 13, the executive said. As the position deteriorated rapidly, the bank gathered internal analysts and examiners to investigate, and Dimon grew more distressed by the day, the executive said. 
While no one has been fired yet, Dimon told analysts he will take “corrective actions.” The bank is keeping employees involved on hand while it deals with the transactions, and some are likely to lose their jobs afterward, said an executive with knowledge of the situation. The bank is also reevaluating its risk-monitoring team within the chief investment office, the person said. 
JPMorgan risks losing more money now because other market participants will figure out what the bank has to do to unload its position, said Charles Peabody, an analyst with Portales Partners LLC in New York. Costs from the trades may affect earnings through the end of the year, he said.

When there’s blood in the water, the sharks are going to attack that animal,” said Peabody, who downgraded his recommendation on the stock in March to sector perform. “It could make it very difficult for them to unwind a trade.” 
[...] Dimon said losses could widen or narrow in coming weeks and months, and that he can’t estimate potential costs.
[...] “It’s a major event that confirms a lot of investors’ worst fears about bank risk,” said Frank Partnoy, a former derivatives trader who’s now a law and finance professor at the University of San Diego. Concern is “that at a large, supposedly sophisticated institution, even something called a ‘hedge’ can contain all kinds of hidden risks that the senior people don’t understand.”
Iksil may have amassed a $100 billion position in contracts on Series 9 of the Markit CDX North America Investment Grade Index, counterparts at hedge funds and rival banks said in April. They based their estimates on the trades and price movements they witnessed as well as their understanding of the size and structure of the markets. The positions amounted to tens of billions of dollars, under the firm’s own math, a person familiar with its view said at the time. 
[...] Satyajit Das, the author of “Extreme Money: Masters of the Universe and the Cult of Risk,” compared the publicity around JPMorgan’s situation to losses that spiraled at hedge funds like Long-Term Capital Management in 1998 and Amaranth Advisors LLC in 2006.
“A $2 billion loss suggests a position of considerable size,” Das said. “I think you remember LTCM and a few other people like Amaranth that have had the exact same problem and have learned it’s a bit like hell -- easy to get into, not so easy to get out of.” 


Rahul said...

This shows how much volatility still prevails on hedging side. Cannot imagine the worlds renowned institutions failing. It is very clear the US Government allowed the institution of this stature to freely do whatever they feel. It is merely a poor risk assessment. Lehman Brother is another example. Today in our country State Bank of India would have gone through similar turmoil had it not due to strong Government controls. We criticize Indian Government many time but should thank for strong controls. In that sense our financial institutions are in very strong and less volatile than US financial Institutions. Slow and steady India can rise provided we control corruption.

pej said...

Thanks for your comment Rahul. Unfortunately, I cannot agree with your assessment: losses and bankruptcies are part of the free market definition.
The Indian Government is making hundreds if not thousands of wrong decisions every month, and due to the central planning nature of them, they have a far deeper impact that any one company could have.

Moreover, thinking that "Big Government is the Solution provided we control corruption" is as unrealistic as to say "I could fly if only there was no gravity". Well, corruption feeds on big government, and there's no way to get rid of it, since it's very existence is the big government and the centralization of power.

India is headed for a very severe downturn, as soon as the massive credit bubble pops.