What You Need To Know: JP Morgan Loses At Least $2 Billion on Trading

May 11, 2012 02:26 AM

via a special arrangement with Informa Economics, Inc.

Trading losses at $2 billion; another $1 billion could unfold | Raising call for tough regulations on Wall Street

NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.

The situation: JP Morgan revealed late Thursday that the firm had racked up $2 billion in trading losses  (some say $2.3 billion) over the past six weeks and could face another $1 billion in losses in the second quarter due to market volatility, bringing the issue of derivatives trading back into focus as that was what company officials said was at the source of the steep loss.

The Wall Street Journal and Bloomberg News reported on the trades placed by the company’s Chief Investment Office (CIO) which is charged with managing risk. When asked about the matter in an April call, JPMorganChase CEO Jamie Dimon dismissed it as a "tempest in a teapot." It appears that was a pretty big teapot.

Just before the conference call in which Dimon discussed the matter, JPMorgan released the following statement:

"Since March 31, 2012, CIO has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed. The losses in CIO’s synthetic credit portfolio have been partially offset by realized gains from sales, predominantly of credit-related positions, in CIO’s AFS securities portfolio."

Dimon’s response: The head of the firm has been seen as one of the more astute on Wall Street, but he was frank and blunt in announcing the situation on Thursday.

The trading that caused the loss was "flawed, complex, poorly reviewed, poorly executed and poorly monitored," Dimon stated, labeling it an "egregious, self-inflicted" mistake by the firm.  "I am not sure how many times I can say this: It was bad strategy, executed poorly," Dimon said.

"In hindsight, this was bad execution, bad strategy, but also the environment -- because this is mark to market," Dimon noted. "But I just don't want to make excuses. This is not how we want to run a business."

"Hopefully, this will not be an issue by the end of the year, but it does depend on the decisions and the markets," Dimon said. "With hindsight we should have been paying more attention to it."

Are other firms making the same kind of mistakes, Dimon was asked. He was very blunt about this -- "Just because we're stupid doesn't mean everyone else is."

Regulator/lawmaker response: Nothing yet from the Securities and Exchange Commission or the Federal Reserve, but Senate Carl Levin (D-Mich.) seized on the matter, labeling it "the latest evidence that what banks call ‘hedges' are often risky bets that so-called ‘too big to fail’ banks have no business making." The revelation by JPMorgan is "a stark reminder of the need for regulators to establish tough, effective standards… to protect taxpayers from having to cover such high-risk bets," he added

The Volcker rule is set to come into effect July 21 and would put restrictions on banks’ trading with their own money. Firms would have at least two years to comply with the new rules.

But the Volcker Rule will be bandied about in the press even though not all are convinced that the rule would have prevented what took place.

The situation "plays right into the hands of a whole bunch of pundits out there," Dimon stated Thursday. "We will have to deal with that—that's life."

Would the trade have been in violation of the Volcker Rule if it was in effect? Dimon simply said, "This doesn't violate the Volcker rule, but it violates the Dimon principle."

Impact on JPMorgan. Dimon said they "don’t give overall earnings guidance and we are not confirming current analyst estimates, if you did adjust current analyst estimates for the loss, we still earned approximately $4 billion after-tax this quarter give or take," he said on the call. "When you look at all the things we've done, we've been very careful. And we've been quite successful. This obviously wasn't."

Bloomberg reported that the CIO group of traders had a $200 billion portfolio and posted profits of $5 billion in 2010.

JPMorgan shares fell in European trading and will likely take a hit when the opening bell rings in New York today.

Prior to the disclosure of the losses, JPMorgan stock had risen 23 percent this year.

It will cost more to insure JPMorgan debt, as data compiled by Bloomberg noted that credit default swaps insuring the firm’s debt rose 17 basis points to 124 – the highest since Feb. 16.

The cost of insuring debt of JPMorgan from default rose. Credit-default swaps insuring the bank’s debt climbed 17 basis points to 124, the highest since Feb. 16, according to data compiled by Bloomberg.

JPMorgan had $2.32 trillion of assets supported by $190 billion of shareholder equity at the end of March which industry observers note is an equity ratio of almost 13 percent, which is four times the level for most in the industry.

Bottom line: This now brings into the situation whether "too big to trade" is now another layer that has to be considered in terms of financial markets and regulation of those markets. JPMorgan has been one of the more "aggressive" firms of late – Dimon said he preferred the term "better" – and they will now become the "poster child" for Levin and others seeking to tighten regulation of banks and other financial firms.

It’s still not clear that reforms coming that are part of the Dodd-Frank financial reform law would have prevented this from taking place. And so far, there are no calls for financial help for the firm. But it has dented the overall market psyche and will put even closer scrutiny on banks by investors and regulators.

And in particular, the focus will be on the types of tools that banks and others use to manage risk. In their filings, JPMorgan acknowledged that their plan for hedging risk "has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed." That appears to be an at-least $2 billion or more understatement and again will not temper the arguments for more scrutiny of firms like JPMorgan.

What could become key is whether the trades were meant to hedge against specific risks as opposed to just being a bet on the markets. If they were aimed at hedging specific risks, that could well mean it was outside of the scope of what the Volcker rule is meant to limit. That could prove a tall task to prove.

Depending on whether there are further revelations, it appears JPMorgan may well weather this storm. But for the banking and financial industry, this gives them yet another challenge besides a slow-growing world economy – proving that risk and in particular finding ways to manage risk are not four-letter words. In our sound-bite society, that will be a tall order.


NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.






Back to news


Spell Check

No comments have been posted to this News Article

Corn College TV Education Series


Get nearly 8 hours of educational video with Farm Journal's top agronomists. Produced in the field and neatly organized by topic, from spring prep to post-harvest. Order now!


Market Data provided by QTInfo.com
Brought to you by Beyer