Warm Southern Breeze

"… there is no such thing as nothing."

JPMorgan Chase CEO blames “Errors, Sloppiness & Bad Judgement” for $2B Credit Default Swap & Derivatives loss

Posted by Warm Southern Breeze on Thursday, May 10, 2012

Give particular attention to this sentence, which is found later in the article: “Bank executives, including Dimon, have argued for weaker rules and broader exemptions.”

Give attention also to the last paragraph of the second story: “Of course, this loss only goes to show how weak the Volcker Rule is: Dimon is adamant, and probably correct, in saying that Iksil’s bets were Volcker-compliant, despite the fact that they clearly violate the spirit of the rule. Now that we’ve entered election season, Congress isn’t going to step in to tighten things up — but maybe the SEC will pay more attention to Occupy’s letter, now. JP Morgan more or less invented risk management. If they can’t do it, no bank can. And no sensible regulator can ever trust the banks to self-regulate.”

Is there any remaining argument against deregulating banks?

Is there any remaining argument against re-instituting the Glass-Steagall Act (which separated Banks, Insurance & Wall Street and forbade them from commingling in each others’ businesses)?

Ahead of the Greek financial crisis – in which Goldman Sachs had a direct and unscrupulous role by hiding sales of financial vehicles from Greek, European & American regulators – German chancellor Angela Merkel said this at a March 5, 2010 press conference in Berlin with Greek Prime Minister George Papandreou, (ref: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a26n.U6qS6cU):

Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb.”  

Now, I wouldn’t expect you or the average reader to be knowledgeable about these things. Honestly, most folks aren’t. But that’s not a condemnation of you, dear reader. Rather, it is a statement acknowledging that banks, bankers, Wall Street types, and Insurance firms do not want to be regulated, and would rather operate free-willy-nilly – without any rules. You and I must  abide by rules. Why shouldn’t they? And as they have consistently demonstrated, they cannot be trusted to do the right thing.

For additional information on Goldman Sachs involvement in the Greek Debt Crisis, I refer you to this 02/08/2010 news item from German news magazine, Der Spiegel: “Greek Debt Crisis How Goldman Sachs Helped Greece to Mask its True Debt,” By Beat Balzli.

JPMorgan Chase acknowledges $2 billion trading loss and ‘many errors’

By Associated Press, Updated: Thursday, May 10, 6:05 PM

JPMorgan Chase, the largest bank in the United States, said Thursday that it lost $2 billion in the past six weeks in a trading portfolio designed to hedge against risks the company takes with its own money.

The company’s stock plunged almost 7 percent in after-hours trading after the loss was announced. Other bank stocks, including Citigroup and Bank of America, suffered heavy losses as well.

“The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought,” CEO Jamie Dimon told reporters. “There were many errors, sloppiness and bad judgment.”

The trading loss is an embarrassment for a bank that came through the 2008 financial crisis in much better health than its peers. It kept clear of risky investments that hurt many other banks.

The loss came in a portfolio of the complex financial instruments known as derivatives, and in a division of JPMorgan designed to help control its exposure to risk in the financial markets and invest excess money in its corporate treasury.

Bloomberg News reported in April that a single JPMorgan trader in London, known in the bond market as “the London whale,” was making such large trades that he was moving prices in the $10 trillion market.

Dimon said the losses were “somewhat related” to that story, but seemed to suggest that the problem was broader. Dimon also said the company had “acted too defensively,” and should have looked into the division more closely.

The Wall Street Journal reported last month that JPMorgan had invested heavily in an index of credit-default swaps, insurance-like products that protect against default by bond issuers.

Hedge funds were betting that the index would lose value, forcing JPMorgan to sell investments at a loss. The losses came in part because financial markets have been far more volatile since the end of March.

Partly because of the $2 billion trading loss, JPMorgan said it expects a loss of $800 million this quarter for a segment of its business known as corporate and private equity. It had planned on a profit for the segment of $200 million.

The loss is expected to hurt JPMorgan’s overall earnings for the second quarter, which ends June 30. Dimon apologized for the losses, which he said occurred since the first quarter, which ended March 31.

“We will admit it, we will learn from it, we will fix it, and we will move on,” he said. Dimon spoke in a hastily scheduled conference call with stock analysts. Reporters were allowed to listen.

Among other bank stocks, Citigroup was down 3.3 percent in after-hours trading, Bank of America was down 2.9 percent, Morgan Stanley was down 2.4 percent, and Goldman Sachs was down 2.2 percent.

JPMorgan is trying to unload the portfolio in question in a “responsible” manner, Dimon said, to minimize the cost to its shareholders. Analysts said more losses were possible depending on market conditions.

Dimon said the type of trading that led to the $2 billion loss would not be banned by the so-called Volcker rule, which takes effect this summer and will ban certain types of trading by banks with their own money.

The Federal Reserve said last month that it would begin enforcing that rule in July 2014.

Some analysts were skeptical that the investments were designed to protect against JPMorgan’s own losses. They said the bank appeared to have been betting for its own benefit, a practice known as “proprietary trading.”

Bank executives, including Dimon, have argued for weaker rules and broader exemptions.

JPMorgan has been a strong critic of several provisions that would have made this loss less likely, said Michael Greenberger, former enforcement director of the Commodity Futures Trading Commission, which regulates many types of derivatives.

“These instruments are not regularly and efficiently priced, and a company can wake up one day, as AIG did in 2008, and find out they’re in a terrific hole. It can just blow up overnight,” said Greenberger, a professor at the University of Maryland.

The disclosure quickly led to intensified calls for a heavier-handed approach by regulators to monitoring banks’ trading activity.

“The enormous loss JP Morgan announced today is just the latest evidence that what banks call ‘hedges’ are often risky bets that so-called ‘too big to fail’ banks have no business making,” said Sen. Carl Levin, D-Mich.


AP Business Writer Pallavi Gogoi contributed to this report.


JP Morgan: When basis trades blow up

By Felix Salmon
May 10, 2012

I’m not sure if it was the biggest quarterly loss of all time, but Merrill Lynch’s $16 billion loss in the fourth quarter of 2008 certainly ranks very high up there in the annals of investment-bank blowups. It happened after the bank had already been taken over by Bank of America, and it was in the middle of the financial crisis, so it didn’t get nearly the amount of attention it deserved. But it was not simply a case of assets plunging in value. Instead, it was, in very large part, a basis trade blowup.

The basis trade is an arbitrage, basically. There are two different ways the market measures credit risk: by looking at credit spreads — the yield on a certain issuer’s bonds, relative to the risk-free rate — or by looking at CDS spreads, which are basically the same thing but set in the derivatives market rather than the cash bond market. Most of the time, CDS spreads and cash spreads are tightly coupled. But sometimes they’re not. And at Merrill, a huge part of that $16 billion loss was reportedly due to a bad basis bet: the basis on many credits became very large and very negative during the financial crisis.

This time around, the basis-trade disaster has happened at JP Morgan, where the famous London Whale seems to have contrived to lose $2 billion on what was meant to be a hedging operation. And once again, although the details are still very murky, the culprit seems to be the CDS-cash basis.

I’ve been meaning to write a post about the CDS-cash basis for a few days now, which is why I happen to have this chart handy, showing the basis for various European banks as of Tuesday May 8.

CDS-Cash basis

Credit Default Swap v Cash

These are very big numbers, for very big banks: UBS is at 75bp, Deutsche is at 83bp, Natixis is at 116bp, and IKB is at a whopping 392bp. And this is just the banks — other corporates have seen similar price action. The cost of protection has gone up sharply, while the cash bonds are still trading at very low spreads.

Bruno Iksil, the London Whale, had a massive long position on corporate CDS in general, and the CDX.NA.IG.9 index in particular. He was selling protection, betting that credit spreads would go down, rather than up. The position was meant to be a hedge, although it’s a bit unclear how JP Morgan could have some massive short position in corporate debt that it was hedging against. In any case, CDS spreads went up — and credit spreads, in the cash market, didn’t.

Cue a $2 billion loss.

Rarely has a position been as widely publicized as Iksil’s, and I wouldn’t be at all surprised to learn that the credits with the highest basis were precisely the credits CDX.NA.IG.9 index. Whenever a trader has a large and known position, the market is almost certain to move violently against that trader — and that seems to be exactly what happened here. On the conference call, when asked what he should have been watching more closely, Dimon said “trading losses — and newspapers”. It wasn’t a joke. Once your positions become public knowledge, the market will smell blood.

Of course, this loss only goes to show how weak the Volcker Rule is: Dimon is adamant, and probably correct, in saying that Iksil’s bets were Volcker-compliant, despite the fact that they clearly violate the spirit of the rule. Now that we’ve entered election season, Congress isn’t going to step in to tighten things up — but maybe the SEC will pay more attention to Occupy’s letter, now. JP Morgan more or less invented risk management. If they can’t do it, no bank can. And no sensible regulator can ever trust the banks to self-regulate.


JP Morgan reveals shock $US2bn loss on ‘London Whale’ trades

  • by: Dan Fitzpatrick and Liz Rappaport
  • From: The Wall Street Journal
  • May 11, 2012 8:59AM

JP MORGAN CHASE took $US2 billion in trading losses in the past six weeks and could face an additional $US1bn in second-quarter losses due to market volatility, chief executive James Dimon said overnight in a hastily arranged conference call after US markets closed.

The losses stemmed from derivatives bets gone wrong in the bank’s Chief Investment Office, which manages risk for the New York company. The Wall Street Journal reported last month that large bets – by a London-based trader named Bruno Michel Iksil – being made in that office had roiled a sector of the debt markets.

The loss is a black eye for the bank, which sailed through the financial crisis in better shape than many of its peers, and for Mr Dimon, who was deemed King of Wall Street during the financial crisis. It comes at a time when large banks are fighting efforts by regulators to rein in risky trading with measures such as the so called Volcker rule.

Shares in JP Morgan fell 5.8 per cent in after-hours trading overnight.

JP Morgan, the largest bank by assets in the US, said in its quarterly regulatory filing that a plan it has been using to hedge risks “has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed”.

Mr Dimon said the so called synthetic hedge, using insurance-like contracts known as credit default swaps (CDS), was “poorly executed” and “poorly monitored”. He said that the bank has an extensive review under way of what went wrong, and that there were “many errors”, “sloppiness” and “bad judgment” on the bank’s part.

Credit-default swaps are a type of derivative that act as insurance against a debt issuer defaulting. The instrument rises in value and ultimately pays out to the buyer if a debt issuer defaults.

No one has been fired as a result of the losses, but Mr Dimon could take such action once the firm completes its review of what happened.

“We will admit it, we will fix it and move on,” Mr Dimon said. “This trading violates the Dimon principle.”

The bank raised its estimate of losses at the unit to $US800 million from the previous $US200m. Mr Dimon said yesterday that the trading losses had been offset by $US1bn or so in gains on securities sales.

The Journal reported in April that hedge funds and other investors were making bets in the CDS markets to take advantage of volatility that stemmed from the trades done by Mr Iksil, who worked out of the Chief Investment Office.

Soon after the April article was published, Mr Dimon said on the company’s earnings call that questions about the office’s trading were “a complete tempest in a teapot”.

“Every bank has a major portfolio,” he said on the April 13 call. “In those portfolios you make investments that you think are wise to offset your exposures.”

Mr Iksil, who has worked at JP Morgan since 2007, became bullish on the value of some corporate debt earlier this year. He sold protection on an index of these companies in the form of CDS called the CDX IG 9.

His trading moved the index during the first quarter, traders said. A sign of how hot the trade is: The net “notional” volume in the index ballooned to $US144.6bn on March 30 from $US92.6bn at the start of the year, according to Depository Trust & Clearing Corp data.

Mr Iksil’s group had roughly $US350bn of investment securities as of December 31, 2011, or about 15 per cent of the bank’s total assets, according to company filings.

JP Morgan’s loss comes in a period in which many other large US banks posted placid trading results. Goldman Sachs Group’s trading operations had one losing day in the first quarter, in which it lost no more than $US25m, it said in a filing yesterday.

Bank of America had a perfect trading quarter, with no losing days. Morgan Stanley had four days during which it suffered losses.

“This is yet another example of the need for the more than $US700 trillion derivatives market to be brought into the light of financial regulation,” said Dennis Kelleher, president of Better Markets, a liberal non-profit group focused on financial reform.

The Volcker rule is a part of the Dodd-Frank financial overhaul legislation passed in the US in July of 2010. The rule, conceived of by former Federal Reserve chairman Paul Volcker, prohibits financial institutions from using their own proprietary cash to take big bets in the markets. The rule is not yet in place, but many financial firms have cut back on businesses and activities, such as specific trading desks that use bank cash and investments in hedge funds and private equity funds, that seem to violate the rule.

Banks have been arguing broadly that the rule would cut liquidity and raise prices in markets, while many critics of the large banks have said the trading needs to be reined in more aggressively.

The trading loss “plays right into the hands of a whole bunch of pundits out there”, Mr Dimon said. “We will have to deal with that – that’s life.”

The losses could potentially expose bank employees to so called clawback policies that permit the recovery of compensation in the event of a financial re-statement. Banks like JP Morgan have adopted such policies, which also are required under the Dodd-Frank financial overhaul law.

Additional reporting by Victoria McGrane and Robin Sidel


One Response to “JPMorgan Chase CEO blames “Errors, Sloppiness & Bad Judgement” for $2B Credit Default Swap & Derivatives loss”

  1. […] financial markets to once again become abusive, and falter again. Complex financial services called “derivatives,” and CDSs (Credit Default Swaps), became highly popular, and in a Berlin press conference Friday, March 5, 2010 with Greek Prime […]


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