This is How a Big Bank Blew $6.2 Billion in High-Risk Trades

This is How a Big Bank Blew $6.2 Billion in High-Risk Trades
JPMorgan Chase CEO Jamie Dimon

Higher-ups at JPMorgan Chase didn’t do much to stop the downward spiral in credit-derivative bets by the so-called London Whale trader.
The end-result was a $6.2 billion loss in proprietary funds that mostly took shape during the first quarter of 2012 by the largest U.S. bank by assets.
A report released Thursday by the Senate Permanent Subcommittee on Investigations reveals to the extent that senior managers at JPMorgan Chase went to hide “substantial losses for months at a time.”  The 307-page document provides e-mails, instant messages and phone recordings showing how traders went about their charade.
The bank inflated trade values, misled or dodged federal regulators, and misinformed investors and the public about the trading strategy, the report reveals.
But the report also re-ignites the debate among lawmakers on how to keep big banks from putting their own funds at risk in such trading activities.
JPMorgan Chase spun off its Chief Investment Office (CIO) in 2005 as a separate unit within the bank that was charged with investing the bank’s excess deposits.
The report put it this way: “The Subcommittee’s investigation has exposed not only high-risk activities and troubling misconduct at JPMorgan Chase, but also broader, systemic problems related to the valuation, risk analysis, disclosure, and oversight of synthetic credit derivatives held by U.S. financial institutions.”
Synthetic credit derivatives generate gains and losses tied to credit performance, without the holder buying or selling actual debt. Financial institutions use these instruments to protect themselves against the likelihood that corporations will fail to repay their loans.
In the first quarter of 2012, the CIO traders mounted a sustained trading spree, eventually increasing the size of the its synthetic credit portfolio threefold, from $51 billion to $157 billion, the Senate report said.
By March, the portfolio included at least $62 billion in holdings in a U.S. credit index for investment-grade companies; $71 billion in holdings in a credit index for European investment-grade companies; and $22 billion in holdings in a U.S. credit index for high-yield (non-investment grade ) companies.
“Those holdings were created, in part, by an enormous series of trades in March, in which the CIO bought $40 billion in notional long positions, which the OCC (bank regulator) later characterized as “doubling down” on a failed trading strategy,” the report said.
By the end of March 2012, the portfolio held over 100 different credit derivative instruments, with a high-risk mix of short and long positions, referencing both investment grade and non-investment grade corporations, and including both shorter and longer term maturities.
“JPMorgan Chase personnel described the resulting (portfolio) as ‘huge’ and of ‘a perilous size’ since a small drop in price could quickly translate into massive losses,” the Senate report said.
The Senate report said JPMorgan Chase was unable to explain why the synthetic credit portfolio’s hedges were treated differently from other types of hedges within the CIO.
“While its original approval document indicated that the SCP (synthetic credit portfolio) was created with a hedging function in mind, the bank was unable to provide documentation over the next five years detailing the SCP’s hedging objectives and strategies; the assets, portfolio, risks, or tail events it was supposed to hedge; or how the size, nature, and effectiveness of its hedges were determined.”

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