JP Morgan Screws Up With Derivatives Trading

[John Mace]

Originally Posted by Trom

Uhhh, you made the claim. How do I cite something that hasn't happened? Cite back at you.

Let's not worry about it. My point was really that it wasn't the government or the taxpayers taking the hit. Whether it's JPM or JPM's investors is the same thing in my book.

Originally Posted by Voyager

Every investment has a risk. Investments with greater risk yield greater returns when they are going well - and also crash harder. Management, who want to increase returns, clearly are going to move to investments with higher risk. It is the job of the risk management departments to stop them.
Okay so far?

OK so far.

2008 and this situation have clearly demonstrated that risk management departments are not up to the job. The $2 billion loss was not an acceptable result of trading - it got the manager responsible fired. That is different from it not blowing up the company. Why did risk management fail? It might be the pressure to make a better return, it might be because the products are so complicated that they aren't understood, or the models might be wrong.
But it is clear that banks cannot regulate themselves, even well-run ones, thus we need regulations imposed by someone who doesn't have a duty to increase their short run profitability. I can't think anyone but the government who can do this, can you?
If by "this particular risk" you mean whether there should be a regulation to stop the exact thing they did, then no one I've seen agrees. If we ban one trading strategy five more will pop up. What this particular risk did was falsify the claim that much of the proposed regulation was unnecessary because the banks wouldn't make that kind of mistake again.

That's where you lose me. How does this particular loss compare to the kinds of losses that created the meltdown in 2007/2008? What if the loss had been $5M? What if they had gotten lucky and made $2B instead of losing it?

I don't care about the loss, itself-- that is, the $ amount. I want to understand what it is about the nature of this particular loss that ties it to the kinds of losses that occurred in 2007/2008. I'm just not seeing it in anyone's post so far.

[Hbns]

NM John Mace was kind enough to concede the point.

[Hbns]

Originally Posted by John Mace

I don't care about the loss, itself-- that is, the $ amount. I want to understand what it is about the nature of this particular loss that ties it to the kinds of losses that occurred in 2007/2008.

I don't know that it is tied to 07/08 other than this again seems to be a case of driving up a derivative until someone is left holding the bag.

Scuttlebutt I have heard is that the JPM trades were sufficient to influence the market and by extension the derivative fund, and this was being actively and successfully done until enough other traders took opposite positions to quell the upward manipulation. Hell I don't even have a problem with that really. The market was self correcting as it should be.

The only thing that bothers me is the multiplied exposure that these derivative funds seem to have. It seems to be easy for the firms to overlook just how exposed they are or have become, and this isn't a good thing.

[Trom]

Originally Posted by Hbns

NM John Mace was kind enough to concede the point.

Investors in JPM are not the same as people who use JPM as a custodian of their accounts. The claim that people using JPM as custodian of their accounts could lose money from this is what I was responding to. It's an important distinction.

[John Mace]

Originally Posted by Trom

Investors in JPM are not the same as people who use JPM as a custodian of their accounts. The claim that people using JPM as custodian of their accounts could lose money from this is what I was responding to. It's an important distinction.

Yes, I agree. If I have 401k invested in the S&P500 at JPM, I better not be affected by this. If I own JPM stock, then I'm SOL. I hadn't noticed that he was talking about both those situations earlier.

[elucidator]

Originally Posted by Hbns

....The market was self correcting as it should be....

I've heard this phrase many a time, and I'm not quite sure I believe, or maybe just don't understand it. Is that "self-correcting" in the same sense as lemming population control mechanisms?

[FinnAgain]

Lemmings do not work like that.

[elucidator]

I go then to the river, to perform the Ancient Albanian Ritual of Self-abasement, accompanied by a Chorus of Bitter Virgins, intoning dirges of woe and humiliation.

[Voyager]

Originally Posted by ralph124c

Why doesn't the government encourage banks to invest in state lottery tickets? They could buy up huge blocs, ensuring a steady return..and they would be helping with state finances.
Sounds like a plan!

Hush! Someone might be listening.

[Voyager]

Originally Posted by John Mace

That's where you lose me. How does this particular loss compare to the kinds of losses that created the meltdown in 2007/2008? What if the loss had been $5M? What if they had gotten lucky and made $2B instead of losing it?

I don't care about the loss, itself-- that is, the $ amount. I want to understand what it is about the nature of this particular loss that ties it to the kinds of losses that occurred in 2007/2008. I'm just not seeing it in anyone's post so far.

In 2007 the risk management departments of banks in some way decided that the housing market would never go down nationwide. Beyond that, an article in the Times magazine about a risk evaluation tool everyone was using (which I think was developed by JPM) said that the fatal flaw was that the rules allowed the risk to be cut to 1% or something - except everyone created instruments that had 1% risk, which simple probability tells you was a guaranteed disaster. Basically the goal of everyone was not to reduce risk, but to play the tool so that they got the maximum allowable risk (and return).

In this case the risk management formula was changed in a way that reduced the risk of this investment. (I've seen no evidence that this was deliberate.) The Times article I mentioned before said that the Chief Investment Office brought in risk management people they were friendly with, and that New York didn't really understand the complexity of the trades being done in London. (Which should also ring a bell.) Even when the alarm bells went off in April, with very erratic trading sessions with big gains and big losses, the amount invested increased. Dimon was busy with other problems until it was too late.
And just like 2008, this did not happen from anyone being crooked or breaking any laws. The bank of course says that its risk management is just fine - I think the results say otherwise.
So we have more or less out of control traders dealing in trades no one understands without enough supervision. That is why it is similar.

[Voyager]

Originally Posted by Trom

Investors in JPM are not the same as people who use JPM as a custodian of their accounts. The claim that people using JPM as custodian of their accounts could lose money from this is what I was responding to. It's an important distinction.

Well, yes and no. Joe Nocera's column today discusses this. It seems that the money used as the base of this investment came from insured JPM deposits. Instead of investing these in safe loans, they decided that to get higher returns (and it doesn't seem these returns would go to the investors) they would invest in corporate bonds. The first level hedge was basically insurance on the bonds (like what AIG sold) and the second level was a hedge on the hedge, which no one seems to really understand.

I don't know if investing insured deposits in riskier trades to make more money for the bank is proprietary trading or not. The authors of the bill think so. But it is exactly the kind of thing Glass Steagall prevented.

[Trom]

Originally Posted by Voyager

Well, yes and no. Joe Nocera's column today discusses this. It seems that the money used as the base of this investment came from insured JPM deposits. Instead of investing these in safe loans, they decided that to get higher returns (and it doesn't seem these returns would go to the investors) they would invest in corporate bonds. The first level hedge was basically insurance on the bonds (like what AIG sold) and the second level was a hedge on the hedge, which no one seems to really understand.

I don't know if investing insured deposits in riskier trades to make more money for the bank is proprietary trading or not. The authors of the bill think so. But it is exactly the kind of thing Glass Steagall prevented.

Customer accounts are sooooo far down the list of things that get touched in the event of failure it's pretty much just fear-mongering to bring it up in this context. The institution would have to essentially fail, stock go to zero, preferred stock go to zero, bond holders take a hair cut/get wiped out, SIPC insurance (which covers $500k per account) be exhausted, and then the insurance covering deposits not covered by SIPC (in the neighborhood of hundreds of millions of dollars for large institutions) would have to be burnt through. Then customers might have to be worried. Most likely another institution would purchase the customer accounts and the only thing people would notice would be a different bank's name at the top of their monthly statement.

[Voyager]

Originally Posted by Trom

Customer accounts are sooooo far down the list of things that get touched in the event of failure it's pretty much just fear-mongering to bring it up in this context. The institution would have to essentially fail, stock go to zero, preferred stock go to zero, bond holders take a hair cut/get wiped out, SIPC insurance (which covers $500k per account) be exhausted, and then the insurance covering deposits not covered by SIPC (in the neighborhood of hundreds of millions of dollars for large institutions) would have to be burnt through. Then customers might have to be worried. Most likely another institution would purchase the customer accounts and the only thing people would notice would be a different bank's name at the top of their monthly statement.

Nowhere did I say or claim that customer accounts were at risk. The point was whether trading using customer money but for the bank's profit can be considered proprietary trading or not. If the customers had bought a bond fund, then it is clearly not proprietary trading, including the hedges.
In this case the first hedge is allowed. That seems pretty clear. And that is not where they lost the money. The first hedge was going down in value as the underlying investment went up. Now, if this was a pure hedge that would be expected. You can't expect both sides to make money. But because the Chief Investment Office was a profit center, they did the second level of hedging which is where they ran into trouble. And that one seems proprietary to me.

[Trom]

Originally Posted by Voyager

Nowhere did I say or claim that customer accounts were at risk. The point was whether trading using customer money but for the bank's profit can be considered proprietary trading or not. If the customers had bought a bond fund, then it is clearly not proprietary trading, including the hedges.
In this case the first hedge is allowed. That seems pretty clear. And that is not where they lost the money. The first hedge was going down in value as the underlying investment went up. Now, if this was a pure hedge that would be expected. You can't expect both sides to make money. But because the Chief Investment Office was a profit center, they did the second level of hedging which is where they ran into trouble. And that one seems proprietary to me.

You quoted my post in which I was rebutting the statement that customer funds were at risk. So, I figured I'd clarify - they aren't.

I don't care to argue about whether or not the trade was a proper hedge or proprietary, as I don't think it is really the issue.

[Voyager]

Originally Posted by Trom

You quoted my post in which I was rebutting the statement that customer funds were at risk. So, I figured I'd clarify - they aren't.

I don't care to argue about whether or not the trade was a proper hedge or proprietary, as I don't think it is really the issue.

I guess you missed where I said insured deposits.

[Randvek]

Originally Posted by Trom

I don't care to argue about whether or not the trade was a proper hedge or proprietary, as I don't think it is really the issue.

Agreed. "How" isn't nearly as important as the fact that this entire loss is on the shoulders of one man who doesn't even have the decency of getting himself elected before playing recklessly with that kind of money.

[Trom]

Originally Posted by Voyager

I guess you missed where I said insured deposits.

I don't follow you. All I've attempted to do in this thread is rebut this false statement:

Originally Posted by Hbns

There is no secret reserve stash to replenish the funds that were traded to take this losing position. Those people with IRA's and 401k's in JPM administered funds are most likely who are going to cover it.

[ralph124c]

JPMC is now hinting that the losses may be quite a bit higher..stay tuned!

[elucidator]

A little higher. A few hundred million, maybe. No biggie.

[Evil Captor]

Basically, all the pro-JPM positions I've seen are just saying, "Hey, the company wasn't ruined this time."
But what about next time? There won't be one? Jamie Diamant said there wouldn't be a THIS time!

[Voyager]

Originally Posted by elucidator

A little higher. A few hundred million, maybe. No biggie.

People are talking $4 billion. The problem is, the hedge is getting worse and worse, and since they are the market they have no way of getting out of it, since even the suckers know it is a bad deal. Not that a $4 billion loss if fundamentally worse than a $2 billion loss in terms of the need for regulation.

[Cheshire Human]

The page I just got here from said

"JP Morgan Screws Up With..."
"Evil Captor"

What, did they make you CEO just before the bubble burst?

Sorry, carry on...

[Evil Captor]

Originally Posted by Cheshire Human

The page I just got here from said

"JP Morgan Screws Up With..."
"Evil Captor"

What, did they make you CEO just before the bubble burst?

Sorry, carry on...

Isn't it obvious? They were looking for a chump to hold the bag when the balloon went sour!

[China Guy]

The issue is that these banks have an explicit and implicit US government and taxpayer guarantees. These guarantees do not encourage risk management. Back when most of the investment banks were investment banks, and Glass Stegal was still in place, places like Goldman Sachs, Morgan Stanley et al were partnerships. It was partner money at risk and not "shareholders" and there was a natural incentive to manage risk because the partners would lose their homes if it went south. Now all that happens is Uncle Sugar bails you out for 10% a year, no one goes to jail, and bonuses were "honored by existing contract."

The biggest fault I have with the great bailout is that we (US taxpayers) essentially gave sweethart deals to the banks to stay in business, when the gubmint should have acted like a loan shark and taken at least one testicle for the privledge of the banks not going bankrupt like they would have.

Now, I'm off of my soapbox. There is no evidence that the banks have ringfenced their commercial and investment banking operations (UK, bless their hearts, are putting this in place). That means a "hedge" on the bank going south and costing billions could actually impact commercial banking deposits, trigger deposit insurance, and cause systemic banking risk. Long-Term Capital Management (LTCM) lost 4.6 billion U.S. dollars in fixed income arbitrage in September 1998, and damn near triggered a serious financial crisis. JPM could easily lose more than that by the time all their positions are unwound. The JPM competitors and counterparties are all salivating at just how badly they can fuck over JPM and maximize their bonuses. After all, who cares if the financial system collapses as long as I get my bonus in hand before that happens.

JPM have hinted that they will claw back bonuses of those in the chain, which would raise maybe 1 or 200 million. I'd say there was a chance at self regulation if JPM clawed back the entire loss from the general employee bonuses paid. I mean, no big whoop if JPM lose $2 billion or if that increases to $5 billion since the 2010 employee payout was $10 billion. Cite: http://www.guardian.co.uk/business/2...ers-share-10bn

John Mace, net net, the problem is that a) banks don't self regulate, b) the casino arm can destroy the deposit base (which is at least partially guarantee by Uncle Sugar) c) a big enough loss can cause systemic risk to the banking industry, and d) if enough banks act like lemmings then there is a systemic incident.