JP Morgan Screws Up With Derivatives Trading

JP Morgan has announced major losses associated with derivatives trading, proving once again that this is one financial instrument that is literally TOO HOT to handle and portends certain disaster for our economy if it’s not cut off at the knees.

Here’s aRobert Reich editorial in the Huffington Post that covers the topic quite well.

The LEAST that Washington should do is reinstate Glass-Steagall and break up the big banks. Too big to fail is too big to govern, and we need our financial institutions to serve us, not themselves.

Here is what I predict will happen: nothing. Wall Street owns, not just the Republican Party, but the Democratic Party and the Obama administration as well. The big banks just have too much money, and the politicians need that money too badly for them to hold Wall Street to account. Citizens United may well prove to be the death knell of American democracy.

“Derivatives” refers to a rather broad spectrum of financial products, from the pork belly and orange juice futures I used to hear about when I got up to school in the morning to synthetic CDOs that nearly no one understands. Skimming the linked Reich editorial doesn’t make it clear which were involved here (I’m thinking it wasn’t pork bellies), but it’s a mistake to broad-brush all derivatives just because the irresponsible use/creation of some has led to financial instability. Lots of derivatives–perhaps most–are perfectly legitimate, safe ways of reducing exposure to risk (and shifting that risk to those who are willing to bear it in hopes of a profit).

Past that, I don’t understand the damn things well enough to comment. Carry on!

I read the Reich article and a more detailed technical analysis from the London Financial Times. I don’t completely understand it, but my glib interpretation is that a JPM trader took a derivative position that basically bet against a particular credit index. This type of trade (a curve trade) involves daily management of the position–pushing funds around within the index–and the size of the position was such that it substantially impacted the present value of the index, eventually making it cheaper compared to its constituent parts. Other traders spotted this and started buying up the index (hoping for an upward correction), but the JPM trader’s management of the position kept the index artificially low, i.e. he was working against the other traders. Eventually the JPM trader couldn’t keep the pressure on, the index shot up and JPM took a huge loss.

What’s interesting in the FT article is that the other traders suspected the index was being kept artificially low by a single trader at JPM, but since the derivatives market is unregulated they had no one to compain to about it.

Its like that old Brando movie, The Appaloosa, where Brando and a Mexican bandito are arm-wrestling Durango style, where the loser gets struck by a deadly Mexican scorpion whose sting is invariably fatal. Only real flaw, there is no such scorpion, but its entirely possible to blow away 2 billion dollars.

But as long as its not pension funds, or mortgage backed stuff, shit that impacts ordinary shmucks like me and you, fine. Let them fuck each other over to their hearts content. Not that I think thats a particularly good idea, but it might keep them busy, keep them occupied so they don’t dream up some other half-assed scheme.

Scant hope of that, I fear.

“Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” - Warren Buffett -2003

Well even after the 2008 debacle there were financial analysts saying, “You don’t have to fix the whole CDO market, if you just fix this tiny thing, the problem will go away, we promise.” Problem is, the problem is systemic to American business: whenever the self-interest of the management/traders runs against the interests of the market/economy/society as a whole, the self-interest is gonna win every time, because the rewards are insanely huge and the risks insanely small. And it’s gonna stay that way, because Wall Street owns Washington.

Too technical for me (and at a guess for all the posters, including the OP, speculating about this in the thread so far), but a couple of observations from someone mostly clueless about this entire situation. First off, business involves risk. JPM took a risk and it didn’t pay off. It happens. You simply can’t take all risk out of the equation. Secondly, and this is from memory here, but JPM is a multi-billion dollar a year company, so while a $2 billion loss on this risk is going to hurt, I seriously doubt that they can’t cover it. Again, business involves risk, and when you take risks you, well, take risks. If it pays off then you get large rewards…if it doesn’t, then it can be painful, and may even drive you out of business. C’est la vie. Thirdly, is more a request for information…I know that there are some legislation being looked at for new regulation (i.e. Volcker Rule), but would it even have effected this? I’ve heard different takes on it, with some saying it would have prevented the trade and some saying it might not have had an effect. Anyone know? As I said, this is all too technical for me so I’m not fully grasping most of the aspects here.

What I do know though is that you simply can’t take all risk out of business, not if you expect your economy to actually be responsive and grow. You could, of course, regulate things to death, but what you are going to get is a shitty economy if you set the bar too high. By the same token, you need to have a bar, and this might be a case where the bar was just to low. I really don’t know, to be honest…and I doubt the OP does either. Hopefully some 'dopers will wander in who know a bit more about the technical aspects here and will be willing to edjumacate the rest of us on at least the basics of what happened, why, and what should have been done to ‘fix’ this issue…or if anything ‘should’ have been done at all, considering that doing business is risky, and that sometimes you take risks and they simply don’t pay off.


Yes. AFAICT, the position is not yet unwound and the loss may exceed $2 billion. Now you might ask why the public should care if Jamie Dimon and his stockholders lose a few billion. Well, maybe it will work out OK in this case, but similar episodes could lead to a credit crisis or more bailouts by Treasury.

And for what? Why did Jamie and his boys (and girl!) need to do this? It was so they could drive Ferraris of course, but what public service do they claim to serve? If you break it down, you discover that some piece of paper was selling for 101.3 that “should” have been priced at 101.4 and the “public service” provided by the investment bank’s activity was to attempt to move that price to its more appropriate level (while pocketing most of the difference). Bah!

Wall Street bankers are greedy? That’s well and good and in the category of “Dog bites man.”

However, that U.S. policy makers have sold the public down the river so that the Wall Street boys can keep buying their Ferraris is a travesty. The OWS movement should have focused on abuses like this, but got diverted by mainstream apathy.

(BTW, there’s something about this story the Thai government doesn’t like. When I first clicked in OP, one link worked, the other took me to the Thai censorship rejection page. A few minutes later … both links are rejected. And, a link to the story is also disallowed by Thailand’s censors.)

Got their knickers tied up in a knot, do they?

No one is arguing that an ordinary business taking risks is bad, or should be regulated. And there is nothing wrong with derivatives themselves - they are certainly complex, can be risky, and hard to understand, but if an ordinary business wants to take on that risk, that’s their problem.

The problem is that these large banks and financial institutions are not ordinary businesses. They have become so large, and have their fingers in so many parts of the economy, that the failure (e.g. bankruptcy) of any one of them would cause massive, widespread economic devastation. As a result, these institutions are essentially protected from failure by the government. If they make a series of risky investments which blow up and threaten them with bankruptcy, taxpayers will bail them out.

So, there is a strong push for much tighter regulation of these “too big to fail” institutions, that would prevent them making risky investments in order to minimize the chance of future failures and future bailouts. Wall Street’s response is essentially, “Nah, we don’t need that, we’re smart and competent people, we know what we’re doing, we’re not going to do anything stupid ever again!”

In particular, JP Morgan and Jamie Dimon have been some of the strongest opponents of increased regulation, and until now, have largely been able to back up their protests with a record of relative competence. This is a black eye for them, and a huge setback for the claim that these too-big-to-fail institutions will be able to avert future failures by self-policing.

I disagree with Evil Captor that there is anything wrong with derivatives themselves. If some hedge fund wants to go hog wild with complicated, risky investments, that’s fine with me. The problem is when these large superbanks, that are essentially backstopped by US taxpayers, want to be able to play in that game.

Total arachnid hijack, please disregard:

Durango Scorpion. Invariably fatal, no. But I wouldn’t juggle them.

Seems to me the safest and easiest thing to do that still allows risks and the “free hand” of the market to work is to just to limit the SIZE of any institution. And WHY do these things need to be SO big? Is there really an economy of scale at these sizes when its just paper pushing? I can see why just a few automakers are going to be much more efficient than a hundred. Banks and such, not so much.

No, no hijack. Depositing a few of those in the right places would be good for the banking industry.

Actually, it doesn’t explain anything and reads more like a scare tactic than anything else.

Perhaps you can explain to all of us why “derivatives” have to be “cut off at the knees”.

I’m all ears (or eyes, really).

Here’s what has to happen. First off, to fix the financial industry, you have to consult a lefty-type hippy. You’re welcome.

Banking and finance has to be boring. Dull. Plodding along with modest but reliable investment returns. Maybe not the kind of career that attracts greed-ridden young people who cannot wait to get their business degrees so they can get out there and trade, trade, trade! and die at fifty rolling around in piles of hundred dollar bills with cocaine and supermodels. Not that I fault them for their ambitions, except that its stupid. A golden vacuum.

But this is always the problem, isn’t it? Wall Street isn’t a means of investment, its a casino. Read Mark Twain’s Gilded Age and tell me whats different? They called it “speculation”, but its pretty much the same. Its not investment, its not even predatory capitalism, its barely capitalism. Its gambling by experts who fleece the noobs and then play against each other. Its like prison where sociopathy is a survival skill, but the rapes are all strictly cash.

We need to regulate the living shit out of it. Make it dull. Boring. I recognize this will put a lot of traders and salesmen out of work. Plenty of jobs for barristas and bicycle messengers. Or they can stand by the freeway entrance in three piece suits and signs that say “Will lie for food”.

But lest this be taken to mean that I have little respect for people who have devoted their lives to greasing the treads of the machine, let me make myself clear. Fuck 'em.

Here’s a bit simpler of an explanation

As far as I can tell, this was technically considered hedging, which banks are allowed to do with depositors’ money, while it looks an awful lot like proprietary trading, which would be banned under the Volcker Rule.

It was one massive proprietary bet using derivative instruments. Derivatives in and of themselves are neutral, but sometimes in the sense that a loaded handgun lying around is neutral. One thing to know about derivatives is that they are a zero sum game. For every winner, there is an equal loser.

A challenge with some derivatives is that they are highly leveraged. A loss is magnified.

Another challenge is that the big banks have implicit and explicit US government/taxpayer guarantees.

Repealing Glass Steagle was the dumbest thing done in the past 80 years and should be re-instituted to remove system risk in the banking industry.

What happened to JPM was classic. The trader went long and wrong, and the entire market lined up against them. No institution and no government can stand up to the market lining up against them. Ask the Bank of England when they tried to defend the pound back in 1993-ish. I wonder how many billions the final loss will be recorded at. $2billion is just the tip of the iceberg

Unless the problem is very very much larger than has so far been reported, we certainly cannot expect anything to happen before the election, and probably not after it either.

Perhaps someone can explain it to me because I do not see the problem here.

Someone made a bet on the markets and they lost.

Unless they want another tax payer bailout seems to me this is how markets are supposed to work.

If they suck at their job and lose billions well tough shit for them.

Playing in the markets is all about risk. Derivatives are explicitly about buying/selling/managing risk. The whole point is to transfer risk from one to another.

If you get burned then sucks to be you. That is the game you played and you fucked up.

Take your lumps and move on…or fail if it comes to that.

But if JP Morgan fails, we’re pretty much all fucked. Remember when Lehman Brothers failed? It would be a lot worse than that.