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JPMorgan ‘Rogue Trader’ Losses Send Chills Through Markets

Filed by KOSU News in Business.
May 11, 2012

According to The Associated Press:

The head of the Securities and Exchange Commission says the agency is focused on a surprise $2 billion trading loss by JPMorgan Chase.

SEC Chairman Mary Schapiro told reporters “I think it’s safe to say that all the regulators are focused on this.” She declined to make any further comment related to JPMorgan.

We’ve also updated the rest of our original post, which follows:

“It was a bad strategy. It was badly executed.”

The words of JPMorgan Chase’s CEO, Jamie Dimon, as he admitted late yesterday that the investment bank – or more precisely, a single “rogue trader” working for the bank, had lost some $2 billion in the last six weeks in risky hedge-fund trades.

The news has sent chills through the markets. Shares of JPMorgan Chase, the largest U.S. bank, lost 7 percent in after hours and British bank Barclays lost 2.9 percent, while more than 2 percent was shaved from Royal Bank of Scotland.

NPR’s Jim Zarroli reports, the trades at JPMorgan Chase:

took place in a unit of the company that is supposed to manage or hedge risk. But this time the unit employed an unusually complex strategy that ended up backfiring on the bank.

The losses are especially embarrassing for Dimon because he had taken pains to deny the rumors circulating around the bank.

The Wall Street Journal elaborates:

[the losses] stemmed from trades in the bank’s chief investment office, where a single trader—dubbed the “London Whale”—reportedly took massive positions in credit-default swaps.

Mr. Dimon, who in April had described news reports of the trader’s leviathan market exposure as a “tempest in a teapot,” on Thursday called the losses “egregious mistakes” and said the losses could deepen this quarter and beyond.

Although Bruno Michel Iksil, known as ‘the London Whale’, is being called a ‘rogue trader’, that’s not precisely accurate.

So far, there’s no evidence of fraud, points out Sebastian Mallaby, a hedge-fund expert at the Council on Foreign Relations and author of the book More Money Than God: Hedge Funds and the Making of a New Elite.

Mallaby tells NPR that the markets are concerned about a knock-on effect for the other banks.

Iksil “was betting that, essentially, that the economy would strengthen, which would push down the risk of default to private companies, so if you were selling protection against default, you’d make a profit as the default risk went down,” Mallaby says.

“If JPMorgan loses a lot of money by selling credit-default swaps and then starts buying to cover its position, anyone else who was also selling them before will see the market move against them. That could mean that other traders could lose money sharply,” he says.

The losses at JPMorgan Chase come as Congress is debating the so-called Volcker Rule. Named after former Federal Reserve Chairman Paul Volcker, it is designed to prevent certain kinds of high-risk trading, but it’s not clear if the rule would cover the precise trades that got JPMorgan Chase in trouble. Dimon has been a big critic of the rule.

But Mallaby says trading in credit-default swaps and other kinds of derivatives can be so complicated that oversight is difficult.

“Even a chief executive like Dimon, who’s supposed to be one of the best and brightest in the industry, was himself taken by surprise,” he says. “If the managers themselves of these banks miss it, whether Volcker Rule enforcers will get it, I think is up for debate.”

The Wall Street Journal’s MarketWatch says:

Dimon denied on a hastily convened conference call that the trading activity of the bank — which in part were bets that the corporate credit on an index of 125 companies — violated the Volcker Rule, part of the sweeping Dodd-Frank bank reform measures passed after the financial crisis.

There’s one good reason for Dimon’s contention: The Volcker Rule isn’t in effect for another two years. In fact, Paul Volcker, the former Federal Reserve chairman, was in front of Congress just Wednesday defending the still-to-be-implemented regulation against ferocious attacks.

But Dimon may have been right even if the Volcker Rule were in effect today. That’s because the rule does permit trading on behalf of a client. It’s going to be down to judgment calls by regulators as to whether trading is proprietary or not.

The most significant damage to JPMorgan Chase may not be the $2 billion in trading losses or the even bigger hit it’s likely to take from shareholders in the next few days. The image of JPMorgan Chase as one of the best-run investment banks is also going to be tarnished.

As Salon says:

Until now JPMorgan was renowned for the excellence of its risk management strategies. It was one of the few big banks to come out of the financial crisis stronger than before the meltdown. While other banks collapsed or sought shotgun mergers, J.P. Morgan was the killer whale gobbling up the weakened predators around it. Dimon even complained mightily about being forced to take a government bailout. His bank didn’t need it, he said, and he returned the money as fast as he possibly could.

[Copyright 2012 National Public Radio]

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