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Shares of JP Morgan Chase & Co. (NYSE:JPM) were hit hard in after hours trading after the "winning bank" of the financial crisis announced a surprise $2 billion trading loss.

The Synthetic Credit Loss

JPMorgan announced a surprise loss of $2 billion in its Chief Investment Office. This division of the bank is responsible for investing "excess funds" from its trading activities into safe securities. The division lost the money after an investment in synthetic credit securities, proved riskier than previously expected.

According to Chief Executive Officer Jamie Dimon the portfolio has proven to be "riskier, more volatile and less effective as an economic hedge than the firm previously expected. There were many errors, sloppiness and bad judgment."

Increased Risk

Former employees of the unit say the Chief Investment Office has transformed into a unit which takes bigger and more riskier bets under command of CEO Jamie Dimon. Unwinding the trades could lead to large trading losses and cause massive volatility in financial markets. According to the bank, the division has repositioned itself and the unit may hold the positions for the longer term.

Embarrassment

The trading losses come as a great embarrassment for the bank and its Chief Executive Officer Jamie Dimon, who successfully steered the bank away from risky investments during the financial crisis of 2008, during which many competitors failed or received massive bail-outs.

Furthermore it comes as a surprise that trading losses are incurred in the Chief Investment Office, a unit designed to invest "excess" trading funds into safe short term securities.

At last comes the constant lobbying from Jamie Dimon and many of his colleagues who put pressure on the Federal Reserve Board to allow the bank to pay out higher dividends and repurchase its own shares, as the bank has a "fortress" balance sheet. Furthermore Dimon has intensively lobbied in political areas again the Volcker rule which limits the possibility of banks to engage in proprietary bets (bets with the firms own capital). Dimon has actively argued for weaker rules and broader exemptions from the Volcker rule which will take into effect this summer.

Second Quarter Results

As a result of the $2 billion loss the corporate and private equity business will report a loss of roughly $800 million for the current second quarter, compared to a projected profit of $200 million. The bank will try to unload the portfolio in a "responsible" manner in order to minimize costs to its shareholders.

Credit Default Swaps for JPMorgan widened 7 basis points after the announcement to 118 basis points. Dimon continued by saying losses could further accelerate depending on market circumstances and the company should have never engaged in the strategy which is "bad, grew more complex and was poorly managed."

JP Morgan reported a $5.4 billion profit for the first quarter of 2011.

Historical Trading Losses

The loss comes not alone in a sector dominated by large losses triggered by rogue traders. In 2008 Jerome Kerviel caused a Euro 4.9 billion loss for French bank Societe Generale after a large drop in equity indices revealed his unauthorized traders. Last year Kweku Adoboli lost $2 billion for Swiss-based UBS after making unauthorized trades.

Market Impact

In a response to the events the SP500 immediately fell 10 points and shares of JPMorgan traded 7% lower to levels around $38, last seen in February 2012. Other banks trade lower in after hours trading as well. Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) fell between 2 and 4% in reaction to the news.

The enormous loss is the latest evidence that the "hedges" are often a risky bet used by too-big-to-fail banks.

Source: JPMorgan: Embarrassing Trading Loss Highlights Weakness In Financial Sector