After Thursday's close, JPMorgan (JPM) disclosed in its 2Q2012 10-Q after-tax losses of $800 million, stemming from corporate hedging operations. A slight delay in the regulatory filing had suggested that there might be a problem, which this afternoon's market weakness may have anticipated.
The company attributed the losses to a trader in its London-based Chief Investment Office, part of its corporate segment. And while this particular trader made a lot of money for JPM, his success in recent quarters reportedly earned him the enmity of several London-based hedge funds. These took what appear to have been coordinated positions against him, resulting in fair value losses of as much as $2 billion.
Mistakes were made. JPM recently implemented a new value at risk model (VAR) that underestimated and understated the firm's risk. The company has returned to the prior model, which it deems superior. In its conference call, the company says that it will "not do something stupid" (like selling its positions below intrinsic value), but will seek to maximize the value of these positions, holding inventory and bearing the additional volatility. The company appears to have forthrightly come to terms with and acknowledged its planning, management, and oversight errors.
In the broader scheme of things, JPM (which was expected to report income of more than $5 billion in 2Q2012) can absorb such a loss without much impact to its regulatory capital. And adverse moves in debit and credit valuation adjustments might even offset these fair value losses.
These losses are not life-threatening for JPMorgan, and the company is still expected to report a 2Q2012 gain. Moreover, we should expect banks to take risks. It is why they exist. Regarding its risk taking, JPM has proven more adept than most others, having come through the 2008 financial panic well and even able to take advantage of the crisis, absorbing both Bear Stearns in 2007 and Washington Mutual in 2009. And, these losses are probably a special case, given the involvement of the London-based hedge funds. And while they're in the billions before tax, these are fair value losses that will likely be mitigated in time.
However, this is a political year in the U.S. And with Washington's antipathy to Wall Street unassuaged, it took less than an hour for the usual political suspects to raise their voices. Senator Carl Levin, for one, who led the charge against Goldman Sachs in 2010, cites the JPM announcement as a "stark reminder" regarding the Volcker Rule's yet-to-be-implemented proprietary trading ban, which he deems inadequate and in need of strengthening.
It's by no means clear that these transactions would have been prohibited under the Volcker Rule (if indeed regulators are ever able to articulate the Rule in regulation). For its part, JPM says no, that these weren't proprietary trades, but rather hedges, not covered under the Rule. Hedge accounting being what it is, the distinction will likely be lost in indeterminate and interminable argument. But it seems likely that our politicians will use this as a lever to advance their respective political and re-election agendas. It's just too attractive not to take advantage.
And politically, CEO Jamie Dimon has made himself a target with his trenchant and pointed criticisms of the Treasury, Federal Reserve, financial reform, and proposed and yet to be proposed Dodd-Frank regulations. For example, in Atlanta last year, Dimon famously asked Fed Chairman Bernanke whether regulators considered the impact of all the new laws and proposed regulations on U.S. economic activity and whether these might explain the tepid recovery. And Bernanke even more famously responded, no, that it was too difficult! And while the problem was more the answer than it was the question, the question may have proven just a tad too successful.
Today's announcement is a clear embarrassment that increases Dimon's and JPM's vulnerability in this charged political season. How will the administration respond? Too big to fail certainly is applicable to JPM, the nation's largest bank by assets ($2.32 trillion), but it's not an issue here. It's not failing. But, this is an election year, and Obama must motivate the OWS crowd. Will this prove his lever? Will Carl Levin call a Senate hearing with all the attendant media firestorm?
On the other hand, the economy is doing poorly, apparently slowing. A political attack on Wall Street's best and largest won't help economic activity. And if economic activity flags, so do President Obama's re-election chances. And while it suits his rhetorical proclivities and instincts, he will also accept his nomination from a podium staged in the Bank of America Stadium in Charlotte, N.C.
What to do with the stock? Overnight, JPM, Citigroup (C), and Bank of America (BAC) were trading 2-3% lower. JPMorgan trades at 0.85X its $47.60 book value and 8.15x and 7.28x respective 2012 and 2013 EPS multiples. Fundamentally, the stock is inexpensive, but expect the political response to drive near-term valuations.