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Paulo Santos, Think Finance (393 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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Bruno Iksil's actions that led to yesterday's JPMorgan (JPM) announcement of surprise losses in its CIO (Chief Investment Office) division are familiar. Although the CIO was supposed to manage JPM's risks and exposures, it was pretty obvious that this division was really taking risk. And it was not just taking risk in any ordinary fashion. It was flexing JPM's muscles in the market, to produce the prices it wanted.

This was plain to see in a Bloomberg article from one month ago, titled "JPMorgan Trader's Positions Said to Distort Credit Indexes." Here Iksil, nicknamed "The London Whale," was taking massive trades that, unsurprisingly, were moving prices beyond rationality.

Anyone who has traded professionally has already seen similar behavior. Be it the former pit traders moving from squeeze to squeeze, or much larger hedge funds moving the markets in their own positions. It is a common and well-known tactic for large hedge funds to keep on reinforcing their existing positions when new money comes in. This generates a virtuous cycle, the positions moving in favor of the fund generate performance, performance brings in new money, and new money allows the fund to push the positions further and further.

This also generates mispricing. And at some point a blow up. Many of the historical blow ups, attributed to rogue traders, happened this way. Be them Nick Leeson of Barings fame trying to move the Japanese market, Jérôme Kerviel moving the German DAX or Sumitomo cornering the copper market. The news here was simply that Bruno Iksil acted with his superior's knowledge.

Every time one sees obviously irrational mispricing in the markets, such as with Salesforce.com (CRM) or Amazon.com (AMZN), one has to ask if something similar isn't happening, with someone or a reduced number of institutions pushing existing positions as far as the market will bear. For instance, it was quite suspicious that Amazon.com would choose to do a massive share buyback in Q1 2012 out of the blue, yet that's the kind of thing one expects when there's trouble controlling the float, especially as it seemed to come when some high profile investors sold (Soros).

There's a good reason why most organized derivatives markets have position limits. It's an acknowledgement that this kind of practice is highly likely to happen. One clearly wonders if the credit derivatives Iksil was trading had those - most certainly they didn't seem to.

Finally, these kinds of actions can produce artificial marked-to-market profits, and hence bonuses, for a while. One also wonders if those were disgorged, for if not, the clear incentive is for these actions to be repeated. Over and over again.

Source: JPMorgan: Trader's Actions Appear Familiar