JPMorgan Shareholders: Brace Yourselves For More Potential Losses, Government Scrutiny

| About: JPMorgan Chase (JPM)

JPMorgan Chase & Co. (NYSE:JPM) showed its hand to the market and announced its intention to unwind positions relating to its recent two billion dollar trading loss, but that does not mean the losses are over. Worse yet, JPM's troubles relating to this may jump the shark and extend from the mere monetary to the regulatory. Seeing it at a 10% discount to last week, investors looking to jump into JPM may want to wait for the next shoe or shoes to drop.

While it is often unclear what policy decisions a government agency may make in response to what it is likely to recognize as a bank taking unnecessary or misunderstood risks, the instinctive reflexes of JPM's peers are far more predictable. These derivatives traders now know that JPM has essentially handicapped itself, telegraphing to the market that it must unwind at least a portion of its alleged poorly constructed recent hedging model, and they are likely to take every advantage of the situation.

Examples of such market reaction may already be visible, as derivatives traders will be seeking to profit on speculation that JPM will cash out at a significant loss or sit still, potentially letting the losses grow and even multiply. Derivatives traders have apparently identified that the 10-year Markit CDX North America Investment Grade Index Series 9 is one of the bank's largest loss-creating positions.

The index, which was trading around 111 at the end of the first quarter of 2011, traded between a low of about 126 and a high of about 139 subsequent to Jamie Dimon's disclosing the loss and JPM's intentions. This significant recent volatility appears indicative of displacements within the index that exist due to JPM painting itself into a corner, thereby drying up market liquidity and powering increased volatility.

Given JPM's significant derivative book to unwind and the desire of most traders to juice every pip from a trade, JPM's loss appears primed to increase. Moreover, it appears likely that JPM will have to be forthcoming with greater detail regarding the totality of its bad bets and what, if anything, it will actually be doing with them.

More particularly, Jamie Dimon has been a critic of Dodd-Frank and the Volcker rule, designed to restrict proprietary trading by banks holding federally insured deposits. His prior criticism, coupled with the complexity and sizable losses relating JPM's disclosed loss will undoubtedly become a talking point for political discourse, and a justification for both heightened regulation of the banking system as well as particular investigation into JPM's policies and procedures.

The market is still unclear as to whether this $2 billion loss occurred through its London or New York offices. While JPM's disclosure appeared to indicate that the decision was made out of New York, the market has been rumbling for weeks about JPM's London Whale, Bruno Iksil, who was trading derivative positions large enough to demonstrably move prices on their own. It now appears that the trades may have been made out of London, while the oversight came from New York. Greater detail into the oversight, intent and composition of these investments should be forthcoming.

JPMorgan Chase shares fell by more than 9% on Friday, after reporting the loss and the troublesome derivatives position. See a recent chart of JPM, below

The news not only hit JPM shares on Friday, but most major financials as well, with Bank of America (NYSE:BAC) falling about 2%, Citigroup (NYSE:C) falling about 4.2% and Goldman Sachs (NYSE:GS) falling about 3.9%. Conversely, Wells Fargo (NYSE:WFC) traded slightly up on Friday due to its more traditional banking model.

Because this loss may get larger, and regulatory oversight is likely to heighten scrutiny of such proprietary derivatives trading, more negative news appears primed to hit both JPM and the broader U.S. banking complex that is engaged in such derivatives trading.

Disclosure: I am long BAC, C.

Disclaimer: This article is intended to be informative and should not be construed as personalized advice as it does not take into account your specific situation or objectives.