JP Morgan – Is It The London Whale Or The Smell Of Fish?

There has been much hoopla over the $2 Billion loss that JP Morgan reported this week. (6) The trader responsible is named Bruno Iksil, nicknamed the "London Whale". (3) It is not the loss itself, nor the trader who is responsible that is troubling. It is the manner in which it is being described, the attitude towards the loss, and what future impacts this scenario can bring that would carry the seeds of something more serious. In fact, losses are expected to mount in future quarters, and this process has already started. (13)

There was an admission by James Dimon that "We know we were sloppy. We know we were stupid. We know there was bad judgement, …" (9) At the same time, this trade was considered to be non-life threatening to JP Morgan. "This is not a risk that is life threatening to JPMorgan. This is a stupid thing that … we should never have done. But we are still going to earn a lot of money this quarter. So it isn't like the company is jeopardized," James Dimon stated. With a loss this big, the underlying position was likely very big. (6)(9)(11) The group responsible for doing this trading was assuming positions in the $10 trillion range (6). If a trade is that big, (6) and illiquid, (9) is this not a concern? The fact that there is expected difficulty in unwinding the trade also confirms that it is illiquid or too large. (11) It was stated in the past that risky bets were not being made by this part of JP Morgan, but this does not seem true now. (9) If there was no issue for the bank here, why did Fitch downgrade JP Morgan's ratings? (9)

The use of VaR to assess risk is also suspect. The VaR for JP Morgan was restated to reflect a bigger loss than what was done previously. VaR is an acronym for Value at Risk, which is a way of measuring the probability of loss for a trade. (12) The word "restated" should always be a cause for possible concern due to the reason why something could be restated. Was it due to some structural change? Was the restatement for someone's benefit? Why was it restated now and not previously? The next item to ponder is: why is VaR being used to summarize the risk of such a complicated trade? VaR makes assumptions that don't work for trades that are complex, illiquid, and statistically non-normal. (12) The actual underlying assumptions are a normal distribution, a fluid market to exit in case something goes wrong, and risk that is visible at all times.

James Dimon didn't know what was going on under him. (1) It is possible that people didn't tell him even though it is their job, but keep in mind a couple of things. Profit and loss statements done on trading are produced daily, and for a position of great size, (6) (9) (11) you would think that everyone would know where this trade is at. Why was it only addressed when the earnings were released? (6) This problem may escalate, reaching JP Morgan's counterparties, which would include many other institutions.

Sources:

1) http://www.bloomberg.com/news/2012-05-11/fisher-says-excessively-big-banks-can-lose-risk-focus.html

2) http://dealbook.nytimes.com/2012/05/11/s-e-c-opens-investigation-into-jpmorgans-2-billion-loss/

3) http://www.cnbc.com/id/47448409

4) http://www.bloomberg.com/news/2012-05-13/elizabeth-warren-calls-for-dimon-to-resign-from-new-york-fed.html

5) http://www.infowars.com/jp-morgans-2-billion-loss-just-a-preview-of-coming-derivatives-collapse/

6) http://www.bloomberg.com/news/2012-05-11/jpmorgan-loses-2-billion-as-mistakes-trounce-hedges.html

7) http://www.bloomberg.com/news/2012-05-13/jpmorgan-executives-said-to-depart-this-week-after-trading-loss.html

8) http://www.bloomberg.com/news/2012-05-13/dimon-says-jpmorgan-loss-gives-ammunition-to-regulators.html

9) http://news.yahoo.com/jpmorgan-2-billion-loss-hits-shares-credit-image-005556430--sector.html

10) http://www.latimes.com/business/sc-dc-0514-dimon-20120514,0,1093110.story

11) http://www.bloomberg.com/news/2012-05-10/jpmorgan-chase-says-cio-unit-suffered-significant-loss.html

12) http://www.economonitor.com/blog/2012/05/jp-morgan-loss-bomb-confirms-that-its-time-to-kill-var/?utm_source=contactology&utm_medium=email&utm_campaign=EconoMonitor%20Highlights%3A%20Rough%20Ride%20in%20Europe%2C%20JPMorgan%20%26%20FinReg

13)

http://www.theglobeandmail.com/globe-investor/jpmorgan-trading-losses-climb-to-3-billion-paper-reports/article2435398/

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.