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Exactly Whose Money Did the London Whale Lose?

Whose $6 billion did JPMorgan Chase & Co. (JPM) lose during the now-infamous London Whale debacle?

Was it depositors’ money or shareholders’ money? Or was no money lost at all? And was the whole thing the very “tempest in a teapot” that Chief Executive Officer Jamie Dimon originally called it?

What the bank has told us so far -- during its news conference on May 10, in Dimon’s two rounds of testimony before Congress, and in the come-to-Jesus live presentation to analysts on July 13 -- is that the man behind the trades, Bruno Iksil, aka the London Whale, worked in the company’s chief investment office. The CIO’s job, we have been told, is to invest the difference between the $1.1 trillion in deposits the bank has on hand from its customers and the $750 billion the bank has lent out to corporate borrowers.

That $350 billion -- an awful lot of money even by Wall Street’s standards -- was invested on a daily basis under the direction of a well-respected banker, Ina Drew, who was paid about $15 million a year for her services. Drew and her team invested the $350 billion in short-term, seemingly safe investments. The overall yield on the portfolio was about 2.6 percent, according to Dimon.

Dangerous Hedge

With Drew’s authorization -- but, Dimon insists, without his knowledge -- Iksil took a $10 billion chunk of the $350 billion portfolio and made a proprietary bet in an obscure debt index. (JPMorgan Chase likes to call Iksil’s gamble a “hedge.”) For myriad reasons -- among them that the bet was wrong and that Iksil had such a large position in the tranche that escape would have been extremely costly -- JPMorgan Chase has lost $5.8 billion, and counting.

To my mind, the money that Iksil lost was depositors’ money. Iksil worked for the CIO, where depositors’ money is invested until it is lent out. The trade lost almost $6 billion in cash, which we know is real because hedge funds such as Saba Capital, run by wunderkind Boaz Weinstein, and Blue Mountain Capital staked out the other side of Iksil’s trade and made a fortune. How could there be any confusion that the money Iksil lost came from the bank’s depositors?

Not so fast, says JPMorgan Chase. When I wrote in passing last week that I believed JPMorgan Chase depositors lost their money as a result of the London Whale, Joseph Evangelisti, the bank’s head of communications, sandblasted me.

“That’s untrue,” he e-mailed. “We lost shareholder money, not depositor money. Depositors have never lost a penny from our institution.”

We debated it back and forth. Although I concede in this instance no individual depositor lost his or her money, it’s only because there was no run on the bank by depositors at the same time the London Whale was being harpooned. Had depositors suddenly lined up and wanted their $1.1 trillion back, not only would JPMorgan Chase be kaput, but those depositors with more than $250,000 in their accounts -- that is, above the limits of the Federal Deposit Insurance Corp. -- surely would have been left with losses.

Liquidation Mode

Evangelisti wasn’t buying that either. He says the bank would have had more than enough assets to sell in liquidation mode to cover even those depositors with more than $250,000 in their accounts.

“Depositors did not lose money -- that’s a fact,” he reiterated. “And by the way, the $350 billion portfolio is sitting on a $9 or $10 billion gain.” He added: “If what you say is true, we would be taking money out of depositors’ accounts.”

But taking money out of depositors’ accounts is exactly what banks do. People like you and me put money into banks because they are perceived as safer than a mattress. In return, we get access to our money whenever we want -- assuming everyone doesn’t demand money at the same time -- plus a tiny sliver of interest. (At the moment, checking deposits at Chase receive 0.01 percent annual interest, while savings deposits get a whopping 0.30 percent annual interest.)

In effect, depository banks such as JPMorgan Chase, Citigroup Inc. (C) and Bank of America Corp. get our money for free and then turn around and use it for all sorts of things, including making loans to individuals and businesses that pay much higher rates of interest than the banks pay their depositors. This is banking 101. The London Whale fiasco also taught us that sometimes banks use that money to make crazy, proprietary bets on interest rates -- and sometimes that money gets lost.

JPMorgan Chase wants us to believe that it was shareholders’ money that was lost, not depositors’ money. There is no question that JPMorgan Chase’s stock got hammered when the full extent of the London Whale losses became known; shareholders lost almost $25 billion, in addition to the $6 billion Iksil lost on his trades.

Now that the JPMorgan Chase stock has returned more or less to where it was trading before the scandal, it’s safe to say shareholders have lost nothing as a result of the London Whale (except the time value of money over the period it recovered what it had lost).

Evangelisti said depositors lost nothing and, in fact, the CIO account has an embedded $10 billion unrealized gain. This leaves me feeling a little like the casino executive in “Ocean’s Eleven” who, upon realizing the casino’s vault had just been robbed of close to $163 million, incredulously asks Andy Garcia’s casino-owner character: “I don’t understand. What happened to all that money?”

A month ago JPMorgan Chase announced that Lee Raymond, the no-nonsense former CEO of Exxon Mobil Corp. (XOM), would lead another investigation by the board of directors into the London Whale fiasco. One thing he might try to pin down is an explanation, once and for all, of what exactly happened to all that money.

(William D. Cohan, the author of “Money and Power: How Goldman Sachs Came to Rule the World,” is a Bloomberg View columnist. He was formerly an investment banker at Lazard Freres, Merrill Lynch and JPMorgan Chase, against which he lost an arbitration case over his dismissal. His sister-in-law, Ellen Futter, is on JPMorgan Chase’s board of directors. The opinions expressed are his own.)

To contact the writer of this article: William D. Cohan at wdcohan@yahoo.com.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.

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