JPMorgan Shares Tumble After $2B London Trading Loss

JPMorgan’s Specific Trades Weren’t Monitored, Regulator Says
Bloomberg News first reported April 5 that London-based JPMorgan trader Bruno Iksil had amassed positions linked to the financial health of corporations that were so large he was driving price moves in the $10 trillion market. Photographer: Peter Foley/Bloomberg

JPMorgan Chase & Co. fell the most in nine months after Chief Executive Officer Jamie Dimon said the firm suffered a $2 billion trading loss he attributed to “egregious” failures in a unit managing risks.

JPMorgan dropped 9.3 percent to $36.96 at 4:15 p.m. in New York, marking the stock’s biggest decline since Aug. 8 and the day’s second-worst showing in the Standard & Poor’s 500 Index.

The bank’s chief investment office, run by Ina Drew, 55, took flawed positions on synthetic credit securities that remain volatile and may cost the lender an additional $1 billion this quarter or next, Dimon, 56, said yesterday in a conference call with analysts. The loss originated out of the firm’s London CIO unit, an executive at the bank said.

“There were many errors, sloppiness and bad judgment,” Dimon said. “These were egregious mistakes, they were self-inflicted.”

The chief investment office was thrust into the debate over U.S. efforts to ban proprietary trading when Bloomberg News reported last month that the unit had taken bets so big that JPMorgan, the largest and most profitable U.S. bank, probably couldn’t unwind them without losing money or roiling financial markets. Dimon, 56, had transformed the unit in recent years to make bigger and riskier speculative trades with the bank’s money, five former employees said.

FSA Examination

The U.K.’s Financial Services Authority, which regulates banks, is examining the role London employees played in the loss, according to two people familiar with the talks. The agency hasn’t opened a formal investigation and there was no evidence of criminal activity, these people said.

“It will weigh on the sector pretty bad,” said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia. Miller and Christopher Mutascio at Stifel Nicolaus & Co. downgraded their recommendations on the shares today. “Investors are going to say that these are general big black boxes that can’t be analyzed, not even the management companies understand what they’re doing themselves.”

Dimon had defended the chief investment office as a “sophisticated” guardian of the bank’s funds on an April 13 conference call, calling news coverage “a complete tempest in a teapot.” On May 2, he led fellow Wall Street CEOs in a closed-door meeting to lobby the Federal Reserve about softening proposed U.S. reforms that might crimp their profits.

‘Bunch of Pundits’

Yesterday, he said the timing of the trading blunders “plays right into the hands of a bunch of pundits out there” who are pushing for a strict version of the proprietary trading ban named for former Federal Reserve Chairman Paul Volcker.

Given Dimon’s resistance to the ban and new regulations, “he’s got a lot of egg on his face right now,” said Craig Pirrong, a finance professor at the University of Houston. “Any chance they had of getting a relative loosening of Volcker rule, anything of that nature, that’s out the window.”

The chief investment office’s push into risk-taking was led by Achilles Macris, 50, according to three former employees, Bloomberg News reported on April 13. He was hired in 2006 as its top executive in London and led an expansion into corporate and mortgage-debt investments with a mandate to generate profits for the New York-based bank, they said. Dimon closely supervised the transition from its previous focus on protecting JPMorgan from risks inherent in its banking business, such as interest-rate and currency movements, they said.

‘Talented People’

“I wouldn’t call it ‘more aggressive,’ I would call it ‘better,’” Dimon told analysts yesterday. “We added different types of people, talented people and stuff like that.” Until recently, they were careful and successful, he said.

“It’s classic Wall Street hubris, which we’ve seen so many times before,” said Simon Johnson, a former chief economist at the International Monetary Fund who now teaches at the Massachusetts Institute of Technology. “What’s particularly ironic here is that Jamie presents himself, and is believed by others to be, the king of risk management.”

Bloomberg News first reported April 5 that London-based JPMorgan trader Bruno Iksil had amassed positions linked to the financial health of corporations that were so large he was driving price moves in the $10 trillion market.

The $2 billion loss occurred in London under multiple traders, according to an executive at the bank, who spoke on the condition of anonymity. Dimon wasn’t immediately told about their shift in strategy and didn’t know the magnitude of the losses until after the company reported earnings April 13, the executive said. As the position deteriorated rapidly, the bank gathered internal analysts and examiners to investigate, and Dimon grew more distressed by the day, the executive said.

‘Corrective Action’

While no one has been fired yet, Dimon told analysts he will take “corrective action.” The bank is keeping employees involved on hand while it deals with the transactions, and some are likely to lose their jobs afterward, said an executive with knowledge of the situation. The bank is also reevaluating its risk-monitoring team within the chief investment office, the person said.

JPMorgan risks losing more money now because other market participants will figure out what the bank has to do to unload its position, said Charles Peabody, an analyst with Portales Partners LLC in New York. Costs from the trades may affect earnings through the end of the year, he said.

Sharks to Blood

“When there’s blood in the water, the sharks are going to attack that animal,” said Peabody, who downgraded his recommendation on the stock in March to sector perform. “It could make it very difficult for them to unwind a trade.”

Investors bet more damage lies ahead. Bearish JPMorgan options had the second-largest increase in trading among all U.S. stocks today as 418,892 puts to sell JPMorgan shares changed hands. That was 12 times the four-week average and 1.4 times the number of calls to buy, the data show. JPMorgan’s June $35 puts were the most-traded options on the stock as they more than tripled to 85 cents from a close of 26 cents yesterday.

More than 216 million JPMorgan shares traded, breaking the prior one-day record set in 2008.

Dimon declined on the call to discuss the specific transactions or people involved. Synthetic credit products are derivatives that generate gains and losses tied to credit performance without the owner buying or selling actual debt. JPMorgan used the instruments to hedge exposure on loans and other credit risks tied to corporations, banks and sovereign governments. The losses emerged after the firm tried to reduce that position and unwind the portfolio, Dimon said.

The bank said losses were partly offset by gains from the sales from its available-for-sale credit portfolio, resulting in a net loss for the firm’s corporate division, which includes the CIO, of about $800 million after taxes. Dimon said losses could widen or narrow in coming weeks and months, and that he can’t estimate potential costs.

Long-Term Holdings

As the bank repositions the synthetic credit portfolio, the chief investment office “may hold certain of its current synthetic credit positions for the longer term,” the firm said.

“Hopefully, this will not be an issue by the end of the year, but it does depend on the decisions and the markets,” Dimon said.

JPMorgan also changed how it calculates so-called value at risk, or VAR, a measure of how much the company estimates it could lose on securities on 95 percent of days. The company restated its VAR for the first quarter, previously disclosed at $67 million, at $129 million. The bank used a new model for calculating its trading risk in the first quarter that Dimon said was “inadequate.” It is reverting to the old model.

Hidden Risk

“It’s a major event that confirms a lot of investors’ worst fears about bank risk,” said Frank Partnoy, a former derivatives trader who’s now a law and finance professor at the University of San Diego. Concern is “that at a large, supposedly sophisticated institution, even something called a ‘hedge’ can contain all kinds of hidden risks that the senior people don’t understand.”

Iksil may have amassed a $100 billion position in contracts on Series 9 of the Markit CDX North America Investment Grade Index, counterparts at hedge funds and rival banks said in April. They based their estimates on the trades and price movements they witnessed as well as their understanding of the size and structure of the markets. The positions amounted to tens of billions of dollars, under the firm’s own math, a person familiar with its view said at the time.

Two Dimensions

The trade on the index probably wasn’t a one-way bet, the market participants said. Iksil may have offset it by buying protection on the same index with contracts that expire about seven months from now, the people said. That strategy would pay JPMorgan the difference between the long-dated contracts and the short-dated ones, and the trade would gain when the gap narrows. The hedge would end in December unless another trade is made to replace it.

Satyajit Das, the author of “Extreme Money: Masters of the Universe and the Cult of Risk,” compared the publicity around JPMorgan’s situation to losses that spiraled at hedge funds like Long-Term Capital Management in 1998 and Amaranth Advisors LLC in 2006.

“A $2 billion loss suggests a position of considerable size,” Das said. “I think you remember LTCM and a few other people like Amaranth that have had the exact same problem and have learned it’s a bit like hell -- easy to get into, not so easy to get out of.”

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