JPMorgan: Too Big To Exist?

From Chief Investment Officer Thomas J. Feeney (www.Thomasjfeeney.com)


The news of the week was that JPMorgan Chase (JPM), held in esteem by many as the pre-eminent mega-bank, had sorely miscalculated and lost a couple of billion dollars or so on what was characterized as a "hedge." These guys were reputed to be the best and the brightest. If this was a hedge, where are the offsetting profits?
You will find that the article was originally written by

This debacle was not the work of a single rogue trader. Allegedly, the decisions were made in the Chief Investment Office.

Late in the day Friday, Fitch downgraded its ratings on the bank's long-term debt and indicated that all the bank's debt was on credit watch negative. The ratings agency indicated that the magnitude of the loss implies a lack of liquidity. Fitch also stated that the complexity of the bank's operations makes it difficult to assess risk exposure.

Onerous as a multi-billion dollar loss might be to the House of Morgan, by itself it won't threaten the bank or the banking system. Two important questions present themselves, however. 1) Is this a stand-alone sour derivative trade or--according to the cockroach theory--having seen one, can we assume that there are many still to appear? And 2) Could this be a common trade in the banking industry, which might fall apart at other giant banks as well, cumulatively causing risk to the system?

Common sense dictates we should not have to worry about such questions. No bank should be so large that it could threaten the financial system and, therefore, be too big to fail.


Read more: http://www.thomasjfeeney.com/2012/05/jp-morgan-ch…

So, monkeys, what do you all think will come out of all of this? According to the WSJ the JPMorgan staff at the center of its $2.3B trading loss are set to leave the company, including investment chief Ina Drew and "London whale" Bruno Michel Iksil. Bloomberg reports that all the London staff of JPM's chief investment office could be fired.

Leaving the world stunned; is this just the beginning of another market collapse? A 2 billion dollar loss for JPMorgan is nothing compared to its total exposure of over 70 trillion dollars. Overall, the 9 largest U.S. banks have a total of more than 200 trillion dollars of exposure to derivatives. That is approximately 3 times the size of the entire global economy.

 
Best Response

And all of this could have been stopped if we didn't repeal Glass-Stegal in 2000. Brilliant idea to get rid of Glass-Stegal in the first place.

Here's what's going to happen. As it stands, the trade is wideing against JPM. It's now 17bps wider than it was the day JPM announced the problem. So you now have the Unwind problem to worry about. Unwinding a trade that is continuing the widen (in the absence of government intervention) means that JPMorgan will take a major loss if the IG9 index continues to move the way it is unless JPM's already unwound the trade and are just keeping their mouths shut on it. I think the losses are going to be worse than expected on this trade. I also think that their recent appointment has basically put the Treasury behind JPM but that's neither here nor there. I think what matters is how the unwind goes because this could be a big issue and create a new panic in the markets. If the Unwind does not go well and JPM takes massive losses on the trade, then you will see a panic as investors look to move their money away from JPM. If they can unwind the trade without a major loss, then it won't be that bad.

 
Frieds:
And all of this could have been stopped if we didn't repeal Glass-Stegal in 2000. Brilliant idea to get rid of Glass-Stegal in the first place.

Here's what's going to happen. As it stands, the trade is wideing against JPM. It's now 17bps wider than it was the day JPM announced the problem. So you now have the Unwind problem to worry about. Unwinding a trade that is continuing the widen (in the absence of government intervention) means that JPMorgan will take a major loss if the IG9 index continues to move the way it is unless JPM's already unwound the trade and are just keeping their mouths shut on it. I think the losses are going to be worse than expected on this trade. I also think that their recent appointment has basically put the Treasury behind JPM but that's neither here nor there. I think what matters is how the unwind goes because this could be a big issue and create a new panic in the markets. If the Unwind does not go well and JPM takes massive losses on the trade, then you will see a panic as investors look to move their money away from JPM. If they can unwind the trade without a major loss, then it won't be that bad.

Totally agree. However, if the position is as big as reported I don't see how they can get out without incurring in (big) further losses.

 
Maximus Decimus Meridius:
if the position is as big as reported I don't see how they can get out without incurring in (big) further losses.
They likely can't and they will be squeezed even more now that everyone knows their position.
Get busy living
 
Maximus Decimus Meridius:
Frieds:
And all of this could have been stopped if we didn't repeal Glass-Stegal in 2000. Brilliant idea to get rid of Glass-Stegal in the first place.

Here's what's going to happen. As it stands, the trade is wideing against JPM. It's now 17bps wider than it was the day JPM announced the problem. So you now have the Unwind problem to worry about. Unwinding a trade that is continuing the widen (in the absence of government intervention) means that JPMorgan will take a major loss if the IG9 index continues to move the way it is unless JPM's already unwound the trade and are just keeping their mouths shut on it. I think the losses are going to be worse than expected on this trade. I also think that their recent appointment has basically put the Treasury behind JPM but that's neither here nor there. I think what matters is how the unwind goes because this could be a big issue and create a new panic in the markets. If the Unwind does not go well and JPM takes massive losses on the trade, then you will see a panic as investors look to move their money away from JPM. If they can unwind the trade without a major loss, then it won't be that bad.

Totally agree. However, if the position is as big as reported I don't see how they can get out without incurring in (big) further losses.

Their position is considerably wider than the original they reported a few days ago. Therefore they won't unwind without absorbing an even larger loss...

[quote]The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.[/quote]
 

That's exactly the problem: the trade is still on and the market smells blood.

[quote]The HBS guys have MAD SWAGGER. They frequently wear their class jackets to boston bars, strutting and acting like they own the joint. They just ooze success, confidence, swagger, basically attributes of alpha males.[/quote]
 

A $2 billion dollar loss on a five year contract widening 20 basis points means a little more than $200 billion in notional, IIRC, so that's the maximum exposure. I'm not sure where the $70 trillion number is coming from.

Quick primer on credit deltas:

Credit delta~= (a little less than the term left on the cds for a high grade CDS) *notional

EG for a $200 B contract with 5 years left on it:

($200 B notional/10,000 basis points/year)* 4.8 years= -$96 million/bp

During the credit crisis, I don't think spreads on the IG made it much past 500 basis points for the longer term stuff, and by that point, the duration starts to reduce and the CDS seller starts benefitting from some convexity.

 
IlliniProgrammer:
A $2 billion dollar loss on a five year contract widening 20 basis points means a little more than $200 billion in notional, IIRC, so that's the maximum exposure. I'm not sure where the $70 trillion number is coming from.

Quick primer on credit deltas:

Credit delta~= (a little less than the term left on the cds for a high grade CDS) *notional

EG for a $200 B contract with 5 years left on it:

($200 B notional/10,000 basis points/year)* 4.8 years= -$96 million/bp

During the credit crisis, I don't think spreads on the IG made it much past 500 basis points for the longer term stuff, and by that point, the duration starts to reduce and the CDS seller starts benefitting from some convexity.

Was this loss related exclusively to CDS trading and Bruno group? Not much details on the nature of trades they made, usually these things are kept secret and only regulators can have access to that. They mentioned hedging that went wrong, if that is the case then it maybe have been hedging through instruments that don't eliminate totally the exposure, the WSJ mentioned pair trading activities, I guess that it narrowed while it should have widened and vice versa, the LTCM scenario. The 70 trillions is just rubbish, on the swaps market the nominal value often is hundred of times larger than the real exposure. Just conventions that provide nothing in term of risk management.

 

^

CDS index trading, i.e. being short an investment grade CDS index through tranches. As "double-shorting" means they end up long (and again, this was supposed to be a hedge but my bet is it was way directional), they wanted spreads to compress in the index. Well, ever since reaching the 1420s or so top on SPX a few weeks back, equities have fallen while spreads have widened, totally risk-off mode.

As Illini had already explained up above re the DV01, they are basically $100mm in the red for every bp move higher in IG18 (they used an older series, IG9 apparently, but the spreads move in tandem).

 

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