From the Belly of JPMorgan, a Closer View of the Whale Trade

Photographer: Jonathan Ernst/Bloomberg

JPMorgan Chase CEO Jamie Dimon at Senate hearings prompted by the bank’s trading loss.

Today’s blockbuster news arrives with a 132-page user’s guide as JPMorgan Chase & Co. cut Chief Executive Officer Jamie Dimon’s pay by 50 percent and issued a detailed report on the “London Whale” trades that left the bank with a $6.2 billion loss. If you’ve already read the news stories, set aside an hour to read  the report itself, here.

The picture of trading that the report draws is much more nuanced than the usual idea of cowboys taking crazy risks with the bank’s money. What comes out in the report is a story of a trader very worried about his position, and pushed deeper in by superiors.

Bruno Iksil, the trader at the center of the JPMorgan saga, has been nicknamed “the London Whale.” The report, unfortunately, doesn’t identify the traders involved by name, citing U.K. privacy laws, so we have to guess at the identities. What’s clear is that early on at least one trader — possibly Iksil (I emailed a lawyer who has represented Iksil to ask, but haven’t heard back) — is not at all eager to be the big fish here. On January 30 the trader:

(Page 34) “… suggested to another (more senior) trader that CIO should stop increasing ‘the notional,’ which were ‘becom[ing] scary,’ and take losses (‘full pain’) now …”

His doubts are significant enough that he requests a meeting with managers, including Ina Drew, the head of JPMorgan’s Chief Investment Office. At the meeting he says his portfolio could lose an additional $100 million. Drew, the report says, at the meeting appears not to be overly concerned.

On March 12, with losses in the portfolio growing, “a trader informed another trader” of growing losses. He says that,

(Page 49) “… mark-to-market losses in the Synthetic Credit Portfolio based on ‘crude mids’ [nb: a valuation method] had grown to approximately $50 million, and that he viewed these losses as a warning sign. He recommended that they reflect this as a loss on the books, even though they could not explain the market movement.”

The Wall Street Journal reported in August that JPMorgan had concluded that Iksil’s boss, Javier Martin-Artajo, had prodded Iksil for higher valuations. It’s not clear from the report if the first trader is Iksil and the second is Martin-Artajo. The more senior trader disagrees and puts off the discussion.

Over the course of the next month the position worsens. Yet again there’s a discussion of potential losses, which in one calculation range up to $750 million. Instead of the worst-case scenarios getting sent up the ladder, the numbers get massaged:

(Page 59) “Over the weekend of April 7 and 8, two of the traders prepared the requested analysis. One of them initially attempted to formulate a loss estimate by constructing numerous loss scenarios that were very harsh … According to the trader who prepared the loss estimates, the other trader responded that he had just had a discussion with Ms. Drew and another senior team member, and that he (the latter trader) wanted to see a different analysis. Specifically, he informed the trader who had generated the estimates that he had too many negative scenarios in his initial work, and that he was going to scare Ms. Drew if he said they could lose more than $200 or $300 million.”

What should be happening at the bank is that higher-ups and risk experts are carefully monitoring the trading and pulling the plug on excessive risk. What actually seems to be happening here is that the person making the trades is intensely aware that he is in trouble, and at risk of sinking deeper.

Over at Reuters Felix Salmon reads the JPMorgan report as demonstrating the near-impossibility of hedging catastrophic risk. He’s probably right about this, but the more general problem may be what the report shows about the difficulty of evaluating risk, catastrophic or not, in a bank like JPMorgan. As the numbers get sent up the ladder, they seemed to be softened and their significance missed.

In an earlier post on this blog I asked whether proprietary trading was really the biggest risk to investment banks. The JPMorgan report introduces an important element in the mix: big banks by nature may not be set up well to manage trading risk.

In theory, a giant enterprise has the advantage of deep pockets that let a bank weather freak mishaps. Deep pockets don’t protect JPMorgan here. They just make it possible to keep losing money. In a hedge fund run by traders this whole story may well have ended with a loss of millions in January, instead of billions later.

The exception that might prove the trading rule here may be Goldman Sachs & Co. Goldman’s fourth quarter profit nearly tripled over last year’s, going to $2.89 billion from $1.01 billion. A big part of the profits came from Goldman’s proprietary investments. Goldman has used its own capital in both much-publicized investments (Goldman’s stake in Facebook) and discreet ones (the Multi-Strategy Investing unit).

Thanks to disciplined risk-taking, Goldman has made money on investing and trading. The question here is whether other banks can match that kind of discipline to surmount the inherent obstacles to trading in a big corporation. It’s not encouraging that in this case a company normally as well-run as JPMorgan could not.

PS: Felix Salmon notes that even after the JPMorgan report we have no idea of how a loss in the hundreds of millions of dollars turned into one of more than six billion. I second that, and it’s scary. At various points there were good faith efforts to estimate the potential losses, and they turned out to be way, way off the mark.

PPS, January 17: Kevin Roose at New York Magazine has an interesting post dissecting the report. Roose says notes that the report is harsh on people like Ina Drew who no longer work at JPMorgan, and much less so on those still there. Good point, though not sure that’s true of Bruno Iksil, who might come off fairly well if he is indeed the trader who keeps raising concerns.

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