In one popular picture, Wall Street traders shrug off losing hundreds of millions of dollars because the money isn’t their own. Why worry about a few zeros when it’s the shareholders’ cash at stake?
Thanks to the Senate report on the JPMorgan “whale trades” released yesterday, we now know that’s an oversimplification. To put it simply: Traders don’t lose huge amounts of money because they don’t care. What makes them take reckless risks is not generally the prospect of huge gains. It’s the hope of avoiding losses.
In January, based on JPMorgan’s own report on the trades, I speculated in this blog that far from being the cowboy of the first accounts, Bruno Iksil (aka JPMorgan’s “London Whale”) was worried about his positions, and pushed in deeper by his superiors. The Senate report provides a trove of emails and recorded calls confirming that anxiety, though they make clear that “worried” was an understatement.
Terrified and despondent is more like it. The report is filled with intimate detail of just how closed-in and desperate Iksil’s position was in the month before Bloomberg broke the “London Whale” story.
First, some back-story: Sitting on a portfolio that would cost $590 million to unwind, Iksil and his superiors were working on strategies to cut that to less than $300 million. Problem is, those strategies weren’t working and Iksil’s complex derivative portfolio was losing money. Hoping that the market would turn around, Iksil had tossed out JPMorgan’s standard valuation models; whether this was Iksil’s idea, or that of his boss, Javier Martin-Artajo, is not clear from the Senate report. Using optimistic forecasts, he’d mark relatively small losses in the portfolio.
By March, 2010, about a month before the story hit the press, it was becoming clear to Iksil that this wouldn’t work. Iksil worked with a trader named Julien Grout–referred to in the earlier JPMorgan reports as a “junior trader”*–on valuing his portfolio. Grout, whose role had been largely missing from the narrative before today’s report, was responsible for keeping track of Iksil’s gains and losses at any one time.
Grout and Iksil appear to have seen eye-to-eye on the trap they’d fallen into. The two spoke openly of how far the portfolio’s likely real value was “lagging” the numbers getting reported up on the books–and just how anxious it made them. By March, Grout is already envisioning a bad end. He tells Iksil:
(p. 109) “I have a vague idea you know how this is going to end up … it will be a big fiasco and it will be a big drama when, in fact, everybody should have, should have seen it coming a long time ago. … Anyway, you see, we cannot win here. … I believe that it is better to say that it’s dead, that we are going to crash.”
Iksil and Grout agree on this. Grout begins keeping a spreadsheet with a more conservative accounting that showed greater losses than he and Iksil had marked on the portfolio; much later, Ina Drew described this as a “shadow P&L document. A week later Iksil tries to get Javier Martin-Artajo, his boss, to report a big “one-off” loss on the books to bring the two sets of books into line.
(p. 114) Mr. Grout: “And what does he think?”
Mr. Iksil: “He says nothing. Me, I find that ridiculous. I’ll send you the thing that I sent.”
Mr. Grout: “You sent him a thing in which you proposed doing that?”
Yes, Iksil tells Grout, but Martin-Artajo didn’t exactly warm to the idea. Says Iksil:
“I don’t know where he wants to stop, this guy, you see, but it’s becoming idiotic.”
As the day goes on, Iksil grows even more abjectly miserable. In a phone call later that same day, he tells Grout that there’s no way to get out of his position:
“Now it’s worse than before … there’s nothing that can be done, absolutely nothing that can be done, there’s no hope. … The book continues to grow, more and more monstrous.”
This seems to be the moment of psychic capitulation. Iksil knows he has lost hundreds of millions of dollars. The problem is no longer how to keep from losing the money, but how to avoid getting pulled in even deeper. Four days later, on March 20, with Martin-Arajo unwilling to acknowledge the loss, Iksil goes over his boss’s head. To senior managers, including Ina Drew, he estimates a $43 million one-day loss and $207 million in cumulative losses .. The phone dialogue that follows:
(p. 118) Mr. Martin-Artajo: “Yeah, I don’t understand your logic, mate. I just don’t understand. I’ve told Achilles. He told me that he didn’t want to show the loss until we know what we are going to do tomorrow. But it doesn’t matter. I know that you have a problem; you want to be at peace with yourself. It’s ok, Bruno, ok, it’s alright. I know that you are in a hard position here.”
Mr. Iksil: “… It’s sort of my logic is strange but, in fact I have to choose between one bad thing and one thing that I think was worse.”
When you think about it, it’s surprising that Iksil says he has to choose between a bad thing (coming clean about the numbers) and something that’s worse … because Iksil has really been making that kind of choice since at least January. That’s what got him into this mess in the first place. The difference is that the “something worse” was a high chance of a big loss. What’s changed at by the time of this conversation is that the something worse has turned into the certainty of many-million dollar loss. That seems to take several days to really sink in for Iksil. Three days later, he sends Grout an instant message:
(p. 123) “It is over/it is hopeless now. … I tell you, they are going to trash/destroy us. … we are dead i tell you.”
The great psychologist Daniel Kahneman in Thinking, Fast and Slow (a book I mentioned in my last post) describes the logic of risk seeking and risk aversion. There’s a good chance you understand “risk aversion” fairly well: most folks avoid many risks because the chance of losing a dollar feels worse than the chance of gaining one. Much less well known, though, is an observation that Kahneman makes about risk-seeking behavior. Faced with the certainty of a small loss and the probability of a bigger one, the great majority of people will choose to take the riskier course.
This is exactly the kind of thinking that you see in action at JPMorgan. As long as there seems to be some chance of getting out of the situation without a loss, Iksil and his superiors ratchet up the risk. That’s pretty much what the vast majority of people do in this situation.
The aim here isn’t to let Iksil off the hook. It’s not irrelevant in this story that Iksil was paid $6.74 million in 2011–the kind of money that traders are expected to earn by making the right move, not the riskier one that most folks could be expected to make. Nonetheless, it’s telling that Iksil is clearly sufficiently anguished about what he’s doing that his boss is trying to calm him down–even in the moment that Iksil has gone upstairs and very possibly cost both of them their jobs.
It’s likely that many people hearing the story of the London Whale will have little sympathy for a man who made that much money. Fair enough, though even people in positions of power and wealth can experience genuine conflict. Macbeth, you’ll recall, did much worse things than Iksil or any of his colleagues.
Whether or not you’re inclined to feel empathetic about this kind of conflict, though, it’s worth thinking about what an institution like JPMorgan can do to prevent it from happening in the future. It’s especially troubling in this story that Iksil several times tries to bring the problems with his portfolio to higher-ups, and nobody at JPMorgan makes it easy for him.
A key irony here is that trading houses have decades of experience in suppressing naturally risk-averse behavior. Indeed, Kahneman reports that even ordinary people asked to “think like a trader” will dispassionately evaluate small gains on losses on simple trades. Nothing in the investment bank, though, effectively counter-balances the risk-seeking behavior of the trader backed into a corner.
If anything, the strongest check here seems to be Iksil’s desire to do the right thing and, in his boss’s words, “be at peace with himself.” That’s not a scalable model for the financial system. Over and over again, banks have been hammered with the message that they can’t take undue risks in the hopes of outsized gains. What gets lost is that greed isn’t the only dangerous impulse that drives the market. The other one is fear.
*Some context on “junior trader” is relevant here. In 2011, Grout was paid $1 million by JPMorgan. That’s certainly less than the $6.74 million that Iksil was paid, but enough that most people will see the word “junior” here as relative.