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15th May 2012

Significance of the JPM trading losses
Opinion

Firstly, what is not of such significance is the amount of money lost. JPMorgan Chase's loss of $2bn will not seriously effect capital or solvency, and even profit to shareholders whilst dented, is not such a big deal. The sum lost is 'only' around one month's projected profit (though may grow to nearer two months over time). Executive chairman Jamie Dimon has admitted that some positions still are to be unwound and this will now be much more difficult.


This is not a rogue trader incident. Dimon has characterised the strategy as “flawed, complex, poorly reviewed, poorly executed and poorly monitored”. He has not suggested however that Chief Investment Officer, Ina Drew, or Achilles Macris, chief architect of the strategy were acting outside of their authority or attempted to conceal their actions in any way. The retirement of Drew was announced on Monday whilst Macris and another trader, Jarvis Martin-Artajo are understood to have offered their resignations. Some reports also link the trades to Bruno Michel Iksi, AKA 'the London Whale', another trader. The fact that it was authorised actions is the first thing that makes the incident of major significance.


The second item of significance is that it has happened in a US universal bank and not an investment only bank. That a bank which many of the US public rely on for their retail banking is still taking what is characterised as huge bets makes the incident so much more important to the politicians and the public.


A third item of significance was that the losses arose from synthetics derivatives, where all profit and losses are within financial markets and there is no direct investment in 'the real world'. The term hedging is used to mean different things in different contexts. Dimon described the trades as hedging, yet the synthetic investment does not appear to be a proportionate counter top any other positions. In this case it was money invested in CDX.NA.IG.9, an index that tracks the performance of Credit Default Swaps relating to a range of North American companies. During the investigation of the previous banking crisis the investment in such complex products was widely criticised for carrying large risk and diverting money from what was seen as the job of a bank to invest in the real world.


Perhaps the most significant other risk management factor was the period over which the losses grew without recognition and a change in strategy. This is true within risk management and leads to Dimon himself. He was initially dismissive when asked about rumours of trading losses during April. He has since apologised and explained that he was not aware of the size of the losses at the time. There is also a London story about pressure from Dimon on the loss making unit situated in London to make a higher return on the funds which was a factor leading to the defective strategy. It is unlikely that shareholders or regulators will seek Dimon's head, given his success during the banking crisis in leading JPM through with very few losses. Both groups may however exert pressure for a splitting of the chairman and CEO roles. Many regulators will be concerned which is that if this can still happen in what was regarded as one of the best risk managed banks then where else might it happen. It is almost certain the Too Big To Fail banks worldwide will have new questions to answer this week on proprietary positions.


The incident is a major boost in the campaign to implement the Volcker rule as originally envisaged and this could be the JPM incident's most important lasting legacy. The rule prevents banks from engaging in proprietary trading (trading at their own risk), with limited exceptions. It is a part of the Dodd-Frank Act, and is due for implementation in July of this year. However under pressure from those who argued it would hinder US Banks competitiveness there was likelihood of delay or significant dilution to the principle before this incident. Jamie Dimon was one of the most outspoken against the Volcker Rule implementation.


It was announced on Monday that:

Matt Zames, currently co-head of Global Fixed Income in the Investment Bank and head of Capital Markets within the Mortgage Bank, will succeed Drew as the firm's Chief Investment Officer and continue in his mortgage-related responsibilities.

Mike Cavanagh, CEO, Treasury & Securities Services (TSS) group, is to lead a dedicated team of senior executives from across our company to oversee and coordinate the firmwide response to the recent losses in the Chief Investment Office. The new role will be in addition to his current duties.