Thursday, May 10, 2012 – JP Morgan Chase Goes Boom


DOW +19 = 12,855
SPX + 3 = 1357
NAS – 1 = 2933
10 YR YLD + .05 = 1.88%
OIL – .26 = 96.55
GOLD + 4.00 = 1594.40
SILV -.23 = 29.14
PLAT – 13.00 = 1492.00

So, it was a quiet day in the markets, not much going on; the Dow and the S&P managed to eke out modest gains, and this was welcome following 6 days of losses. Back in early April I told you to start getting out of the market, based in part, on the the idea of “Sell in May and stay away”. Sure, enough, May has been ugly, but not every day is ugly. There will be ups and downs. The past six days have been down; today the markets stopped banging their head against a wall, but the headache hasn’t gone away. All in all, an uneventful trading day.

And then after the closing bell – boom!
JP Morgan Chase lost about $2 billion on mark-to-market accounting tied to synthetic credit securities after positions taken by its chief investment office were riskier than expected.
JPMorgan’s chief investment office, or CIO has been transformed in recent years under Chief Executive Officer Jamie Dimon, into a unit that makes bigger and riskier speculative bets with the bank’s money, five former employees of the bank said earlier this year. Some of the bets were so big that the bank probably couldn’t unwind them without losing money or roiling financial markets. Losses in CIO’s synthetic credit portfolio have been partially offset by gains from sales, mostly of credit-related positions, in the ‘‘AFS securities portfolio,’’ according to the filing. It’s estimated the net loss is around $800 million for the corporate segment of JP Morgan Chase, however, as of March 31, 2012, the value of CIO’s total AFS securities portfolio exceeded its cost by approximately $8 billion.
The bank issued a statement: “This portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed.” JPMorgan said net income in its Corporate unit will be more volatile in future periods.
JPMorgan said it’s “repositioning” the synthetic credit portfolio, and that the CIO ‘‘may hold certain of its current synthetic credit positions for the longer term.’’ Which sounds like they are stuck with some nasty trades that they can’t dump.
On a rapidly-arranged conference call, Dimon called the strategy “flawed.” Its execution was riddled with “errors, sloppiness and bad judgement,” Dimon said, reminding those on the call that the issues had nothing to do with clients, though readily admitting it “puts egg on our face and we deserve any criticism we get.”
Dimon warned that unwinding the “egregious” and “self-inflicted” mistakes will be rectified, during a period that may entail some increased volatility because the firm will be responsible in getting out of the positions. “We’re not going to do something stupid,” he said. “Volatility will be high, and it could cost $1 billion or more.” During a conference call after the news came out, Dimon said the $800 million loss figure could get better or worse during the quarter. Hopefully, by the end of the year the impact will not be significant, he said.
Dealing with the issue will not impact the firm’s plans to return capital to shareholders via dividends and buybacks in 2012, Dimon said. When asked why the firm decided to disclose the information, he said “it’s not going to stop us from building a great company,” but that JPMorgan wanted to be transparent given that the situation arose so soon after the end of the first quarter.
As for whether the strategy may have run afoul of regulators, the JPMorgan chief said that whether or not the trading was above-board under the Volcker Rule, “it violates the Dimon Principle.” Yea, sure. It didn’t violate anything a month ago, as news was coming out that Bruno Iksil, the London based manager of the CIO unit was revealed to be making massive bets in credit default swaps. It didn’t violate anything until it turned into a loss.
Here is Dimon’s description of the CIO prop desk during the conference call: “I did want to talk about the topics in the news around CIO and just take a step back and remind our investors about that activity and performance. We have more liabilities, $1.1 trillion of deposits than we have loans, approximately $720 billion. And we take that differential and we invest it, and that portfolio today is approximately $360 billion. We invest those dollars in high grade, low-risk securities. We have got about $175 billion worth of mortgage securities, we have got government agency securities, high-grade credit and covered bonds, securitized products, municipals, marketable CDs. The vast majority of those are government or government-backed and very high grade in nature. We invest those in order to hedge the interest rate risk of the firm as a function of that liability and asset mismatch.”
Well, that’s just a load of bull. Dimon can’t claim the proprietary trading desk was just hedging; no, they were gambling and they were gambling big. The CIO’s growing size and market power made it an increasingly important customer to Wall Street’s trading desks and a market influence watched by hedge funds and other investors, the former employees said. Iksil’s positions in credit-derivatives have become so large that some market participants dubbed him “Voldemort,” after the villain of the Harry Potter series who’s so powerful he can’t be called by name.
Shares of JPMorgan, frequently held up as an example of a bank that withstood the bursting of the housing bubble and subsequent crisis better than most, plunged 6.9% to $37.94 in uncommonly high volume trading after hours.
What’s next? The last time there was a good trading scandal, the Fed cut interest rates by 75 basis points; I don’t think that will happen now. A credit rating downgrade is very possible; likely a two notch cut, which in turn would push up borrowing costs. A two notch cut would force JPM to raise an additional $1.7 billion in collateral. Ouch.
From the Conference Call:
Question: was anybody else doing this kind of trade?
Dimon says he doesn’t know. “Just because we were stupid doesn’t mean everybody else was.”

Wanna bet? JP Morgan Chase has generally been considered one of the bright kids in the banking pool. Now we start the fun part; trying to figure out just how many greater fools are out there. And how much toxic garbage does JP Morgan have on the books and just how toxic is it, and can you trust JP Morgan? And if JPM has problems, what about everybody else – there problems may be even worse. Who can you trust? Well, clearly you can’t trust anybody. And if you cant trust anybody, what happens next? Credit spreads widen. What happens if credit spreads soar? It gets really, really ugly. JP Morgan’s losses could grow like a cancer, before you turn around, you might see $20 billion in losses. Remember when Bear Stearns collapsed? Allan Schwarz, the Bear CEO went on CNBC and said everything was fine. Bear had a $17 billion dollar liquidity cushion. One day, everything is fine, the next it isn’t, and they’re taping a dollar bill on your front door.
The difference is that this time there are no more bailouts. The president promised: no more bailouts, never again. 
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