Almost immediately after the stock market closed yesterday, JPMorgan Chase asked Wall Street analysts to attend a highly unusual, hastily assembled, postmarket conference call. Speculation was rampant: What could be so urgent? A credit-rating downgrade? A government investigation? CEO Jamie Dimon delivered the now all too familiar sounding bombshell: JPMorgan, the largest bank in the U.S., had suffered a $2 billion trading loss over a recent six-week period on a complex derivatives portfolio — initially designed to reduce risk — that spiraled out of control.
JPMorgan (JPM) shares dived nearly 7% as Dimon spoke, wiping out almost $10 billion in shareholder equity and dragging down other bank stocks ahead of Friday’s market. With all of Wall Street listening, Dimon tersely explained his version of what happened: JPMorgan’s so-called chief investment office, which ostensibly manages risk for the bank, had engineered a “synthetic credit portfolio” as a “hedge” to balance out potential losses elsewhere on its books. Over the past two months, the positions started yielding huge trading losses. Finally, JPMorgan was forced to take a $2 billion trading loss, about $1 billion of which it was able to mitigate by selling other assets. Dimon warned that even now, the bank continues to carry a portion of the huge position, which could cause an additional $1 billion in losses. “The portfolio still has a lot of risk and volatility going forward,” he said.
Dimon’s disclosure immediately prompted calls for stronger financial regulation, but the tough-talking, New York City–born CEO defiantly dismissed suggestions that the Volcker Rule, which is supposed to prevent banks from making risky bets, should be strengthened. For Dimon, a powerful Wall Street figure who had emerged from the financial crisis with the least damaged reputation among major bank CEOs, the episode was an embarrassing black eye. At $2.3 billion — so far — this bad trade could become one of the top 10 largest trading losses on record.
At various times contrite, annoyed and combative, Dimon fielded questions from incredulous Wall Street analysts who wanted to know how such a debacle could have occurred, especially so soon after a devastating financial crisis that many experts blame, in part, on the very same financial instruments — credit-default swaps — that are at the heart of the JPMorgan’s current losses. “In hindsight,” Dimon said, “the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective of an economic hedge than we thought.” Speaking with unusual candor — even as he never accepted personal responsibility — Dimon said the bank made “egregious mistakes.” He said several high-level bank committees including “audit, legal and risk” are investigating the breakdown. “What happened violates our own standards and principles of how we want to operate the company,” Dimon said. “This is not how we want to run a business.”
Although Dimon refused to go into details about the trading positions or who at the bank was responsible, he obliquely acknowledged that the source of the activity was a mysterious trader named Bruno Iksil, also known as “the London Whale” (and “Voldemort”), who had attracted intense scrutiny in the hedge-fund community in recent weeks for large, market-moving credit-default-swap positions he had taken. Iksil, a French-born, London-based JPMorgan trader, had built derivative positions with a face value of $100 billion or more, according to the Wall Street Journal, but stopped trading in April. Around that time, several reports emerged that hedge funds had taken large positions opposing Iksil’s trades — reports Dimon dismissed as “a complete tempest in a teapot.”
On Thursday, in a humbling climb-down, Dimon acknowledged that JPMorgan should have paid closer attention to the news reports, not to mention the portfolio’s mounting losses. He said JPMorgan had doubled its value-at-risk metric, a measure of the bank’s potential losses on a daily basis, to levels not seen since the financial crisis. “We have egg on our face, and we deserve any criticism we get,” Dimon said. “These were egregious mistakes, they were self-inflicted, and we are accountable.”
As the nation’s largest bank, JPMorgan can absorb the $800 million loss it now expects to take as a result of the botched trades. But the episode raises immediate questions about the effectiveness of new financial regulations, including the Volcker Rule, which is supposed to take effect on July 21 and is designed prevent the still-too-big-to-fail Wall Street banks from making risky, so-called proprietary bets. JPMorgan’s ill-fated credit portfolio does not appear to have violated the rule, because, as Slate’s Matthew Yglesias pointed out, the rule contains a huge loophole that allows banks to take large positions for the purposes of hedging.
“This trading may not violate the Volcker rule, but it violates the Dimon Principle,” Dimon said on the call, without elaborating on what, exactly, the Dimon Principle entails — although presumably it precludes $2 billion trading losses. Pressed by an analyst about how he might respond to pressure to increase the Volcker Rule’s strength or the financial regulatory regime more broadly, Dimon was defiant. “This is very unfortunate,” he said, “but it does not change analysis, facts and detailed argument.” He added, “This plays right into the hands of a bunch of pundits out there, but that’s life, and we’ll have to deal with that.”
As if on cue, Sen. Carl Levin, the Michigan Democrat, issued a statement citing the episode as proof that stronger financial safeguards are needed. “The enormous loss JPMorgan announced today is just the latest evidence that what banks call ‘hedges’ are often risky bets that so-called ‘too big to fail’ banks have no business making,” Levin said. “Today’s announcement is a stark reminder of the need for regulators to establish tough, effective standards.”