Pink Iguana

Home » Market Structure » You’re going to need a bigger supercomputer.

You’re going to need a bigger supercomputer.


NYT DealBook, JPMorgan Discloses $2 Billion in Trading Losses, here.

JPMorgan Chase, which emerged from the financial crisis as the nation’s biggest bank, disclosed on Thursday that it had lost more than $2 billion in trading, a surprising stumble that promises to escalate the debate over whether regulations need to rein in trading by banks.

Jamie Dimon, the chief executive of JPMorgan, blamed “errors, sloppiness and bad judgment” for the loss, which stemmed from a hedging strategy that backfired.

The trading in that hedge roiled markets a month ago, when rumors started circulating of a JPMorgan trader in London whose bets were so big that he was nicknamed “the London Whale” and “Voldemort,” after the Harry Potter villain.

WSJ Deal Journal,  J.P. Morgan Reveals ‘London Whale’-Size Losses, here.

J.P. Morgan Chase & Co., the nation’s largest bank, surprised the market today, saying it has taken large losses stemming from derivatives bets gone wrong in the bank’s Chief Investment Office.

At 4:30, the bank sent out an unusual notice saying that it would be holding a call at 5 p.m. but included no details about what the call would be about. A person familiar with the matter said the call would include CEO Jamie Dimon and discuss the bank’s quarterly filing.

On the conference call, J.P. Morgan CEO Jamie Dimon said the bank had taken $2 billion in trading losses in the past six weeks and could face an additional $1 billion in second-quarter losses due to market volatility.

DealBreaker, Whale Sushi On The Menu At JPMorgan Executive Lunchroom For Next Few Months, here.

Whaledemort remains something of a riddle wrapped in an enigma wrapped in barnacles, and the Q&A reflected that. BAML’s Guy Moszkowski and others pressed Dimon on, as Moszkowski put it, “why did you feel the need to add synthetic credit exposure?”; others asked a not-unrelated question, which was, roughly, “c’mon Jamie, was this guy actually ‘hedging’ or was this just a crazy prop bet?” Dimon’s answers were not super satisfying but they were clear enough: the Whale was hedging, not adding, credit exposure. But he wasn’t just doing that by getting short lots of bonds or buying lots of CDS. Instead, he was doing something that had him getting long credit via CDX – presumably massive flatteners or tranche trades that were relatively neutral to small moves in credit but made lots of money if things got rapidly worse. These were not prop trades, not massively long credit – rather, the Whale was long credit via longer-dated CDX and short credit via shorter-dated CDX and/or tranches.

That is a simple enough trade, for some value of “enough,” but apparently not simple enough for JPMorgan! At some point they decided to reduce this credit hedge, or “re-hedge” it (Jamie’s exact words vary but whatever, you get the idea, they were short credit through some things and they decided to reduce that short position in some fashion by getting long more CDX or closing some of their shorts or whatever), and that re-hedging was “flawed, complex, poorly reviewed, poorly executed, and poorly managed” but otherwise fine. Except that, also, they fucked up the model.

Salmon,  JP Morgan: When basis trades blow up, here.

I’m not sure if it was the biggest quarterly loss of all time, but Merrill Lynch’s $16 billion loss in the fourth quarter of 2008 certainly ranks very high up there in the annals of investment-bank blowups. It happened after the bank had already been taken over by Bank of America, and it was in the middle of the financial crisis, so it didn’t get nearly the amount of attention it deserved. But it was not simply a case of assets plunging in value. Instead, it was, in very large part, a basis trade blowup.

The basis trade is an arbitrage, basically. There are two different ways the market measures credit risk: by looking at credit spreads — the yield on a certain issuer’s bonds, relative to the risk-free rate — or by looking at CDS spreads, which are basically the same thing but set in the derivatives market rather than the cash bond market. Most of the time, CDS spreads and cash spreads are tightly coupled. But sometimes they’re not. And at Merrill, a huge part of that $16 billion loss was reportedly due to a bad basis bet: the basis on many credits became very large and very negative during the financial crisis.

This time around, the basis-trade disaster has happened at JP Morgan, where the famousLondon Whale seems to have contrived to lose $2 billion on what was meant to be a hedging operation. And once again, although the details are still very murky, the culprit seems to be the CDS-cash basis.

Salmon will probably write a piece on the basis trade but until then there is always
A Credit Trader, Bond-CDS Negative Basis or How to Lose a Billion Dollars on a Trade, here.

Fast forward to early 2009 and Boaz Weinstein, the former star trader and co-head of credit trading at Deutsche Bank is down $1bn, Ken Griffin of Citadel is down 50% and John Thain’s Merril is said to be down $10bn+. Most of these horrific losses are due to a single strategy… the scary negative basis trade.

Bloomberg has written about it here

And there has even been a book published on this strategy… how many trades can say that!

Zerohedge, Is JPM Staring At Another $3 Billion Loss? here. This is Durden at his best.
There are a lot of moving parts in the Dismal tale of Dimon’s demise. The starting point is that Bruno Iksil in the JPMorgan CIO Office, under the premise of hedging the bank’s credit portfolio’s tail risk had placed various tranche trades (levered credit positions with various risk profiles) in the only liquid tranche market that still exists – CDX Series 9 (an ‘orrible portfolio of credits with an initial maturity at the end of 2012). These positions were low cost  (steepeners or equity-mezz) but needed a certain amount of day to day care and maintenance (adjusting hedges and so on). As the market rallied, the positions required increasing amounts of protection be sold to maintain hedges (akin to buying into a rally more and more as it rises). His large size in the market left a mark however that hedge funds tried to fix – that was his index trading was making the index extremely rich (expensive) relative to intrinsics (fair-value).

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: