JP Morgan hurriedly put together a conference call on Thursday (May 10) to tell its investors and other stakeholders that it lost $2-billion in about six weeks.
What went wrong? JP Morgan did say that the losses arose from hedging strategies with synthetic derivatives. The loss also arose in its Chief Investment Office, the unit designed to lower the risk on house hedges and trades.
Two theories have been put forward in the media. The first relates to what is known as the basis trade, a hedging strategy for corporate debt. A few sources reported last month that a trader in JP Morgan's CIO, had placed massive bets on the health of certain companies, and that the positions were so big that rival hedge funds said they were starting to distort the market (read about it here). A second theory is that JP Morgan may have tried to hedge a position by placing various trades on CDX Series 9, an index of liquid credit default swaps (that story is here). More details and clarity will probably emerge and possibly more loses, even though in early days JP Morgan is limiting what it says.
The losses will most likely bring some serious undesirable consequences JP Morgan, in one or more of the following areas:
- The bank’s reputation, which has been carefully built over many years, and especially as the "adult in charge" on Wall Street in the aftermath of the financial crisis. JP Morgan has been known as one of the best run big banks in America.
- A share price decline that already resulted in shareholder value destruction.
- Further expected losses as the hedges and trades are not undwound yet.
- A possible public (or Senate) investigation.
Perhaps worst of all, JP Morgan’s CEO, Jamie Dimon, has been an outspoken critic of more banking regulation in the aftermath of the 2008 financial crisis. This event will make him a much less credible opponent. It will also undermine his arguments that leaving banks more or less alone is a good idea.
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