A Comment on the JP Morgan Loss

By Michael Lewitt,

(Yesterday, after the market close, JPMorgan announced that a series of synthetic credit trades done by its Chief Investment Office had gone terribly wrong and caused a $2 billion loss.)

A "synthetic" trade is another name for a derivative trade, most likely some type of credit default swap. The bank claims that this Chief Investment Office's job is to hedge the bank's overall credit exposures, but that can't be all that it was doing. This office had to be making huge bets on the market in what is nothing more or less than a form of proprietary trading.

This is exactly the type of activity that the Volcker Rule is supposed to ban, but apparently Mr. Dimon didn't get the memo. Investors who have been bidding up the bank's shares since last November have gotten another lesson in the risks that can be created virtually overnight on the balance sheets of large financial institutions. And it would be surprising if the losses stopped at $2 billion. Counterpart use will now be piling on.

In recent weeks, a JPMorgan trader in London, Bruno Michel Iksil, was reported to be making massive credit trades. Mr. Iksil (why is it always a Frenchman?) had gained the moniker of the "London Whale," and it appears that at least part of the losses are related to his activities.

While it would not be surprising if the London Whale had been harpooned, it is troubling that JPMorgan has been so reckless with its capital. This is "only" a $0.30/share loss but shows that even a manager as highly regarded as Mr. Dimon can't reasonably have a handle on all of such a massive bank's activities. That is why a $71 trillion derivatives book should worry everyone.

Mr. Dimon said that the Chief Investment Office's losses were "self-inflicted" and "egregious." Those may sound like harsh words, but coming four years after 2008, they fail to capture just how inexcusable this type of risk-taking is by an institution of such systemic importance as JPMorgan. Investors have learned once again that leaving banking to the bankers is very dangerous.

This episode will no doubt renew calls for a stronger Volcker Rule. But the real lesson here is that nothing can replace humility and competence, and both were sorely missing at JPMorgan. Everyone should remember that the next time the banks come hat in hand to the government for a bailout.