If you don’t know already (which is unlikely), JPMorgan has fallen suddenly from its pedestal of earning an average of more than $4bn a quarter for the past two years.
The bank held a conference call last night to coincide with the release of its Form 10q to confess that it will post a loss of $800m in the second quarter, instead of the $200m profit it had predicted previously.
Worse, it could get worse. "It could cost us as much as $1 billion or more," (in addition to the $800m lost already) Dimon said. "It is risky and it will be for a couple quarters." As JPMorgan unwinds its position, losses seem likely to worsen.
Needless to say, the cause was the chief investment office (CIO) with its $350bn of ‘hedging investments’ staffed by the likes of Bruno Iksil and Achilles Macris. During the first quarter conference call, Jamie Dimon said all the fuss about Bruno’s big positions was a, “storm in a teacup.” Apparently not.
There’s a lot of speculation about what went wrong for Bruno, Achilles et al. Reuters has spoken to “two financial industry sources in Asia” who say they heard that “the JPMorgan trader” took a position that a credit derivative curve, part of the CDX family of investment grade credit indices, would flatten, but was caught out by unexpectedly sharp moves at the long end.
Equally, however, there seems to have been a risk modelling issue going on. Dimon implied yesterday that VaR had been mis-measured in the past quarter and that new VaR models introduced in the quarter were being withdrawn and the bank was reverting to its old ones.
JPMorgan’s 10Q shows the bank had only one day of (big) market-risk related losses last quarter. Alphaville points out that the reworked VaR in the CIO office averaged $129m in Q1 2012, compared to $60m in Q111 and $67m as originally estimated.
Fortunately, JPMorgan has a fortress balance sheet, so it’s all fine. $1 or $2bn may have been lost but Jamie Dimon pointed out that they still have $430bn in liquidity on hand. Nevertheless, it’s all a little reminiscent of the panicked conference calls and sudden losses of the financial crisis and there will be consequences.
1. Senior management look incompetent
In the first place, Jamie Dimon has lost his sheen. So has CFO Douglas Braunstein. In the wake of the first quarter conference call where both offered lots platitudes about just how innocuous the CIO was, both men look duplicitous, or out of touch. Or both.
“It’s a complete tempest in a teapot,” Dimon said, to recap. “Every bank has a major portfolio and in those portfolios you make investments that you think are wise.”
“These positions that you’ve all been writing about are just simply part of that structural credit book, which, by the way, we’ve been reducing over time, and we are very comfortable with the positions that we have,” soothed Braunstein.
Bloomberg reported a few weeks ago that the CIO was Dimon’s baby and that he’d pushed the unit to seek bigger profits by buying higher yielding assets. Dimon should have kept closer tabs on what was happening there. In the circumstances saying, “"I am not sure how many times I can say this: It was bad strategy, executed poorly," which violated the “Dimon Principle,” seems insufficient.
Dimon’s armour is dented. Repercussions are unlikely to be immediate. If compounded by further errors, this could prove the beginning of the end.
2. Jamie Dimon’s been irritating US politicians for some time. They may scent blood and increase regulation further
Jamie Dimon’s spent a long time expounding his opinion that US banks are unfairly targeted by US rule makers and that the shackles binding them are too restrictive.
The loss suggests the shackles may not be binding enough. "The enormous loss J.P. Morgan 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," Sen. Carl Levin (D., Mich.), chairman of the Senate Permanent Subcommittee on Investigations and co-author of legislation that limits trading activities of big banks, said promptly yesterday.
Rules could yet be tightened as a result, further constraining banks’ ability to make (or lose) money. Reuters points out that the Federal Reserve wants to limit banks’ tri-party repo exposure to one another, but has so far resisted doing so.
3. The Volcker Rule may become more stringent
It’s not clear whether the Volcker Rule could be strengthened at this stage, but Dimon was at pains to say the activities of the CIO were in adherence with it.
The Financial Times points out that this seems a serious loophole. Corporate offices like the CIO invest public deposits that the government guarantees: it’s subsidised capital. Banks need to hedge these investments, but JPMorgan’s hedge has lost $2bn in a few weeks. And this is triple the net income last quarter from JPMorgan’s consumer and business banking division.
4. Heads will roll
Bloomberg reported last month that JPMorgan had already been cutting ‘risk taking traders’ from its CIO. It’s now planning to cut a few more.
Dealbook has a list of all of those who may yet find themselves in the firing line. First among them is Bruno Iksil. Second is Michael Cavanagh, head of treasury and security services. Third is John Hogan, chief risk officer. Fourth is Douglas Braunstein, CFO. If Braunstein goes, Dimon may be vulnerable. It’s not clear what’s happening with Achilles Macris.
5. Risk modellers will increase in status
As we noted above, JPMorgan’s losses seem to have something to do with poor risk models. Basel is reviewing whether banks should replace their VaR models with something better. Doing so may be itself be fraught with risk.
6. Risk aversion will increase everywhere, revenues will stagnate
Other banks will be doubly careful about the risk on their treasury trading books. Any revenue boost from this area will disappear.
“With banks building up the level of securities, other banks could similarly be stretching for revenues. We reiterate our view that this decade will show the worst revenue growth for banks since the decade of the Great Depression; either banks accept this fate or stretch for returns (as did MF Global) and suffer the consequences,” say analysts at CLSA.
7. Treasury traders have absolutely no hope of getting paid based on their profits
Treasury traders don’t get paid particularly well anyway. Any hopes that this would change have now been dashed.
JPMorgan spokesman Joseph Evangelisti told Reuters the bank already uses ‘pay formulas’ to mitigate the risk that staff in the Chief Investment Office might be tempted to make risky profits. The same apparently applies to traders elsewhere. Except for people handling the bank's private equity investments, "no one at JPMorgan is paid on their profits and losses," he said.
8. French traders will be shunned
Bruno Iskil was French. So was Jerome Kerviel. So was Fabrice Tourre. French traders are already complaining of persecution.
9. JPMorgan’s deferred bonuses are suddenly worth less
As of yesterday, JPMorgan’s shares were down 7.5%. The good news is that JPMorgan pays a very large proportion of its bonuses in cash.
10. Goldman Sachs suddenly looks more appealing
We’ve been saying for a while what a wonderful place JPMorgan is to work if you’re a trader.
The bank has unquestionably done a good job of earning consistent trading revenues outside the CIO. However, risk may now be reined in across the bank and the fact is that JPMorgan has had a big blowout - one of the worst ever. Goldman hasn’t.