There is little new to report on the multi-billion JPMorgan Chase (JPM) loss. The big question is what position JPM has remaining, what it plans to do with it. The bank probably has the staying power to hold on for awhile, and can avoid dumping it on the market a la Amaranth/Brian Hunter or LTCM. But as Jamie Dimon admitted yesterday, this will expose the bank to considerable volatility going forward.
The exact transaction/transactions at issue is/are unknown, so it is impossible to make a definitive evaluation. What is known does permit some conclusions, however.
The first is that whatever the position is, it is big. And size is often a liability. The bigger the position, the bigger a liability it becomes. Market judo uses your size against you. For if things don’t go your way, it is hard to exit a big position, and even attempting to do so can exacerbate your losses.
Senior traders and dealers described Iksil as a “bright guy”, who was faithfully executing strategies demanded by the bank’s risk management model but who may have simply misjudged the amount of liquidity in the markets.
How many traders could have this as their epitaph: “He Simply Misjudged the Amount of Liquidity in the Markets”?
You can just imagine the Wily Coyote moment. You try to get out of a position and find out you have just run over the cliff and there is nothing to catch your fall, as liquidity disappears from beneath your feet just when you need it.
A couple of other points.
First, there is a lot of pixels being strewn about as to whether the Morgan trade was a prop trade or a hedge, and how this relates to the Volcker Rule. Well, that’s a big part of the problem. There is no hard and fast line. As Holbrook Working pointed out long ago, what is conventionally called hedging is really speculation on the basis. And if your basis position is big enough, and the basis is volatile enough, you can lose a lot of money.
The first member of the billion dollar club-Metallgesellschaft-was allegedly hedging. It wasn’t doing basis trades, per se, but had a huge calendar spread position. Ditto Amaranth. LTCM’s “convergence trades” (that became divergence trades) were essentially basis trades that could be characterized as hedges.
It’s all about size and capital and correlation and volatility. The right (or should I say wrong) combination of those factors-and particular a good dose of sh*t happens-can create a lot of risk, and result in big losses.
This is why much of the discussion of the Volcker Rule is quite beside the point.
Second, there is the question of when things went pear shaped, and when Jamie Dimon knew they were going pear shaped. He was very contrite about, and critical of, the trade yesterday. He vigorously defended it in April. If he got the bad news sometime between the defense and the criticism it’s one thing. If he defended the trade in April knowing that it was already losing, or was substantially riskier than he let on, and that the firm was looking for the exits, it’s quite another.
If it was the latter, you can imagine his dilemma. If he failed to defend the trade vigorously, it would have no doubt resulted in a self-fulfilling disaster, as everyone would have anticipated the impending unloading of the position and traded against it. But if in defending the trade he made misleading or knowingly inaccurate statements, he would face serious legal problems.
Again, right now there are only questions. But no doubt there will be intense scrutiny that will lead to many uncomfortable political and legal moments for Dimon, and for JP Morgan as a whole.
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