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JP Morgan has released almost no detail on the positions that caused it to report a $2 billion loss. It has only said it was a position put on to hedge global credit exposure. There are press reports that is was a sale of an CDS (credit default swap index), not even the sale of the CDS itself, but an index designed to track the prices of CDS. In other words, a deriative of another deriative. On its conference call yesterday, JP Morgan admitted it was a “synthetic”.After all the damage done by financial institutions using synthetics on mortgage CDOs, how do regulators allow banks and/or bank holding companies to continue to engage in this? But here is the real question, was this a hedge or a prop trade?. All news reports indicate JPM was making a bullish credit call here – that alone would fly in the face of it being a hedge to other credit exposures. Most of JPM’s business is credit exposure – it lends money to corporations and individuals. The hedge would be to bet on a systemic sequence of defaults not against them. So unless the press reports on the direction of the bet are wrong, it raises a serious question to how this was supposed to hedge JPMs other long credit exposures.
The other pressing questions is that without any major credit events outside of Greece and Spain in recent weeks, why should there be a mark to market that would produce this kind of loss? Moreover, the reports are the index was one of corporate credits, mostly US companies, so European sovereign debt should have been a non-issue. The answer might lie in trying to price a synthetic of a derivative in which the underlying derivative is in a less than liquid opaque market. One of the great lessons not learned from the AIG disaster, is that we can’t allow for a situation where systemically important financial institutions are pushed under by “mark to markets”. In these types of deriatives, there are few institutions making markets and the ones that are being used to price the instruments might have conflicts on interests in pricing these securities. Hank Greenberg, AIG’s former CEO believes Goldman excessively mark down the value of securities that were falling in the market place, but whose underlying payment stream was still intact.
Had their not been regulatory relief on mark to market requirements in 2009, virtually every major bank would have failed. One is left to believe that JPM’s losses here are because of bad marks on their books. That they changed back the way they calculate Value at Risk (VAR) is some evidence of that.
JP Morgan owes public investors more details to explain how a tempest in a tea pot goes to a $2 billion in 30 days without any major events in the market place. Was tremendous leverage being used that magnfiied even small changes in market prices, much the same way LTCM was brought down? Because there are only two possibilities here – Jamie Dimon had no real understanding of what was going in these positions or he did know and hoped that his people would get this under control perhaps by deleveraging or unwinding positions to avoid having to take such a hit. The conference call yesterday suggested the former – that they already knew there were trading losses in the unit and that they might have been too defensive about articles that appeared in the press regarding these trades. It would imply that division heads had assured Dimon it wasn’t that bad even when it was and there was smoke, yet people were telling him there was no fire. We will know for sure if heads roll in the ensuing weeks.