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$2 billion is just the beginning of JPMorgan's trading debacle
By Catholic Online (NEWS CONSORTIUM)
May 14th, 2012
Catholic Online (www.catholic.org)
May 14th, 2012
Catholic Online (www.catholic.org)
According to some economic analysts, JPMorgan Chase got a pass. Investors had the attitude with the bank, as run by Jamie Dimon that they were going to be non-invasive. JPMorgan Chase knew their way around sub-prime mortgage loans, and many assumed the bank's many foreclosure problems were being handled in a timely manner. Investors allowed Dimon and JPMorgan to skate by on one of the smallest capital cushions, which is how much equity you have to protect against losses.
That didn't deter investors. JPMorgan's shares were rewarded with one of the richest valuations on Wall Street. Until recently, it was one of the few major banks to trade above book value. Citigroup's shares trade at a price-to-book of 0.5.
However -- that is likely to change. Dimon told analysts in an emergency conference call last week that JPMorgan's chief investment office, a division that is supposed to place investments that lower the risk of the bank, not increase it, had lost $2 billion on a trading strategy in the past 40 days. JPMorgan's shares fell nearly 10 percent on Friday and closed at just under $37.
Most attention has been on the $2 billion loss, commenting that it's not that big a deal for a bank that has typically been earning $5 billion every three months and has $55 billion in cash. JPMorgan can handle it. Overall, the bank will still likely show a hefty profit this quarter.
The actual cost of the loss will be much bigger than that. First of all, JPMorgan could end up losing more on the bet than it has already disclosed. Some say the trade is what landed JPMorgan into hot water, which is mostly attributed to a single trader who is based in the U.K. and has come to be known as the London Whale, could be as large as $100 billion.
JPMorgan won't lose anywhere close to that, but transactions like the one JPMorgan appears to have, where it makes multiple bets involving a particular index, in this case one that has to do with large, credit-worthy companies, can be very costly to unwind.
Dimon during the conference call with analysts said the bank's losses on the trade are likely to increase but he didn't say how much.
Dimon is also facing much bigger losses than this one trade. Dimon reportedly began pushing the chief investment office about five years ago to invest the bank's excess cash more aggressively. That tactic has worked until just recently.
While Dimon has yet to say whether he is shutting down the division, it's likely he will at the least have to scale it back.
And that might not be the only business that JPMorgan has to retreat from. By far what makes JPMorgan the riskiest bank on Wall Street, and one of the most profitable, is the bank's derivative trading book, which is far larger than any other bank in the world.
JPMorgan holds derivatives contracts with a notional value of just over $1.6 trillion. That's enough to destroy the bank's capital nearly 10 times over. JPMorgan says its derivative bets aren't nearly that big or as risky as they appear. With hedges and collateral, and the bank says its actual exposure is just $66 billion. But we have just seen how well JPMorgan's hedges can work.
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