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You Say “Voldemort” Like That’s A Bad Thing

Do you think that Bruno Iksil, when he woke up in Paris on Friday looking forward to trading from home in his black jeans, expected to become an international celebrity? The evidence suggests not. You may remember Iksil – possibly under other names like “Voldemort” or “the London Whale™” as the JPMorgan chief investment office trader who has sold protection on $100bn of notional of a CDX investment grade index to … hedge … JPMorgan’s massive short position in credit … or … something?* Anyway a lot of people are mad at him because that’s just too much protection to sell on that index and so they are complaining to Bloomberg and the Journal about how he is manipulating the market and also taking huge proprietary risks with JPMorgan capital that should obvs be regulated out of existence.

This is weird in a lot of ways but one of them is that you can distill a lot of the Volcker-Rule complaints into “my God, you’re telling me that JPMorgan is exposed to $100bn of credit risk on investment-grade debt issued by a diverse mix of 121 U.S. companies!?” No! JPMorgan is exposed to something like $750bn of credit risk on debt issued by a diverse mix of companies. Some of it’s non-US. Some of it’s not even investment grade. And that’s just in its loan book.** Is writing $100bn of protection on the CDX.IG.NA.9 a terrible risk to take with investor and depositor and government-backstop money? Well, define “terrible risk.” It’s certainly less risky than operating the rest of JPMorgan.***

What is going on here? Like, for one thing: who narc’ed on him? And why? The most sensible account as always comes from Lisa Pollack; her take is basically that (1) a bunch of hedge funds are betting that the skew between spreads on the individual names in the CDX.IG.NA.9 (which names they are long) and spreads on the actual index (which they are short) will converge, (2) Iksil recently got massively long the index, blowing out that skew and losing them money on a mark-to-market basis, and (3) the hedge funds are mad and sad and going to the press to embarrass and/or regulate JPMorgan out of this market? This seems fine except that except it’s hard to see the hedge funds making money on an actual skew trade; Markit shows a -12bps skew and my sense is that after bid/ask you just can’t make a living on 12bps of convergence.

There’s a part of me that wants the narc to be JPMorgan itself, calling attention to its brilliant risk management, spooky nicknames, and ability to move markets with one flick of a London-based Frenchman. Also perhaps to provide a platform for its anti-regulatory case. The Bloomberg piece quotes JPMorgan’s Volcker Rule comment letter, which is kind of a masterpiece of “we’re not saying that everything we’re doing WOULD be illegal under the Volcker Rule, but we are saying that you should make it clearer that they wouldn’t be”:

Under the proposed rule, this activity [monkeying in CDX calendar trades] could have been deemed prohibited proprietary trading. The derivatives used in the hedging strategy were booked in the market risk capital trading account and may not have qualified as hedging because: (1) the actions taken were forward-looking and anticipatory; (2) the Firm’s purchases of the credit derivatives may not have been deemed “reasonably correlated” with the underlying risk [but they may have!], as different instruments were used to effect the hedging strategy than the assets giving rise to the risk; and (3) the gains realized upon the unwind of the hedges could have been determined to be larger than the countervailing risks [or not!].

But realistically, the press has been bad, with Bloomberg going so far as to say “Neither Iksil nor JPMorgan have been accused of wrongdoing,” which, ouch! So maybe it’s other banks, jealous of how good JPMorgan’s hedging is, calling attention to the Very Important Issue of how un-Volckery and maybe-market-manipulative it is?

If so I feel like they’re … doing kind of a weak job? I will be surprised if anyone gets worked up about the market manipulation angle given that (1) the losers are eeeeevil hedge funds and (2) it’s having a fairly small effect on the market for one off-the-run CDX index. And for the Volcker Rule angle … I am serenely untroubled by JPMorgan risking $100bn on US investment grade credit, and everyone else is similarly untroubled given that there’s no real evidence that this trade (arguably a hedge, arguably long-term, etc.) would actually violate the Volcker Rule. Regardless of how you get there, though, if your model of bank regulation prohibits JPMorgan from risking $100bn on diversifid US investment grade credit, your model is wrong.

If I were writing the anti-JPMorgan PR campaign here I might come at it differently. If you take these reports at face value – and you can’t entirely; I don’t believe that JPM is long all this credit risk unhedged and neither does anyone who talked to the Journal or Bloomberg – then JPMorgan has invested $100bn of its huuuuge but finite balance sheet in US corporate credit via this trade. Unlike its loans, this extension of credit is unfunded, but still – JPMorgan is not exactly short of cash, as they’d be the first to tell you, and they can always get more if they need it. So it’s reasonable to think that JPMorgan’s ability to extend credit is finite and that is due to capital, not funding. But that $100bn of credit risk has been extended not to the 121 actual businesses in the CDX.IG.NA.9 index, many of whom probably also have too much cash but some of whom could presumably use the money to like Build A Factory or Hire Some Workers or Buy An Instagram or whatever. Instead it’s being extended to … well, indirectly, to eeeeevil hedge funds who are short the credits and churlish enough to complain about it to the press. If you’re a regulator or politician whose complaint about banks is that they aren’t doing enough lending to support the real economy, news that 5% of JPMorgan’s balance sheet is in the form of synthetic corporate lending that doesn’t actually go to those corporates might be enough to get you mad.

What Volcker Rule Could Mean for JPMorgan’s Big Trades [DealBook]
‘London Whale’ Rattles Debt Market [WSJ]
JPMorgan Trader’s Positions Said to Distort Credit Indexes [Bloomberg]
JPMorgan Trader Iksil Fuels Prop-Trading Debate With Bets [Bloomberg]
Hedge funds and the Whale, credit index edition [FTAV]

* Obvs not that. This seems to be some sort of tranching or calendar trade but it’s hard to tell what. My very favorite explanation is that he is hedging DVA on JPMorgan bonds, which oh would I like that to be true, but it can’t really be, can it? Like, even Goldman isn’t really going to sell $100bn of IG credit protection to hedge its DVA.

** Check out page 138 here for a breakdown.

*** Actually, that’s not quite true, according to Math. Per Bloomberg, CDX.IG.NA.9 has a 33% annualized spread volatility, and the current spread is about 120bps. A 33% annual spread move is thus about 40bps. Figure the index has 5 years left on it and just call it 5 years of duration, WHATEVER. So 40bps of spread = 2% of price. 2% annual volatility = 13bps daily volatility (200/16 = 13ish). Incidentally my overconfidence in this fake math comes from reading this; the fakeness of my math is not their fault.

Anyway if JPMorgan took its $2.2trn of assets and put it all into that index, a one standard devation daily move would be 13bps of $2.2trn or around $3bn; a 95%ile move is thus like $1.5bn. One and a half billion dollars of daily VaR would be rather a lot! Per JPM’s annual report, the actual number is $76 million. So JPMorgan as an entity is actually 1/20th as risky as a portfolio of 5-year debt of investment grade US companies, even though (1) is it something other than that portfolio? if so, is that something less risky than that portfolio? and (2) its stock, with a one-year realized price vol of 41%, is roughly 20 times as risky as that portfolio. I submit to you that these are things to ponder with your heart’s mind’s eye.

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55 Responses to “You Say “Voldemort” Like That’s A Bad Thing”

  1. AIG Quant via LEH says:

    Matt, you're making me ill. Today should be a fucking holiday. Damned NYSE.

  2. VonSloneker says:

    It's ok Matt. I could never figure out what this guy was up to either

    -L. Malfoy

  3. Game recognize game says:

    Matt, solid effing article. I'm quite proud of the progress you've made in communicating your analytical ability. No sarcasm.

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  4. Guest says:

    "a one standard devation daily move would be 13bps of $2.2trn or around $3bn; a 95%ile move is thus like $1.5bn" – shouldn't a 95th percentile VaR exceed a 1-stdev move?

  5. Guest says:

    $76mm is "Total trading and credit portfolio VaR". Which is substantially lower than the entire risk of "JPMorgan as an entity" – the entity includes things like, say, mortgages. It actually doesn't even include all credit – per the footnote, "This VaR does not include the retained loan portfolio, which is not MTM."

  6. P. Falcone says:

    Not really clear on how you're using hedge here but glad to see your support for the industry, sometime it seems even my own LPs are a bit peeved at me.

  7. guesticles says:

    MATT. TALK ABOUT INSTAGRAM. PREFERABLY IN THE FORM OF INSTAGRAMMED OFFICE PHOTOS

    – UBS PICTURE QUANT

  8. Guest_of_Honor says:

    Great article Matt. Thanks.

  9. LZU says:

    Brilliant writing! A pleasure to read. Hope you're right about not worrying…

  10. jaketell says:

    At two times JPM capital this is an end of cycle yield grab in an accrual book. A bit primitive actually. A cycle ago Banks got caught on duration and now they are going to get caught on bad entry on credit.

  11. DB says:

    CDX9 is the last series of CDX for which synthetic index tranches trade. I strongly suspect that Iksil is hedging a fairly large cdo position. If you hedge both delta (5y DV01) and jump (P&L from an immediate default), you can end up trading 10-15x the notional of your CDO tranche’s trade size (I see the delta alone of CDX9 10y 3-7 as 6.2x)…

    It sounds like he’s leaving some money on the table by not trading newer vintage CDX as a hedge – but the overlap is something like 86 of 121 names, and then he’d have to go scare up 5.5y liquidity in a bunch of names that rarely trade.

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