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Trading Against Your Clients Works Best When You Lose Money

This is sort of a strange footnote to the London Whale: one of the hedge funds that made money feasting off his carcass was run by JPMorgan*:

Even as a trader for JPMorgan in London was selling piles of insurance on corporate debt, figuring that the economy was on the upswing, a mutual fund elsewhere at the bank was taking the other side of the bet. …

But perhaps one of the most surprising takers of the JPMorgan trade was a mutual fund run out of a completely different part of the bank. The bank’s Strategic Income Opportunities Fund, which holds about $13 billion in client money, owns about $380 million worth of insurance identical to the kind the “London whale” was selling, according to regulatory filings and people with knowledge of the trade. It is unclear how much the fund made.

This is … not surprising. Some people want to sell CDS, some people want to buy it. That’s how there’s a market. And when you’re as big and interconnected as JPMorgan, it’s not surprising that the market often crosses between bits of yourself. That is, it’s sort of silly to think of JPMorgan as a market participant; it is rather a nexus of many many market participants. Some of those participants are “JPMorgan,” in that they’re interested in the performance of JPMorgan as an entity; others of them are “clients” in the sense that they are buying securities from JPMorgan or having their assets managed by JPMorgan in some separate or mutual-fundy way; but to think of them all as JPMorgan is silly.

But the conclusions from this unremarkable fact are sort of interesting:

In that way, it is different from the example of Goldman Sachs in 2007, when it sold subprime mortgage securities while betting against them. In the case of JPMorgan, it was the reverse: the bank took risk with its own money to sell the insurance contracts that have cost the company money. The asset management division, meanwhile, invested on behalf of its clients when it bought the contracts.

In this case, it may turn out to be a silver lining. If nothing else, it indicates that the asset management division, run by Mary Callahan Erdoes, acted independently from the bank, as is required.

“You’ve got so many different businesses, they are not coordinated and they are not telling each other things and that turns out in this case to have been a virtue,” said Robert Litan, vice president for research and policy at the Ewing Marion Kauffman Foundation. “But that also feeds into another concern, and that is that JPMorgan is not only too big to fail but too big to manage.” …

“There’s really effectively only one lesson other than the interesting irony,” said Douglas J. Elliott, a researcher at the Brookings Institution. “The lesson is that the asset management firms really do act like different bodies. They don’t share info. They don’t always have the view of the rest of the firm. That’s how we want it to be, and that’s how it was in this case.”

So, one: yes. I’m sure that’s true – that Bruno Iksil and the managers of this mutual fund didn’t sit down and talk out the risks and rewards of this trade and ultimately decide that one of them should go long and the other should go short.

Two, though: what if this had gone the other way? This trade is in some crude sense unnatural: you would naïvely expect JPMorgan’s CIO to be buying corporate credit protection and its Strategic Whatsit Whosit to be selling.** Imagine it had gone that way: the CIO had bought zillions of dollars of index credit protection, the mutual fund had sold a chunk of it, and then … well in this scenario imagine that CDX deteriorates, the CIO doesn’t get picked off and makes $2 billion, and the mutual fund loses some money. Would the conclusion there be “the asset management firms really do act like different bodies, bodies housing brains that are sometimes smarter and sometimes dumber than the CIO,” or would it be “ZOMG JPMorgan sold corporate credit to customers while betting against it”?

I don’t know! The whole thing where they actually probably don’t share info between asset management and CIO would probably be helpful. And JPMorgan making $2bn off a trade is probably less newsworthy than it losing $2bn. Still, I suspect the main reason that this trade “is different from the example of Goldman Sachs in 2007, when it sold subprime mortgage securities while betting against them” is that here JPMorgan-as-entity lost money and JPMorgan clients made money (maybe!).*** And that the one worse PR move for a bank than losing money for itself is making money trading against its customers.

As One JPMorgan Trader Sold Risky Contracts, Another One Bought Them [DealBook]

* Also not a hedge fund, whatever.

** That mutual fund is a credit fund; its natural state of being is to be long corporate credit though I suppose its purchases of CDX protection were a market hedge to being long specific names. (Or perhaps it is actually not that into corporate credit, whatever.) Similarly, the CIO is at least in part in the business of hedging JPMorgan’s broader credit exposures as a bank, so you’d think it would be interested in buying protection (as it was in addition to selling).

*** I mean, there are also other, more sensible differences, like that GS’s Abacus trades were marketed by the people who stood to gain on them rather than through independent brokers (bad fact for GS), or the fact that JPM’s Structured Whatsit investment decision was made by JPM rather than its clients (bad fact for JPM if it had lost money).

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66 Responses to “Trading Against Your Clients Works Best When You Lose Money”

  1. Guesticles says:

    Eigen used to be a PM at Highbridge, and has the most latitude of any PM at JPMAM- he has his little team up in Boston, and they kind of do their own thing without being bothered by NY, so long as the inflows continue to roll in (historically- they have). What CIO does is opaque to the rest of the Firm, and Asset Management has its own strategists to ignore while PMs make their own investment calls.

    Eigen is a smart guy with a hedge fund background running an opportunistic FI fund, with very little central oversight. If there's blood in the water, it's his job to get on it.

    I've read a few articles on this issue now, and one of the obvious things that the MSM fails to point out is that it's not that JPM was trading against itself- JPM actually lost its own money on a position that its mutual fund investors made money on.

  2. short vol guy says:

    Mutual gunds can't sell puts/naked CDS like that so "imagine" is as close as we can get on that.

  3. Hakuna Matata Guy says:

    I know this is wildly off topic, but what is the deal with the "welcome home Morgan Stanley, We've missed you"

    I feel like im taking crazy pills!

    • Stripper says:

      It means you've been reading DB for less than three years aka you're new here.

      • Hakuna Matata Guy says:

        I highly doubt a banner regarding Morgan Stanley has anything to do with the length of time I have been accessing dealbreaker. Am I not getting a joke from a while back? Probably. But there's no way they put that up there just because of me, even I'm not that vein!

        • beavis says:

          heh heh heh……vein

        • Stripper says:

          Recall, if you will, that Bess had a post about the MS HR girl "Wideclops" running around firing people in '08-'09 whilst wearing "fuck me boots." The powers that be at MS were so furious they blocked the site completely for 3+ years despite Bess personally calling and apologizing. Evidently the site is now unblocked at MS and Bess is excited for that slice of her target demographic to be back.

          -DB history quant

  4. Guest says:

    Thar she blows

    London Whale Said to Leave JPMorgan http://dealbook.nytimes.com/2012/05/16/london-wha

    • HighFrequencyHater says:

      Wasn't there someone that pulled at Iksil at Deutsche couple years prior too?

      ~Confirmation bias guy

  5. Guest says:

    "They don’t share info."

    This is too broad a statement to be true. In this case, the CIO and the asset manager were literally on opposite sides of the ocean, and not only that, but the asset manager wasn't even in the same offices as HQ. That very naturally limits the amount of communication that goes on.

    But with a bank where the asset manager and the prop desk manager – excuse me, I misspoke, I meant the *hedge* desk manager! – are in the same building, as they are with others of the Wall Street firms, the chances of information not flowing between the two are nearly zero. Factor in people who move between the groups, people who happen to know each other from other connections (e.g. college), and idle chatter in the cafeteria, and it's virtually guaranteed that information is going to flow, and that someone, between the prop desk (whoops!) *hedge* desk, and the asset manager, is going to be on the losing end of that.

    • PermaGuestII says:

      Are you the same moronic guest that keeps making the "they talk to each other in the cafeteria!" comment on every story that involves bulge bracket AM divisions, or is your name actually legion?

      -guy who has spent 10+ years in sell- and buy-side fixed income and can count on one hand the number of times he has actually eaten lunch in the company cafeteria instead of on the desk

      • Insider says:

        You're wasting your time, PG, people like Guest always think information barriers are fake, but we know they're not. The biggest reason, besides the obvious regulatory violation, is that there is zero incentive for anyone to share info like this. If they're on the same side of the trade, then it's a race to see who can get position improvement the quickest (forget momentum, that can work against you at the exit door), and if they're on opposite sides, who cares? The JPM PM undoubtedly knew who was the large player on the other side, but if anything, likely first heard it from his coverage before it was confirmed in the press.

      • Cafeteria Tray Boy says:

        You say you can count on one hand the number of times you've eaten at the cafeteria – well and good. You didn't say that you've never had conversations with people on the other side.

        Look, "cafeteria" is a figure of speech – call it whatever you want, "elevator", "lobby", "in front of the doorman building", "Minetta's", "Penn Station Taco Bell", whatever. The fact of the matter is, people who work on Wall Street have a lot of social contact with each other, and that is doubly true within a given bank, regulations or no regulations. I wasn't born yesterday, and the whole "oh but we never talk to each other" thing rings about as false as someone who lives in Amarillo Texas claiming he doesn't talk to hicks from the sticks.

        At least "Insider" has a reasonable argument – that their interests are in conflict enough that, even though there is information flowing between them, at least the people on the asset management side have enough of an incentive to keep from leaking too much to the trading desks. But where his argument falls down is in the realization that, at most Wall Street firms, the trading desks and the sell side have all the power, and the buy side are just along for the ride. I don't doubt for a second that the traders have access to what is going on in the asset management unit – from the order flow coming from it, if nothing else – but the reverse is not true.

        – Guy who (apparently) has spent more time in Wall Street cafeterias than PermaGuestII

        • PermaGuestII says:

          In what firm at which you have worked does the Asset Management division use the B-D's trading desks to execute?

          • Insider says:

            Zero, of course (he's never worked at one, obviously, he just likes to pontificate about them). Also, what's left of the bulge bracket is drawfed by the size and trading scope of the PIMCOs, WAMCOs, Blackrocks, GSAMs, Fidelitys and JPMIMs (not a complete list) of the world. The sell side definitely does not have "all the power", hasn't for many years, and the buy side seriously lacks the liquidity they need because of it (see Aladdin, etc.)

            Tray Boy just exposed his complete ignorance on both counts.

      • here we go says:

        not to mention all that time in the navy

        shit, you think I never seen a whale go down before… ?

        "i been in this business ten + years "

      • Burger Time says:

        The guy at Five Guys today asked why I never eat there. I said, I eat at my desk.

    • CLOguy says:

      There's a cafeteria in this place??

    • fitting in says:

      Read up on 'fiduciary duty,' Guest, it might do you good. you'll understand how the asset management functions — whether or not divided by the physical body of water from the IB/CIO/Etc.

  6. giest says:

    is that a sperm whale?

  7. Guesttt says:

    cutest picture on DB since Daniela Rausnitz

  8. Guest says:

    why does this matter? this is not like some single name or unique synthetic CDO. this is the IG index. wow – one guy thought the overall credit universe was overpriced while one did not. Isn't that what banks do – long credit risk? This is the equivalent of an event in the equity market where a prop desk is long futures and some mutual fund is underweight. I realize credit derivatives might be hard to understand for equity guys, but this is a non issue.

  9. obvious says:

    The key question that I'm sure you meant to ask was when the JPM asset manager managing the money of other people (aka the "Muppets") executed the trade, did all or part of that fill get soaked up by the Whale? If yes then did they handle the conflict of interest properly? In other words did the Muppets get a good fill on their trade(s) or did the Whale (who was hedging the bonus of the JPM asset manager) get a good fill or did they just trade mid-market or did the CDS desk rip both sides?

  10. J. Coorz says:

    The whole thing is that Dimon should have used better risk management…

    I mean I could see missing a bill six maybe….but two ?

    That's just… we should spend alot of time and resources on this.

  11. Baa3 says:

    not long enough

  12. Fudgie the Whale says:

    Wednesday is Sunday,,,at Carvel

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