Jamie Dimon Chats About Managing Duration Risk With Friendly Congressman

The House’s ping-ponging alternation of smacking and caressing Jamie Dimon today got pretty boring but I was struck by one number that Dimon mentioned, perhaps because it was about the only number that he mentioned. One Republican, with somewhat unclear intent,* suggested that the biggest risk to JPMorgan is that interest rates go up and asked Dimon how JPMorgan hedges that risk. And Dimon pointed out that actually JPMorgan is well set up for that, since it will make money if rates go up, and said “It probably cost us over $1 billion a year to benefit from rising rates.” You can’t as far as I can tell find that number in JPMorgan’s disclosures, but here is a potentially related thing:

So JPMorgan is supposedly spending over $1bn a year on a bet that pays off $2.3bn if rates rise by 100 basis points this year. The odds of that are low, let’s say, less than 45% anyway, which would make that a breakeven trade.

That can’t really be what he meant; nor does it even make sense as a thing. Dimon was discussing that cost in the context of the chief investment office’s available-for-sale portfolio having about a 3-year average duration; at a $375bn portfolio and around a 35bps spread between 3- and 5-year swaps, that suggests that he’d be making about $1bn a year more with about a 4.5-year maturity in that portfolio – at which point he’d I guess be indifferent to rates going up? Of course he’d be making even more with a 10-year average maturity – maybe another $2 or $3 billion – but then he’d lose, instead of breaking even, if rates went up.

I wouldn’t make any economic decisions on that math! I wanted to flag the thing, though, as a weird concession to politicians’ thinking. The “cost” of hedging that rate risk is not as easily reducible to numbers as the exchange suggested: the cost to JPMorgan of being well positioned if interest rates rise is that it is less well positioned if interest rates don’t rise; the better off it is in a high-rate future, the worse off it is in the low-rate now. That is within reason a sliding scale: put all your money in 30-year bonds and you’ll make more interest now but get hosed if rates rise; lend it all overnight and you’ll pay a lot of carry for the option to re-lend it when rates rise. The cost of one choice is giving up the other.** Sometimes there’s a sensible zero to anchor to – Dimon’s implication, here, seems to have been that JPMorgan would make about $1bn per year more if it had zero exposure to rising rates than it does now that it has positive (+$2.2bn/yr) exposure to rising rates – but that doesn’t make the “real” cost $1bn. Why is zero exposure to rising rates the right amount?

Still, the cost is real enough even if the measurement is suspect. JPMorgan is foregoing actual cash interest every quarter in order to retain the flexibility to profit from rising rates. The world being as it is, some of the cash interest that it is foregoing would counterfactually be paid by homeowners who’d love to refinance their houses, but leave that aside – the point I’d focus on is that spending actual cash money often makes you sad. Far better, in many cases, to pay for your hedge – your profit in one counterfactual state of the world – by selling another counterfactual state of the world that you think is less likely. Rather than foregoing interest now in order to profit from rising rates, sell some options on rates going lower in order to pay for options on rates going higher.

That’s hard to do in this specific case – what with rates being pretty much zero-bounded – but it’s a decent description of what JPMorgan probably did to get Dimon hauled in front of Congress. JPMorgan wanted to hedge certain credit-market catastrophes, and rather than whack its profits and incur earnings volatility to pay for that hedge, it instead sold hedges on certain other credit-market catastrophes. But it got those hedges all tangled and ended up in the wrong catastrophe. And it’s perhaps a mark of JPMorgan’s contrition that Jamie Dimon is so willing to talk specifically about the dollars he’s spending to hedge interest rate risks: paying for hedges with cash in the real world is less pleasant and less creative and often less profitable than paying for them with worse outcomes in potential worlds, but right now it probably sounds a lot better to Congress.

House Panel Hearing on JPMorgan [DealBook]

* I’m guessing the subtext was either “all your regulation isn’t free you know” or “buy gold!”

** The same congressman asked Dimon how much it costs him to manage risks in Europe, which he sensibly declined to answer except to say that they avoid some countries and impose maximum risk limits on others. If Spain had enough bonds, JPMorgan could put its whole CIO portolio in 7% yielding Spanish bonds and make $26bn a year in interest, so in some sense the cost of hedging Spanish risk is $26bn a year. In some pretty stupid sense though.

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30 Responses to “Jamie Dimon Chats About Managing Duration Risk With Friendly Congressman”

  1. Guest_of_Honor says:

    I'm pretty sure he means that being short duration is costing him $1B because the yield curve is positive. If he went out the curve in the CIO portfolio he could get another $1B/year in carry but then he'd obviously be taking on increased duration risk.

  2. Im_a_Dude says:

    Matt, any particular reason you wouldn't want to name the said congressman?
    aside for barney frank blowing a gasket, all the congress folk are pretty much the same, so cant remember one from the next.

  3. Guest says:

    Oooh boy, I feel a bit weird right now.

    –Guy who thinks he might have just overdosed on commas and dashes reading this

  4. Guest says:

    Dear Matt,

    In light of recent events, can you please write the next article as if you were addressing the house/senate?

    Friends: Lets give Matt a list of rules to help him in this endeavor, I'll start.

    1. No words with more than 4 syllables

  5. Guest says:

    How could increasing interest rates hurt a bank? If you make a loan on day x at 5% and interest rates go up on day x+1, you still mak 5% on that loan.

    – Moody's fixed income analyst

  6. guest says:

    I believe this post was "meta"?

    – UBS pop culture quant

  7. Grinders says:

    Part of me – the part that thinks it has a chance of understanding this – feels like it might have an opinion about this. I'll get back to you on that.

  8. HandiCapital says:

    When I read Matt's articles I imagine he sounds like Vizzini in a battle of wits.

  9. Term Limits says:

    Duration should never exceed {(435/535)*2yrs}+{(100/535)*6yrs)}

  10. Guest says:

    Got confused and quit reading.

    Well played…

    – B. Iksil

  11. Cincinnatus_C says:

    i'm sorry but this whole post is totally unreadable.

  12. Ross says:

    Jamie Dimon is everything that is wrong with the global financial system today. A disgusting parasite with a sense of entitlement, his and his peers' motto is "Heads we win, tails you lose".
    The global financial system is the biggest danger that humanity is facing today. Their single-mided goal is accumulation of all wealth and power in the hands of a select few, and they are well on their way there.
    One extremely important story that got very little coverage is how the middle class has lost 40% of its wealth in the last two decades or so. And guess where that lost wealth has gone to: Dimon and his ilk.
    People need to wake up and realize how much is at stake every time our "representatives" let these thugs rape and pillage with impunity…

  13. Ross says:

    Thanks matt. you should visit more often.

    – Jamie D.

  14. An Inkling says:

    you may be over-thinking this. he's probably just benchmarking the opportunity cost of being relatively short compared to what might otherwise be a more normal asset duration. $1 bn. is just about the right dimension for a modest, cautionary fore-shortening, too.

  15. Ross says:

    few examples of Dimon’s crude propaganda efforts. I wish I had a transcript; I’m working from rough notes, and some of the memorable howlers were quick asides.

    At one point, Dimon tried calling making loans proprietary. This was an effort to insinuate that the Volcker Rule’s efforts to ban proprietary trading would interfere with core banking businesses.

    Brad Sherman presented Dimon with the results of an IMF study (via Bloomberg) that showed that JP Morgan had lower funding costs due to its implicit government guarantee. Dimon responded by arguing that single A industrial companies pay less for funds than his AA rated bank. Huh? Industrial company funding costs are completely irrelevant and Dimon knows this. It’s a “blow smoke” answer.

    McHenry argued that the Dodd Frank orderly liquidation authority preserved too big to fail. I happen to agree because I’ve gotten estimates that 30% to 50% of JP Morgan’s derivatives contracts are under UK law, and therefore the FDIC could not override their termination or cross default clauses if it tried putting the parent into liquidation and keeping the subsidiaries going. Since derivatives are booked in the depositary, it’s hard to see how the FDIC can stop derivatives not under US law being terminated or subject to higher haircuts as a result of a parent company resolution, and that not producing a risk of a run on the depositary (which is what the OLA was meant to avoid). McHenry then asked for Dimon to discuss the difference between OLA and bankruptcy. There’s a considerable difference, but Dimon dissed McHenry (whose poorly worded question gave Dimon too much rope) by telling him he saw them as the same.

    Dimon (annoyingly) kept claiming the failed trade was a hedge. That’s only because Dimon uses a wildly personal definition of what a hedge is: something to protect you from Bad Things Happening. No, that is either a reserve or insurance. A hedge is a position taken to reduce or limit losses in a position you already have. And he kept promoting the dubious idea that portfolio hedging should include bets against systemic risks (Dimon kept presenting hedging against systemic risk as if it was a unitary phenomenon).

  16. Oscar G says:

    That process was the biggest waste of time. They can't punish an unregulated market. And we all know what happens when these things go to trial.

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