When I got the Senate Permanent Subcommittee on Investigations report on the London Whale last night, I did what any sensible human would do: I ctrl-F’ed for my name and the names of my friends and enemies, gloated briefly, and then set to work rationalizing not reading the rest of it. After all, it’s ridiculous for the Senate to investigate a basically legitimate trade that, though it lost some money, did nothing to destabilize JPMorgan or the financial system as a whole. And we’ve heard all the important Whale stuff before, including in JPMorgan’s own Whale autopsy, and even then it was old news.
But then I started skimming the executive summary and after underlining every sentence in the first ten pages I figured I’d have to give it a closer look. It’s an amazing, horrifying read.
What was the Whale up to? I don’t think you’ll get a better explanation than this, from a January 2012 presentation by the Whale himself, Bruno Iksil (page 74):
Mr. Iksil’s presentation then proposed executing “the trades that make sense.” Specifically, it proposed:
“By doing so, the bank was able to maintain its carefully crafted image that it was weathering the crisis better than its competitors, many of which required government bailouts and experienced significant deterioration in their stock prices,” says Jordan Thomas, a former US Securities and Exchange Commission enforcement lawyer, who represents Eric Ben-Artzi, one of the complainants.
The “in effect” does a lot of work there; Deutsche Bank “in effect” hid billions of dollars of losses because there were no losses. Other than that!
Here’s a synopsis of what seems to have been going on:
Starting in 2005, Deutsche did some credit trades where they bought protection from some Canadian pension funds and sold protection to hedge funds, etc.
The bought and sold protection were not identical, with various technical bits of non-overlap that you can read about at your leisure down below.1
A credit crisis occurred, changing the risks involved in those non-overlapping bits from silly, abstract, purely theoretical risks into significantly more alarming and more-likely-to-occur but still purely theoretical risks.2
Deutsche’s people sort of ran around dopily trying to figure out what to do about it. Here’s a condensed version of the running around they did about the main risk, the “gap option” that DB was short in its leveraged super senior trades:
The OCC report on bank derivative activities is rarely what you would call a laugh riot but I enjoyed that the 2Q2012 one released today gives the London Whale a belated sad trombone:
Commercial banks and savings associations reported trading revenue of $2.0 billion in the second quarter of 2012, 69 percent lower than the first quarter of 2012, and 73 percent lower than in the second quarter of 2011, the Office of the Comptroller of the Currency reported today in the OCC’s Quarterly Report on Bank Trading and Derivatives Activities.
“Trading revenues were weak in the second quarter,” said Martin Pfinsgraff, Deputy Comptroller for Credit and Market Risk. “While both normal seasonal weakness and reduced client demand played a role, it was clearly the highly-publicized losses at JPMorgan Chase that caused the sharp drop in trading revenues.” Mr. Pfinsgraff noted that JPMorgan Chase reported a $3.7 billion loss from credit trading activities, causing the bank to report an aggregate $420 million trading loss for the quarter.
How big a deal Whaledemort is depends on your denominator: compared to JPMorgan’s assets, or even its revenues, he’s a drop in the ocean, but his misadventures in credit derivatives did wipe out two-thirds of all derivative trading revenues among all US banks. And he’s a good enough excuse to talk about a random assortment of other credit-derivative-trading things from the last few days. First is a neat Bloomberg article (appears to be terminal-only now) about CDX NA HY 19: Read more »
In this new ‘Happy Hour’ bit called ‘Backseat Broker,’ Cody Willard, completely disheveled and visibly drunk, rides around town trying to find someone who’ll get in a cab with him and “talk about finance.” Victim number one is Jennifer V. (sounds like ‘Volmer’ but she’s scared of the guy sitting next to her and muddles her words so I can’t be sure). She works in credit derivatives. Cody asks her if there’s anything that can be done to improve the market; better question: is there anything that can be done to improve this segment? No. It is perfection. But, if pressed to come up with something, we can’t help thinking it would be interesting not to have Cody convincing people to get in his cab, but running alongside traffic, seeing who’ll let him into theirs (keep the unkempt look, it’s humanizing). If they want to talk shop, that’s just an added bonus.