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Whale Sushi On The Menu At JPMorgan Executive Lunchroom For Next Few Months

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Jamie Dimon just did a conference call in which he mentioned something called the "Dimon Principle," but he did not define it, so I will propose a definition, which is: If you are going to have a Slytherin alumnus running a $375bn book full of snakes and CDX and TIPS (??) and things, and someone notices and the press starts lobbing in guesses about it, and Congress starts fretting about it, and you say things like "this is a tempest in a teapot," you have to NOT LOSE TWO BILLION DOLLARS ON IT. From JPMorgan's just-filed Q:

In Corporate, within the Corporate/Private Equity segment, net income (excluding Private Equity results and litigation expense) for the second quarter is currently estimated to be a loss of approximately $800 million. (Prior guidance for Corporate quarterly net income (excluding Private Equity results, litigation expense and nonrecurring significant items) was approximately $200 million.) Actual second quarter results could be substantially different from the current estimate and will depend on market levels and portfolio actions related to investments held by the Chief Investment Office (CIO), as well as other activities in Corporate during the remainder of the quarter.

Since March 31, 2012, CIO has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed. The losses in CIO's synthetic credit portfolio have been partially offset by realized gains from sales, predominantly of credit-related positions, in CIO's AFS securities portfolio. As of March 31, 2012, the value of CIO's total AFS securities portfolio exceeded its cost by approximately $8 billion. Since then, this portfolio (inclusive of the realized gains in the second quarter to date) has appreciated in value.

The Firm is currently repositioning CIO's synthetic credit portfolio, which it is doing in conjunction with its assessment of the Firm's overall credit exposure. As this repositioning is being effected in a manner designed to maximize economic value, CIO may hold certain of its current synthetic credit positions for the longer term.

This was an amazingly awkward call! Jamie refused to take questions on personnel, which means no one asked "did you fire the Whale," but it seems clear from his tone of voice that the Whale is praying for termination/death. Here are some things that Jamie Dimon just said:

  • "I can never promise you that we won't make mistakes. This one I would put in the egregious category."
  • "This may not violate the Volcker Rule, but it violates the Dimon principle."*
  • And, when asked if this is due to market conditions and other banks may have similar gaping holes taken out of them: "Just 'cause we're stupid doesn't mean everybody else was."

Whaledemort remains something of a riddle wrapped in an enigma wrapped in barnacles, and the Q&A reflected that. BAML's Guy Moszkowski and others pressed Dimon on, as Moszkowski put it, "why did you feel the need to add synthetic credit exposure?"; others asked a not-unrelated question, which was, roughly, "c'mon Jamie, was this guy actually 'hedging' or was this just a crazy prop bet?" Dimon's answers were not super satisfying but they were clear enough: the Whale was hedging, not adding, credit exposure. But he wasn't just doing that by getting short lots of bonds or buying lots of CDS. Instead, he was doing something that had him getting long credit via CDX - presumably massive flatteners or tranche trades that were relatively neutral to small moves in credit but made lots of money if things got rapidly worse. These were not prop trades, not massively long credit - rather, the Whale was long credit via longer-dated CDX and short credit via shorter-dated CDX and/or tranches.

That is a simple enough trade, for some value of "enough," but apparently not simple enough for JPMorgan! At some point they decided to reduce this credit hedge, or "re-hedge" it (Jamie's exact words vary but whatever, you get the idea, they were short credit through some things and they decided to reduce that short position in some fashion by getting long more CDX or closing some of their shorts or whatever), and that re-hedging was "flawed, complex, poorly reviewed, poorly executed, and poorly managed" but otherwise fine. Except that, also, they fucked up the model. Here is CIO VaR from the earnings release:

Here is the CIO VaR from the Q:

So not $67mm of average daily VaR, as previously reported, but rather $129mm - rising to $186mm at the end of the quarter. This was attributed to modeling changes made over the last year, and someone asked on the call "why did you change the VaR model?," but I'm not convinced that's exactly the right question. This, I suspect, is not an issue of a thing called a "VaR model" that sits in a central location and spits out numbers for regulators and 10-Qs; rather, this looks like the CIO's trading desk modelling the actual P&L and risks of the trade wildly wrong. That seems to me like the simplest way to lose a billion dollars without noticing it. You can see that in Jamie's "just 'cause we're stupid doesn't mean everybody else was": this was not driven by the market moving against them (though it seems to have), it was driven by them getting the math wrong.

Of course Dimon got a question about the Volcker Rule, and it's hard to argue with his answer: this surprise loss doesn't change the arguments, but "this is very unfortunate, it plays into the hands of a bunch of pundits out there, but that's life." The arguments, presumably, are over portfolio hedging - glopping all your credit risk together and then having one guy in London hedge it - versus, um, whatever the other thing is, I guess having each trader hedge all of her own risks. Allowing portfolio hedging seems like a no-brainer but the obvious counter-argument means that any time you concentrate things in one person, if that one person screws up, he has screwed up more things. Perhaps the response here is "but the model was screwed up, so even if we had 100 traders hedging 100 books using this model, they'd have ended up in the same place," but that response is not fully encouraging.

Don't worry, though. JPMorgan will get through this; they'll "manage the position for economics" and their capital return plans are still on track. We know this because Dimon said it and added "our general counsel is sitting right here and would kick me if that wasn't true." No pressure though.

J.P. Morgan Reveals ‘London Whale’-Size Losses [Deal Journal]

* I had a delightful boss at GS the entirety of whose instruction on some trades was "don't fuck it up." This would also be good content for the "Dimon principle."