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Human-Whale Relations At JPMorgan Were Pretty Frosty

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Is JPMorgan too big to manage the quantity of public confusion about its operations? Maybe? This Reuters story about how JPMorgan was betting against its own Whale trades is a bit silly: the fact that JPMorgan's investment bank dealer desk may have been long (short) some of the instruments that JPMorgan's Chief Investment Office was short (long) is not all that noteworthy. JPMorgan contains multitudes; the dealer desk and the CIO sit in different places and do different things and generally might have similar, offsetting, or entirely unrelated positions.1 In fact if you assume that the positions at issue here were mainly the Whale's massive CDX NA IG position - he was very very long index credit, among other trades - you could imagine that the dealer desk would sort of naturally be short the same thing. A big part of a dealer's job is to (1) write single-name CDS to people who want to short particular names and (2) buy index CDS to hedge.2 So it would naturally be looking to buy index protection, and if a certain whale of its acquaintance was selling - why not?

Still there is a piece of news here, which is this:

Two people familiar with Iksil and his boss, Javier Martin-Artajo, said the two CIO employees complained about the investment bank's actions in the spring of 2012, accusing its traders of deliberately trying to move the market against the CIO by leaking information on its position to hedge funds. Iksil made his complaint to a member of JPMorgan's compliance department, one of the people said. But those same sources said they had not seen any evidence to support that claim ...

So, maybe news? There's no evidence to support it; perhaps it's just the Whale's (retrospectively justified?) persecution complex. Still: the Whale crew thought that the investment bank were trying to make them take losses. Imagine that it's true! Why would it be true?

There's a simple answer: JPMorgan, like most banks, is at least in part a collection of competing fiefdoms in competition with each other for resources and the love of Jamie Dimon; the dealer desk got paid for making money for itself, not for helping out the CIO, and so if it could make money by screwing CIO then they would. In fact screwing CIO would be satisfying even if it didn't make money for the investment bank, as it seems that the investment bank was suspicious of CIO's lax oversight, high risk limits, and general aura of being the favorite child. Making your firm lose money just to get back at a colleague you don't like is more of a UBS move, all in all, but the lure of revenge plus making money for your desk might have been strong.

One thing worth considering is the different roles of the CIO and dealer desks. If you're a London Whale, your job is some combination of (1) hedge JPMorgan's macro risks and (2) make your own macro bets. If you're a dealer desk, your job is (1) satisfy customer demand while clipping (reasonable) bid/ask spread, and (2) make money through your skills as a market maker: knowing who's buying, who's selling, who might be buying or selling in the near future, what will cause trades to happen and how you can be there to profit from them. There's now a third element of the dealer job, which is: (3) stay within the Volcker Rule by only making trades in response to customer demand, or in anticipation of “reasonably expected near term demands of clients, customers or counterparties.

If you're the Whale you're clearly trying to spread out your business by getting long (writing protection on) All Of The CDX In The World from different dealers. But since you're writing All Of The CDX In The World, it's kind of hard to disguise. You might reasonably think that, since you've gotta do a lot, you might as well buy an outsized amount from the home team: maybe JPMorgan's dealers are less likely to front-run you than anyone else. (Or maybe not!)

Now you're JPMorgan's dealer desk. And you know that the CIO is long a perilous amount of credit, and by writing all the protection anyone can take, it's been keeping down the price of CDX. At some point that has to break and CDX spreads will rise. So by virtue of your knowledge of your customer, it sort of makes sense to bet against him just as an economic proposition: he's artificially, as it were, keeping down spreads, and when he stops you'll make money. That's the sort of thing - understanding near-term supply and demand dynamics rather than macro credit - that dealers are supposed to do to inform their trading.

But, you might naively say: dealers aren't supposed to be trading! They're just fulfilling customer need, right? Sure whatever. But the thing is if you're the dealer here, (1) you can get short credit by just selling credit to [buying protection from] the Whale - customer demand! and he's demanding! - and (2) building up a large short-credit position is defensible as a response to reasonably expected near term demand. "CIO is going to puke up all this CDX one day, and when they do we want to be ready." If you've got a client with a huge position that you think they can't hold forever, why not position yourself to help them when they eventually get out of it?3 For, of course, a reasonable spread.

It's entirely possible that JPMorgan's dealer desk was short index credit for reasons wholly unrelated to the Whale, and nothing in today's news really suggests otherwise. But ... I mean, they were a CDX dealer? And the Whale was kind of the big piece of market news in their sector? Why wouldn't they set up their book taking into account the Whale's position? Just seems like a sensible way to respond to supply and demand.

And once you've done that ... well, spreading rumors about the Whale would be a much more underhanded (non-compliant, illegal, etc.) way to profit from that position. Of course sometimes dealers do underhanded (non-compliant, maybe even illegal) things to profit from their clients. After all: some dealer spread it around that the Whale was massively long - that's how it got in the paper.4

That doesn't mean it was JPMorgan. It doesn't mean it wasn't. The main thing to think is that JPMorgan's dealer and JPMorgan's CIO seem to have interacted like any other dealer and any other customer. Which is kind of how it's supposed to work.

Exlcusive: JPMorgan bet against itself in 'Whale' trade [Reuters]

1.Here are words:

It is not uncommon for large banks to hold opposing positions in the same market. That is sometimes done as a way of hedging a position or because different trading desks formulate opposing views about a trade.

Still, the revelation that the bank was taking two sides on the same trade also is likely to rekindle the debate about whether banks such as JPMorgan Chase are too big to manage and should be scaled back.

Note incidentally that we knew back in May that CIO traders marked their Whale positions differently from how JPMorgan's dealers marked them. What this tells you is: JPMorgan's dealer desk had positions in the same assets that the Whale did. (Otherwise how would they mark them?) We didn't know, I suppose, whether the dealer desk was invested alongside the CIO, or against it. (Though against was a good bet - see next sentence in the text.) A fun exercise is: if they'd had the same positions as the Whale, would that be scandalous? How? ("Exclusive: JPMorgan investment bank doubled down on money-losing 'Whale' positions"?) More or less scandalous than the actual revelation-ish?

Let's not even start on the fact that we also knew in May that JPMorgan's asset management division also bet against the Whale. JPMorgan: contains multitudes.

2.Highly recommended is the BIS quarterly review I wrote about here (and FTAV wrote about here).

3.I guess this could argue the other way too: "if you've got a client who'll buy all the credit you can sell them, why not load up on long credit for the next time they call you?" Everything, of course, argues both ways, that's why there's a market etc.

3.From the original Whale article:

Kavi Gupta, a trader at Bank of America Merrill Lynch, wrote a message to investors Thursday about the mystery trader, saying hedge funds are accelerating wagers against "the large long," or bullish investor. "Fast money has smelt blood," he wrote. Bank of America declined to comment.

Presumably Gupta wasn't doing a lot of trading for the Whale? One hopes?