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An Accident of History – A History of Accidents – JP Morgan Chase and its $2 billion Debacle (Part 1)

Written by Walter Marlowe Friday, 18 May 2012 19:06
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Walter Marlowe is a US private investor based in London. He blogs @ http://thematicinvest.wordpress.com/

 

Many, if not all of you will have read about JP Morgan (JPM’s) $2.3 bn and growing “hedging loss”.

 

You will have also read about Jamie Dimon’s apology and acceptance of ultimate responsibility. You will note however that he has neither quit nor relinquished his joint Chairman – CEO roles.

 

You will have read that his deputy, Ina Drew, the grossly overpaid senior exec who headed the department responsible for the loss has however resigned, albeit with a generous and no doubt well deserved separation settlement.

And lastly you will have read that even if the loss grows to $3 or $4 bn. this will not, it is said, dent JPM’s profitability or solvency.

Now here’s some very interesting and relevant items you might not have read:

  • Not only does history repeat itself but some of the players involved in a prior trading debacle of note are also involved in the JPM debacle
  • Ina Drew is an alumna of Long Term Capital Management (LTCM) a 1990’s hedge fund that went spectacularly bust and had to be bailed out and then liquidated at the direction of the Federal Reserve – the size and scope of LTCM’s disastrous trading activities were so significant that they threatened the solvency of the western world’s financial system – a mere harbinger of 2007 – 2008 where the taxpayers got to bail-out the failing financial system
  • According to a May 17 Financial Times article analysing the JPM trading loss based on information provided by market participants JPM’s trading activities eerily mirror aspects of LTCM’s loss making trading activities.

Bear with me now, Dear Reader, it gets better.

  • JPM’s Chief Investment Office, headed by Ms. Drew, was charged with “hedging” JPM’s core operational risks, the risks incurred in being a bank such as: taking deposits; making loans; managing checking accounts; making payments; residential mortgage lending as well as trading, market making and investing in bonds, equities and other financial instruments
  • A simple, direct hedging strategy (a very legitimate and even required exercise for a modern bank) was deemed by JPM management as “too expensive” (read- “not profitable”). Hedging is like buying home or auto insurance, it costs money to protect against risk, it’s not supposed to be profitable
  • JPM pursued an arcane, complex and in itself a very risky hedging strategy that effectively was not a hedge at all because it also created new and, in effect, un-hedged risks.
  • The strategy was arcane but the risks involved were not. As a matter of fact the core strategy was very similar to that pursued by LTCM and as such Ms. Drew should have had an intimate understanding of the risk.

Please, continue to bear with me...Part 2 is coming shortly

Last modified on Monday, 21 May 2012 07:53

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