Friday, May 11, 2012

JPMorgan reports $2bn trading loss

JP-Morgan Delivers a Shocker and Voldemort was responsible 

The biggest US bank, JPMorgan has reported a trading loss of at least $2bn on Thursday. The CEO Mr. Jamie Dimon said in the press conference arranged after the markets closure, “errors, sloppiness and bad judgment” were committed by the bank that caused the monumental loss, which “could get worse”. The bank had adopted a risky hedging strategy which could take the total loss to $3bn. The strategies adopted have been "riskier, more volatile and less effective" than originally thought.

Net losses, after accounting for all other inflows and outflows, are expected to cross $800 million by the end of the second quarter. 

The news of the loss caused JPMorgan’s shares to slide by 9%. Effects were also felt by other banks in US and Europe with Bank of America’s shares falling by 2.4%, Barclays 3.5% and Deutsche Bank 1.6%.

JPMorgan’s business unit called Chief Investment Office (CIO) is responsible for hedging the bank’s portfolios of individual holdings. Fluctuations in prices can decrease the value of an asset which can be very costly to a business or individual. To reduce this risk, banks and other financial institutions practice “hedging” whereby the cost of an asset is mutually agreed and maintained by two or more parties to eliminate the risk of any future price fluctuations.

JPMorgan’s CIO unit was responsible for hedging the risks. Mr. Bruno Michel Iksil, a JPMorgan trader based in London who was responsible for making bets as part of his hedging strategy, which is often practiced by the bank, but this time it failed. Mr. Iksil is a well known within the trading circles and is often referred to as the “London Whale” and “Voldemort”.

The Bank is not expected to report any profit, or breakeven, in the first quarter of 2012.  It is not only embarrassing for JPMorgan but the entire banking industry. It was one of the few banks that had enjoyed consumer confidence and was able to rise up from the 2008 global recession more quickly than its rivals. Potential investors and regulatory authorities might think that if JPMorgan could do this, then what about other financial institutions? The news is bound to invite even tighter financial rules.

According to the New York Times, the Federal Reserve and Financial Services Authority, UK’s banking regulator, came to knew about the trading losses a month ago and were having discussions with the concerned bank.

Impact on Volcker Rule

The Volcker rule is one of the primary provisions of the 2010 Wall Street Reform law originally proposed and named after the former Federal Reserve chairman Paul Volcker. The provision aims to put restrictions on banks on making speculative and risky investments that might not benefit the customers or the shareholders. There have been news about banks and other financial institutions lobbying to soften the clauses of Volcker rule but the current events will put an end to such activities. The law is currently being finalized and will be implemented from the third week of July, 2012.

JPMorgan has earlier claimed that tougher financial regulations come with a hefty price tag for the banks and increase their costs up to $600 million. The bank has often publicly criticized the Volcker rule.
Rep. Barney Frank, one of the authors of the rule has said, “The argument that financial institutions do not need the new rules to help them avoid the irresponsible actions that led to the crisis of 2008 is at least $2 billion harder to make today”.

All eyes on JPMorgan

The shocking news of the trading loss has attracted attention not only of the global media but regulators, analysts, economic pundits, and above all the Securities and Exchange Commission. Its chief Mary Schapiro has said, “I think it's safe to say that all the regulators are focused on this."

Ratings Downgrade

Fitch, one of the leading credit rating agencies, have downgraded JPMorgan's long term and short term debt.  The ratings agency believes that although the loss is "manageable" but the bank will face some short term liquidity problems. 

Standard and Poor have revised the bank's ratings to "negative", indicating a possible decline in ratings in future.

Your comments and feedback are always appreciated.
Sarfaraz A.K.