US investment bank JP Morgan has dusted $2 billion on synthetic derivative positions since March 31. According to the company, the Chief Investment Office’s ‘hedging’ strategy gone wrong will result in a net income loss of around $800 million for the corporate division.
Back in April, Bloomberg reported that:
‘JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon has transformed the bank’s chief investment office in the past five years, increasing the size and risk of its speculative bets, according to five former executives with direct knowledge of the changes.
‘Achilles Macris, hired in 2006 as the CIO’s top executive in London, led an expansion into corporate and mortgage-debt investments with a mandate to generate profits for the New York-based bank, three of the former employees said. Dimon, 56, closely supervised the shift from the CIO’s previous focus on protecting JPMorgan from risks inherent in its banking business, such as interest-rate and currency movements, they said.
‘Some of Macris’s bets are now so large that JPMorgan probably can’t unwind them without losing money or roiling financial markets, the former executives said, based on knowledge gleaned from people inside the bank and dealers at other firms.’
‘Former employees’ are a great source of information. Their version of events is usually much closer to the truth than the official line trotted out in conference calls. JP Morgan says the role of the Chief Investment Office (the unit responsible for the losses) was to hedge the banks positions. That is, reduce risk. Commenting on the loss, the bank said:
‘This portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed.’
But the hedging explanation doesn’t stack up. There’s much more to this story than meets the eye. When Bloomberg broke the story of JP Morgan’s huge derivative exposure back in April, the bank panicked. Here’s what Bloomberg said back in April:
‘Bruno Iksil, a London-based trader in Macris’s group,’ (Macris is the head of the bank’s Chief Investment Office – Ed) ‘gained attention last week after moving markets with his trades, drawing a comparison to Federal Reserve Chairman Ben S. Bernanke’s power in the government-bond market.
“What Bernanke is to the Treasury market, Iksil is to the derivatives market,” Bonnie Baha, head of the global developed credit group at DoubleLine Capital LP in Los Angeles said…’
It appears that JP Morgan subsequently tried to de-risk the portfolio, with disastrous consequences. Also, volatility has picked up recently, which has probably made matters worse.
The much more likely explanation is that JP Morgan’s ‘Chief Investment Office’ is (or more likely was) a proprietary trading desk for the company. In other words, it punted shareholder funds on derivatives to boost profits. Or maybe it wasn’t using shareholder funds at all…?
All the action occurred out of the London office.
London is the place to be if you want to use other people’s money to make money for yourself. Remember MF Global? The source of its problems and the reason behind its eventual bankruptcy stemmed from MF Global’s London office.
How do you use others people’s money for your own benefit? The process is known as ‘re-hypothecation’, and London is the centre of the universe for re-hypothecated trades.
According to Wikipedia:
‘Re-hypothecation occurs when banks or broker-dealers re-use the collateral posted by clients such as hedge funds to back the broker’s own trades and borrowing.
‘In the UK, there is no limit on the amount of client assets that can be rehypothecated, except if the client has negotiated an agreement with their broker that includes a limit or prohibition.’
That all sounds a bit heavy for a Friday. But there is something going on here. JP Morgan’s operations straddle the world of banking…and the far murkier world of ‘shadow banking’. Shadow banking is where investment banks, hedge funds, leverage, repos and hypothecated assets all come out to play.
We don’t pretend to understand it all. But it’s crucially important to the global economy. We’ll be digging deeper into the issue in the weeks to come. Stay tuned…
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