JPMorgan $2B Trading Loss Roils Markets, Raises Fears About Bank Risks

May 11, 2012— -- JP Morgan Chase & Co. is rocking the financial markets with the disclosure that its in-house trading operating lost $2 billion in the past six weeks, raising new questions about whether the big banks that caused the financial meltdown have sufficiently changed their ways.

Chief Executive Officer Jamie Dimon said the trading loss was an "egregious" failure in a unit managing risks, but he added in a call with analysts after the markets closed Thursday that just because the bank did something "stupid" that doesn't mean other firms are having such trouble.

"There were many errors, sloppiness and bad judgment," Dimon said. "These were grievous mistakes, they were self-inflicted."

Congress and the FDIC have been grappling with how to prevent "too big to fail" institutions from taking big risks knowing that the U.S. Treasury is there to back them up.

The Securities and Exchange Commission has started an early stage review into the loss, according to the Wall Street Journal.

"I think it's safe to say that all the regulators are focused on this," SEC Chairwoman Mary Schapiro told reporters after a speech at a Washington conference, according to news reports. She declined further comment.

JP Morgan, the largest U.S. bank, traced its big loss to the firm's chief investment office, run in London by Ina Drew, chief investment officer. That unit made losing bets on "synthetic credit securities" -- the same kind of instruments that nearly led to a collapse of the financial system in 2008, prompting a $1 trillion goverment bailout.

Dimon said on Thursday that the timing of the trading blunders "plays right into the hands of a bunch of pundits out there" who want a strict proprietary trading ban, the Volcker Rule, named for former Federal Reserve Chairman Paul Volcker.

Jim Leonard, senior securities analyst with investment firm Morningstar, said one of the main challenges of the Volcker rule is defining proprietary trading, described most simply as trading a firm's own money instead of client funds.

"It's nice in concept and I'm a big fan of it," Leonard said of the Volcker rule. "But when you get into the weeds and execution of the rule, it becomes incredibly difficult."

Because of the complexity of proprietary trading, Leonard said the Volcker rule may not have prevented JP Morgan's giant loss, adding that the full details of JP Morgan's loss have not been revealed.

Financial institutions like JP Morgan may argue that transactions that led to the $2 billion loss are not proprietary bets, Leonard said. Instead, JP Morgan described the incident as a bet to hedge the bank's activities.

"That's what you want them to do generally. If you think the market is going bad against them, you have a unit that will hedge the bank's exposure overall," Leonard said. "But they did it horribly wrong."

Leonard said Dimon responded appropriately to the error if Thursday's announcement took place immediately after he learned of the situation.

"The best thing is to fess up and try to straighten out the problem," Leonard said. Swiss bank UBS and French bank Societe Generale have had to make similar mea culpa announcements when trades went awry.

"If you start to lie and cover up like Lehman and Bear Stearns, that's when you go down," Leonard said. "JP Morgan has had this stellar reputation at being really good at risk control. If you admit you caught the problem and will solve it right now, you will take your losses and they will go away."

Global markets fell on Friday after the big surprise trading loss at JP Morgan Chase shook investor confidence, while political chaos in Greece continued to cast uncertainty over its future in the euro currency bloc.