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

Did the big banks learn their lesson about risky trading?

ByBill Mcguire and Susanna Kim
May 11, 2012, 8:14 AM

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.

JP Morgan stock was down almost 10 percent in late afternoon trading to $36.80.

Some investors said JP Morgan would be able to withstand the fall-out from this bombshell.

Anthony Polini, analyst with Raymond James, wrote in a note to investors Thursday night that although JP Morgan's stock offers "exceptional value," he expects "some near-term pressure on the stock price due to uncertainty related to repositioning [its] hedging strategy."

Polini said that there is a "high probability that management will defuse this issue on or before" the company's conference call in mid-July discussing its second quarter results.

"This has permeated to the wider market as investors assess the possible systemic risk, adding another layer of caution to the fragile trading environment," Jordan Lambert, a trader at Spreadex, told the Associated Press. "When such shocks occur, it is wise to err on the side of caution and consider whether it is a possible 'tip of the iceberg' scenario, especially when one contemplates the interconnectedness of the banking system."

In Europe, the FTSE 100 index of leading British shares dropped 0.3 percent at 5,525 while Germany's DAX fell 0.3 percent too to 6,498. The CAC-40 in France was 0.7 percent lower at 3,107.

The euro was up 0.2 percent at $1.2952, though still near four-month lows against the dollar.

"The profit environment is very uncertain," WisdomTree's director of research, Jeremy Schwartz, said about the financial sector. "The mix of proprietary trading could be a big source of revenue and profit that is going away."

The Associated Press contributed to this report.

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