By Michael Tarsala
A $2 billion loss at J.P. Morgan Chase & Co. (NYSE:JPM) is arguably small; the bank earned more than $18 billion last year.
What’s the big deal then?
It’s a question of whether banks are still making outsized speculative market bets and now calling them hedges to satisfy the Volcker Rule. And whether we can expect even bigger “hedging” losses at other banks — and even more market volatility — in the future.
Don’t take my word for it. Here’s what former Bank of America Corporation (NYSE:BAC) executive Sally Krawcheck tweeted out Thursday night:
“JPM again shows the line b/tw prop trading, hedging, “customer facilitation” is thin indeed; focus has to be on total bank risk.”
Putting a credit hedge on a corporate bond portfolio should be simple stuff. You short a correlated position. You can do it using derivatives, and to me, that’s fine. It’s a normal and expected part of the banking business.
But what kind of mega-position in multiple corporate debts was JPM trying to hedge? Details are still unclear.
The bank appeared to be shorting an index of credit default swaps to the point where it was driving price moves in a $10 trillion market.
Other traders noticed the large positions JPM was taking, and lined up to take counter positions. Many knew that it was JPM behind the seemingly odd trading. And they knew for sure after the WSJ reported that it was JPM behind the trades in early April.
So bank stocks – and possibly broader markets — are likely going to take a hit today.
The reason? JPM seemed to have made a huge and odd bet, er, hedge. Then lots of other institutions lined up to profit from it, raising the stakes in a zero sum game.
The winners are the corporate betters who stacked their chips against JPM.
The losers? Individual investors, who still appear to be subject to the betting whims of the banks.
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The derivative hedging game played by JPMorgan Chase is no different than that played by AIG in 2008.
Yet, Jamie Dimon tells us that Chase had merely “made a terrible, egregious mistake.”
He might as well have said that Chase was wrong in raising in a game of poker, when it would have been more prudent and folded. But why was Chase busy gambling in the first place — right after our economic meltdown, and while fighting government regulation?
One answer is because Chase could bear the gambling losses.
That’s right. With $2 trillion at hand, Chase can yawn when $3 billion goes down the tube.
Nonetheless, Dimon tells us that he sees no problem with the government dismantling big failing banks. This is nice to know because the government should start dismantling big banks before they fail — and before they have another chance to take us down with them.
The important lesson then from this Chase episode is not that stringent regulations are needed to reign in on derivatives, but that banks big enough to take huge hits standing up are ripe enough for us to chop down to size.