Are you, like me, struggling to figure out what the whole "London Whale" event has been about, racing to try to catch up even as things seem to worsen daily?
I'm certainly no expert in this area, just an interested observer, but I thought I'd share what little I'd learned.
First, start with this fine introduction from Heidi Moore at USC's Marketplace site. Moore explains the overall story at a high level, without getting bogged down in detail:
JP Morgan also owns a lot of "high-yield," or junk bonds. Those are low-rated bonds from companies that are close to default. If JP Morgan owns a lot of high-yield bonds, the best way to balance that risk is to bet on investment-grade corporate bonds.
Iksil wanted to find a way to bet that those investment-grade bonds were totally secure, that they would never default.
When you're ready for a more detailed and intricate description, find your way to Lisa Pollack's thorough explanation at the Financial Times Alphaville website: . As Pollack explains the situation, it involves various large market participants taking different positions on the trading:
- The mystery trader, perhaps Mr Iksil, has gone long in a big way on the Markit CDX.NA.IG.9, i.e. sold large amounts of protection against the 121 credits contained therein.
- Hedge funds are aware of the big position.
- The hedge funds are using skew trades (we’ll explain shortly) to express this view.
Just above those paragraphs though:
J.P. Morgan said the CIO unit is “focused on managing the long-term structural assets and liabilities of the firm and is not focused on short-term profits.”
The bank added, “Our CIO activities hedge structural risks and invest to bring the company’s asset and liabilities into better alignment.”
So as far as JP Morgan is concerned, these are long-term hedges. So, reputational risk aside, are these really positions to bet against? After all, if the $100bn position that was referred to in the Bloomberg piece is gross notional, that sounds about right for the size of JP Morgan’s exposure anyway. As of March 30, 2012, there was $884bn gross in total on the index (untranched), and JP Morgan is a huge player in this space. So, whatever… big for sure, but not like crazy mental big.
Skew trading is where one buys or sells protection on the index, while simultaneously selling or buying an equivalent amount of exposure to the underlying credits. All 121 of them in the case of the CDX.NA.IG.9.
At the moment, what the hedge funds that spoke to the journalists are saying is that Iksil has supposedly sold so much protection on the index that its spread is a lot lower than it should be relative to the single-names. So they are betting that the skew will have to go back towards zero (it’s negative now).
Is it sounding like a plot line from The Sopranos yet?
For still more detail, you might find Jon Macaskill's reporting at the Euromoney site interesting, for example: Inside JPMorgan's $2 billion loss-making CIO division. Macaskill says:
The size of the value at risk of the CIO portfolio is startling and has exceeded the VAR in JPMorgan's investment bank in each of the past two quarters, which indicates that Dimon must have approved the risk levels being run by the unit. The CIO had average VAR of $69 million in the fourth quarter of 2011 and $67 million in the first quarter of this year. JPMorgan's investment bank - nowadays the most successful in the world in terms of revenue generation - managed to get by with VAR of $57 million in the fourth quarter of 2011 and $63 million in the first quarter of 2012.
VAR, I believe, is "Value At Risk". The CIO is the "Chief Investment Office", not the (more common in my industry) Chief Information Officer. The JPMorgan CIO seems to have had not enough information, and too much at risk.
Lastly, you'll certainly want to keep up-to-date by monitoring the incredibly prolific Felix Salmon of Reuters, who has written a series of fine articles on the situation, including:
- How Bruno Iksil lost $2 billion
- Why JP Morgan’s CIO found it so easy to make money
- Jamie Dimon’s failure
There are two things you can do when something starts to go wrong in the markets. You can unwind your position at a loss. Or you can try to fix it. Iksil, and Drew, chose the latter.
I'm trying to learn about these things, to be an informed citizen, but it's hard. The "financial engineers" at these large banks have cloaked themselves in mystique and intrigue, and, except for those times where they declare themselves "too big to fail" and demand a few hundred billion from the world's taxpayers, they'd prefer to be let alone to make (or lose) their billions in secrecy.
Still, if you have any good references to sources that explain and illuminate this strange incident, by all means send them along!