Prop Trading

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Jim Grant: We Are Now All Labrats Of Bernanke And The Fourth Branch Of Government





You put Jim Grant on TV and someone mentions the Fed and the result every single time is the equivalent of waving a red curtain in front of a rabid bull. This time was no different, as the Interest Rate Observer once again let Bernanke, with whom he clarified is no longer on speaking terms, have it. The ensuing central-planner bashing was in line with expectations, and just as we presented yesterday in "The Experiment Economy", so too does Grant believe that the Fed is "learning by doing" and follows up by clarifying that this is an experiment, "and we are lab rats in the financial markets." He then proceeds to lament that the credit markets, clueless NYT econopundits notwithstanding, have now lost all informational value as every rate instrument is purely in the manipulated domain of the Fed. "We are all living in a land of speculation and manipulation" is Grant's summary of the current predicament of anyone who wishes to trade these "markets" and it may as well be the best synopsis of the New (ab)normal. And aside from an odd detour into Government Motors, Grant once again hones in on the only true antidote to central planner idiocy, gold: "the best thing about gold is that it's got no P/E multiple. Gold is a speculation on an anticipated macroeconomic outcome, the systematic debasement of currencies by central banks. Why wouldn't they do QE4? What intellectual argument do they have against doing it again, and again, and again." Well...none.

 

 
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Retail Exodus From Stocks Continues: Another $3.6 Billion Pulled Out Last week





There was a time when retail stock outflows were considered a bullish catalyst: after all, retail was always considered the dumb money (not "two and twenty" hedge funds which continue to underperform the stock market, and have done so for the past five years), and would pull money at the bottom and add money at the top. This is no longer the case for the simple reason that while persistent outflows from domestic equity funds continue (and as the recent shuttering of levered ETFs by Direxion shows the infatuation with synthetic mutual fund replacements is now over), for the inverse to be true there have to be inflows, which are now non-existent. In the past two years, or 106 weeks of market data, there here been 17 weeks of inflows, or 16% of the total, amounting to $31 billion. The remainder? Outflows for a total of $300 billion. In the 32 weeks of YTD 2012 money flows, there have been 5 weeks of inflows for a total of $3.6 billion (which was also equal to the outflow in the last week alone) none of which coincided with market tops, and in fact the biggest outflows occurred just as the market hit interim highs. The most recent inflow, as tiny as it may have been, curious occurred during the May lows, proving retail is if anything, the smart money now. In other words, those looking for hints about the market based on retail flows are advised to look elsewhere. What this data does show is that no matter what happens in the stock market, the outflows will persist and are unlikely to reverse direction. Because if the S&P at fresh 2012 (and multi-year) highs is unable to draw retail out of hibernation, nothing will. Where is the money flowing? Why into fixed income of course, proving that as far as the now extinct investor class is concerned, return of capital is the only thing that matters, while HFTs and prop trading desks can fight over all the return on capital scraps provided courtesy of the Chairman. Curious where the volume has gone? Now you know.

 
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Guest Post: The Biggest Conflict Of Interest In Finance?





Maybe this is a naive question, but as Goldman clients get skinned again and again and again and again and again by Goldman’s failed calls — while Goldman itself continues to rack up prop trading profits — I keep wondering just why anyone would take investment advice from a trading firm? And beyond that, why is it even legal for trading firms to advise clients? Isn’t this the biggest conflict of interest possible? We know firms including Goldman have advised clients to buy junk that the trading arm wants to get off its books.

 
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Frontrunning: July 24





  • Greece now in "Great Depression", PM says (Reuters)
  • Geithner "Washington must act to avoid damaging economy" (Reuters)
  • Moody’s warns eurozone core (FT)
  • Germany Pushes Back After Moody’s Lowers Rating Outlook (Bloomberg)
  • Austria's Fekter says Greek euro exit not discussed (Reuters)
  • In Greek crisis, lessons in a shrimp farm's travails (Reuters)
  • Fed's Raskin: No government backstop for banks that do prop trading (Reuters)
  • Campbell Chases Millennials With Lentils Madras Curry (Bloomberg)
 
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Goldman Beats Modest Estimates As Prop Trading Revenue Plunges; Avg Employee Comp Slides 16% From Year Ago To $343,003





On the surface, Goldman's results, which unlike JPM and Citi do not break out the contribution of DVA, aka the top and bottom line contribution from Goldman's CDS blowing out in Q2, were good because they beat expectations of $6.26 billion in revenue and $1.18 in EPS, printing at $6.63 billion and $1.78/share. Of course, going back 3 weeks and the bottom line estimate would have missed then consensus EPS, but who cares: after tall the firm guided down and all the algos know is that GS beat. The problems arise when one spreads the various top line segments which portend nothing new: Client Flow, a proxy for general credit trading, dropped from $3.5 billion to $2.2 billion in Q2, but better than Q2 2012 when it was just $1.6 billion. However, client flow in equities was an abysmal $1.7 billion, down from $2.3 billion in Q2 and $1.9 billion last year as increasingly less people opt to use Goldman's REDi platform or its equity sales team. But most troubling was the epic collapse in the firm's Investing and Lending group, aka its highest margin, Prop Trading operation, which in the aftermath of the JPM fiasco mysteriously saw its revenue collapse from $1.9 billion to a mere $203 million, down from $1 billion a year earlier, and only the second lowest number in the past 3 years. Did the JPM CIO CDS repricing scandal force all banks to suddenly reevaluate their books and mark mid-market? We don't know, but there were no reason why Goldman's prop traders should have generated only $200 million in a quarter in which the bulk of the heat was focused on JPM and others. And finally, in terms of employee retention, Goldman employees can not be happy: in Q2 average comp to the firm's 32,300 total staff also declined to a multi-year low of $343,003, down from $350,864 last quarter, and down 16% from $408,958 a year earlier.

 
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This Is How To Kill JPM's CIO Operation





While JPM may or may not have succeeded in burying its deeply humiliating CIO fiasco at the expense of two things: i) a loss of up to 25% in recurring net income and ii) Jamie Dimon proudly throwing numerous of his key traders under the regulatory bus as scapegoats because it took the firm until July 12 to realize that its entire CDS book was criminally mismarked, thus confirming a "weakness in internal controls" (a statement not only we, but Bloomberg's Jonathan Weil vomits all over), the truth is that one way or another, Jamie Dimon will find a way to reposition his prop trading book somewhere else, even if it means far smaller and less obtrusive profits for the next several years. Yet there is a way to virtually make sure that Jamie Dimon is never allowed to trade as a hedge fund ever again, and in the process risk insolvency and yet another taxpayer bailout. Ironically, it is JPMorgan itself that tells everyone precisely what it is.

 
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Jamie Dimon's Quandary: Now That JPM's Internal Hedge Fund Is Gone, Where Will 25% Of Net Income Come From?





Much has been said about JPM's CIO Loss (which so far has come at a little over $5 billion, just as we calculated in the hours after the original May 10 announcement). And with the so called final number out of the way, investors in JPM have breathed a sigh of relief and are stepping back into the company hopeful that a major wildcard about the firm's future has been removed. The issue, however, is that the CIO loss was never the question: after all JPM could easily sell debt or raise equity to plug liquidity shortfalls. The real issue is that just as we explained months before the loss was even known, the Treasury/CIO department was nothing short of the firm's unbridled hedge fund which could do whatever it chooses, and not be held accountable to anyone at least until its counterparties broke a story of an epic loss to the media. And thus the problem becomes apparent: now that every action of the CIO group is scrutinized under a microscope by everyone from management to auditors to regulators to analysts to fringe blogs, the high flying days of whale trades are forever gone. The question then is just how big was the contribution of the Treasury/CIO group, which until today was buried deep within JPM's Corporate and PE Group and not broken out. Thanks to the new breakout, reminiscent of Goldman starting to break out its own Prop Trading group some years ago, we now know exactly just how big the contribution to both revenue, but more impotantly, net income was courtesy of JPM's Hedge Fund.

The result is nothing short of stunning.

 
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The "New Normal" FX Rip





This is how a completely news-less FX move looks like under the new normal, at precisely the moment when market opens. Did we say no news? Yes. 80 pips move in minutes on absolutely nothing, but an avalanche of very specific stop limit triggers. And since the EURUSD is the highest levered fulcrum security, and since shorts have piled in aggressively in the last few days, ramping the pair to the stratosphere is why risk is soaring, once again on no positive news. And now that the market move has happened, the news to explain it will come fast and furious. One wonders if all of the now unwound CIO capital has moved into JPM's most recent prop trading addition: the CFXO.

 
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JPM Admits CIO Group Consistently Mismarked Hundreds Of Billions In CDS In Effort To Artificially Boost Profits





Back on May 30 we wrote "The Second Act Of The JPM CIO Fiasco Has Arrived - Mismarking Hundreds Of Billions In Credit Default Swaps" in which we made it abundantly clear that due to the Over The Counter nature of CDS one can easily make up whatever marks one wants in order to boost the P&L impact of a given position, this is precisely  what JPM was doing in order to boost its P&L? As of moments ago this too has been proven to be the case. From a just filed very shocking 8K which takes the "Whale" saga to a whole new level. To wit: 'the recently discovered information raises questions about the integrity of the trader marks, and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses being incurred in the portfolio during the first quarter. As a result, the Firm is no longer confident that the trader marks used to prepare the Firm's reported first quarter results (although within the established thresholds) reflect good faith estimates of fair value at quarter end."

 
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JPMorgan To Clawback Bonuses, Will Announce CIO Loss Just Over $5 Billion





Many were stunned when Ina Drew left JPM with millions in bonuses a few short days after Jamie Dimon told Senate and Congress those responsible for the multi-billions CIO loss would see compensation clawbacks. They can be unstunned now, following a report from the WSJ that in a few days JPM will announces millions in clawbacks from disgraced CIO executives. As for the final loss on the CIO? Recall what Zero Hedge calculated (not speculated, not surmised, not made up) in the hours literally after the JPM announcement of a $2 billion loss? We said: "Is JPM Staring At Another $3 Billion Loss?" and elaborated that "this is where we find ourselves now - the net notionals remain huge (and implicitly on JPM's shoulders), his lack of selling has left the credit index maybe 20bps rich to where it might trade given its rough correlation with the S&P 500 and this would imply at least $3bn of losses already in addition at fair-value." We were again spot on: from the WSJ: "J.P. Morgan is expected to announce Friday that the trading blunders will cost the company just over $5 billion in the second quarter, in which the bank is expected to show a profit, according to people familiar with the situation." Math: it's fundamental (Ph.D. economists - take note).

 
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Latest Press: JPMorgan Loss As Large As $9 Billion





We have long said that the maximum potential loss of the JPM CIO trade based on the blow out in IG9 10 year (and associated trades complex), which has about a $200 million DV01, is far beyond not only the $2 billion that Jamie Dimon estimated on May 10, but above our own estimate which was $5 billion on that same day. Today, the NYT "according to people who have been briefed on the situation" which translated means just more media propaganda because all the news on the topic in the past month has been leaks by axed parties, says that 'Losses on JPMorgan Chase’s bungled trade could total as much as $9 billion, far exceeding earlier public estimates, according to people who have been briefed on the situation." Also according to the NYT, and roundly refuting what the other leak had told Bloomberg and other media outlets, "The bank’s exit from its money-losing trade is happening faster than many expected. JPMorgan previously said it hoped to clear its position by early next year; now it is already out of more than half of the trade and may be completely free this year." Obviously, this refutes media "reports" also based on "people familiar" or "conflicted sources" that JPM has unwound its trade, either by novating, or by transferring it over to helpful hedge funds. Bottom line: take everything with a grain of salt until Dimon himself gives an update in two weeks, as this could easily be an upper bound loss estimate starwman to set expectations very low, sending the stock soaring when the "final" announce loss comes in at ~$5 billion, courtesy of other well-known "masking" techniques such as loan loss reserve release and DVA benefits.

 
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Just What Is Mario Draghi Hiding? ECB Declines To Respond To Bloomberg FOIA Request On Greek-Goldman Swaps





Back in February 2010, in the aftermath of the discovery that none other than Goldman Sachs had facilitated for nearly a decade the masking of the true magnitude of non-Maastricht conforming Greek debt, Zero Hedge first identified the prospectus for a Goldman underwritten swap agreement securitization titled Titlos PLC. We titled the analysis "Is Titlos PLC The Downgrade Catalyst Trigger Which Will Destroy Greece?" because for all intents and purposes it was: at that time a rating agency downgrade of the country would lead to a chain of events which would make billions in assets ineligible for ECB collateral, forcing a massive margin call on the National Bank of Greece, which likely would have precipitated a Greek default there and then.  But that is irrelevant for the time being: what is relevant is Titlos itself, and what Bloomberg did after we posted the analysis. It appears that in following in the footsteps of Mark Pittman, Bloomberg sued the ECB under Freedom of Information rules requesting "access to two internal papers drafted for the central bank’s six-member Executive Board. They show how Greece used swaps to hide its borrowings, according to a March 3, 2010, note attached to the papers and obtained by Bloomberg News. The first document is entitled “The impact on government deficit and debt from off-market swaps: the Greek case.” The second reviews Titlos Plc, a securitization that allowed National Bank of Greece SA, the country’s biggest lender, to exchange swaps on Greek government debt for funding from the ECB, the Executive Board said in the cover note. The ECB's response: "The European Central Bank said it can’t release files showing how Greece may have used derivatives to hide its borrowings because disclosure could still inflame the crisis threatening the future of the single currency." Maybe. But what is far more likely is that the reason why the ECB, headed by none other than former Goldmanite Mario Draghi, is desperate to keep these documents secret is for another reason. A very simple reason:

Mario Draghi - 2002-2005:  Vice Chairman and Managing Director at Goldman Sachs International

 
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Ahead Of Tomorrow's Dimon Hearing, Presenting JP Morgan's 93.5% Historical Winning Trade Perfection





We are just about 16 hours away from Jamie Dimon's sworn testimony before the Senate Banking Committee, which even has the theatrical name: "A Breakdown in Risk Management: What Went Wrong at JPMorgan Chase?" Will anyone learn anything? Of course not: Jamie Dimon has been well-schooled in not disclosing critical trading information, and will certainly use the "proprietary position" and "more shareholder losses" excuse for any directed question asking how big the JPM CIO loss has become. Because while the hearing could have been productive, if indeed its purpose was to seek to prevent future massive losses of scale such as the suffered by the JPM prop trading unit and its hundreds of billions in CDS notional position, the last thing anyone will care about tomorrow is market efficiency and actual regulation. First and foremost: grandstanding and posturing, in the case of the politicians, and not disclosing anything, without saying too many "I don't recall"s in the case of Dimon. Which is why we have little hope to get anything out of tomorrow's formulaic 2 hours of largely meaningless droning. That said, considering we have already covered the topic of the JPM loss from a mechanistic standpoint more than any other media outlet, there is one more chart we would like to share with readers.

 
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Ahead Of Jamie Dimon's Senate Testimony, Who Knew What, When: The Full Infographic





One day ahead of Jamie Dimon's blockbuster appearance before the Senate Banking Committee, Bloomberg has released the definitive timeline infographic of who knew what, when, together with damning evidence that, contrary to what has been represented by JPM execs, the firm knew about the massive risk, which an in house risk manager described as "trying to land a Boeing 747 without flying lessons", as far back as 2010. Not only that but the firm was actively engaged in fudging its VaR for years in an attempt to hide the monster in the closet which we dubbed, long before the details were exposed, the "world's largest prop trading desk". Well, now the monster is out, and nobody wants to come within one bid/ask spread of it. And tomorrow, Jamie will have a fun time explaining just how he let all of this happen for years while potentially engaging in material 10(b)-5 fraud in his public filings and statements.

 
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Live Senate Hearing On JPMorgan Prop Trading Loss





Sadly the man who thought (with good reason) he was more important than the Chairsatan (until the whole CIO fiasco blew up in his face of course), Jamie Dimon, will not be there (and will thus not be available to provide an update on the CIO's losses to date, which are likely orders of magnitude greater than the $2 billion benchmark previously disclosed, but that does not mean today's Senate hearing on lack of regulatory oversight and massive bank prop losses will be any less interesting. From C-Span: The Senate Banking Committee will hold an oversight hearing on efforts to overhaul the regulation of derivatives. Lawmakers will focus on the steps the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) are taking to implement provisions of the Dodd-Frank Wall Street Reform Act, and their efforts to reduce systemic risk and improve market oversight. The session also will spotlight J.P. Morgan Chase's $2 billion trading loss, which is under investigated by the FBI and the SEC." We, for one, can't wait to find out what the FBI's trained CDS forensic experts discover on this one...

 
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