How JPMorgan's $5 Million Loss Rose 80-Fold In Minutes After "A Confrontation Between Traders"
Actually that title was misleading: there will be no disclosure of "how", because we don't know. What we do know is that thanks to the magic of JPM's definition of "Mark-To-Market" accounting, a $5 million prop trading loss (and thus forbidden by the Volcker Rule) funded by depositor cash as it took place in the infamous CIO unit whose job was to manage "excess deposits" in a prudent manner, became a $400 million prop trading loss in the span of 88 minutes. But not during trading - the market was long closed. The adjustment was purely on paper.
April 10 was the first trading day in London after the “London Whale” articles were published. When the U.S. markets opened (i.e., towards the middle of the London trading day), one of the traders informed another that he was estimating a loss of approximately $700 million for the day. The latter reported this information to a more senior team member, who became angry and accused the third trader of undermining his credibility at JPMorgan. At 7:02 p.m. GMT on April 10, the trader with responsibility for the P&L Predict circulated a P&L Predict indicating a $5 million loss for the day; according to one of the traders, the trader who circulated this P&L Predict did so at the direction of another trader. After a confrontation between the other two traders, the same trader sent an updated P&L Predict at 8:30 p.m. GMT the same day, this time showing an estimated loss of approximately $400 million. He explained to one of the other traders that the market had improved and that the $400 million figure was an accurate reflection of mark-to-market losses for the day.
And that, ladies and gentlemen, is how "mark-to-market" is implemented in the current commercial bank prop trading units - through a "confrontation between traders."
We learn all this in the Task Force report. What we don't learn is why there was a confrontation, what was the basis for the mismarking, and most importantly, how it is possible that in JPM's wacky Schrodinger world, a Marked to Market loss can be $5 Million and $400 Million at the same time, depending on who a "confrontation" takes place between. Perhaps in JPM, Mark to Muscle is a more appropriate estimation of what is going on.
Why should readers care? Because this 80-fold delta in potential losses is funded, and thus impacts, something dear to all those who have savings at JPM. Their money. Money, which should not be used to speculate in fashion that means an a full wipe out of capital is purely in the eye of the beholder.
What it also means for all other "mark to market" estimates of JPM, and all other banks' profitability, we leave to readers to infer.
Finally, some much more deserved criticism of the JPM's Task Force "report" comes from Bloomberg's Jon Weil:
[H]ow did JPMorgan’s chief investment office, which manages deposits that the bank hasn’t lent, go from being a conservatively run risk manager to a profit center speculating on higher-yielding assets such as credit derivatives? The company’s report, conveniently, said this pivotal question was outside the inquiry’s scope. It’s worth noting that it was Dimon who pushed for the transformation several years ago, as Bloomberg News reported last spring.
“Although the task force has reviewed certain general background information on the origin of the synthetic credit portfolio and its development over time, the task force’s focus was on the events at the end of 2011 and the first several months of 2012 when the losses occurred,” the report said.
The head of the task force that produced the report, Michael Cavanagh, is the co-CEO of JPMorgan’s corporate and investment bank. So it isn’t as if there was a pretense that this was some sort of independent review. The company didn’t disclose the task force’s other members.
The report dodged important disclosure issues. The facts in the report suggest there were serious shortcomings before 2012 in the internal controls over JPMorgan’s valuation processes. Some employees manipulated the numbers to make the trading losses look smaller. And when JPMorgan restated its first- quarter 2012 results last summer, the company acknowledged it had a material weakness in its controls as of March 31. Yet the bank hasn’t amended past disclosures to show control weaknesses in any earlier periods. Why not? This week’s report didn’t address the question.
Another example: During an April 13 call with analysts, about a month before JPMorgan began acknowledging the magnitude of its losses, Douglas Braunstein, JPMorgan’s since-demoted chief financial officer, said “those positions are fully transparent to the regulators” and that the bank’s regulators “get the information on those positions on a regular and recurring basis as part of our normalized reporting.” The statement wasn’t credible then. There’s no reason to believe he had any basis for the remark. Yet the task force’s report didn’t touch it.
The report also included this bizarre disclaimer: “This report sets out the facts that the task force believes are most relevant to understanding the causes of the losses. It reflects the task force’s view of the facts. Others (including regulators conducting their own investigations) may have a different view of the facts, or may focus on facts not described in this report, and may also draw different conclusions regarding the facts and issues.” In other words, we haven’t been told the whole story.
And this is the opacity that one gets when a firm sets off to expose what should otherwise be perfectly public information in the first place. One does start to wonder: if America's banks go to such great lengths to mask how ugly the behind the scenes truth really is, is the true undercapitalization of the US banking sector in the trillions... Or tens of trillions?