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.
There is much more in the must read Bloomberg piece by Erik Schatzker et al, but here are some highlights.
First, we learn that contrary to popular folklore, not only Goldman was betting against US housing (as idiotic as that populist statement is). So was JPM, which somehow nobody mentioned over the past 3 years.
The group started making more exotic trades, betting against an index of subprime mortgage bonds in 2007 that resulted in a roughly $1 billion profit that year, according to one former CIO executive and another person briefed on the trade.
JPM was never about ordinary banking operations. It was all about prop. Any wonder why Jamie Dimon has been so vehemently against the Volcker Rule?
Macris’s team in London, running a portfolio of as much as $200 billion in trades, had a profit of $5 billion in 2010 alone, more than a quarter of JPMorgan’s net income that year, one former executive said
But what is most relevant for the current market is that it seems that JPM is completely unable to unwind its massive prop bet.
Peter Weiland, who graduated from Princeton University with a degree in chemistry and had been overseeing risk for JPMorgan’s proprietary-trading group, was transferred in 2008 into the same role at the CIO. He immediately saw faults in the division’s risk-management system, said two former executives who worked with him.
Weiland became concerned that Bruno Iksil, the trader in Macris’s office now known as the London Whale, had amassed a complex and illiquid position, according to two former executives. Weiland, who declined to comment, warned Macris and Drew about the trades on numerous occasions beginning in 2010, the people said. It was a topic of frequent discussions in the CIO’s global weekly meetings, they said.
Weiland compared efforts to reduce Iksil’s outsized position to the difficulty of trying to safely land a Boeing 747 without flying lessons, one executive said. The position was so large and illiquid, Weiland said he couldn’t get the plane below 35,000 feet, the executive said.
By 2010 Iksil’s value-at-risk, or VaR -- a formula used by banks to assess how much traders might lose in a day -- already was $30 million to $40 million, a person with knowledge of the matter said. At times the figure surpassed $60 million, the person said, about as high as the level for the firm’s entire investment bank, which employs 26,000 people.
The natural response: fudge the VaR calculation of course. After all JPM is exception: the rules that apply to everyone else, do not apply to it.
Early this year, as the size and volatility of its trades were growing, the bank changed the computer-based mathematical formulas for calculating the chief investment office’s VaR. The new model had the effect of understating the risk of losses from Iksil’s trades: It showed an average daily VaR within the CIO of $67 million, about where it stood in the fourth quarter of 2011.
And this was in 2010, long before Iskil decided to delta hedge by buying up tens of billions of IG9 10 year notional. Which is why we fear that our current estimate of JPM's CIO DV01 being at about ~$200 million may well be conservative.
And the biggest problem: an offerless market for the firm's tens of billions in long IG9 10 year positions!
Drew and Macris agreed to reduce Iksil’s positions and tried to do so beginning in early 2011, according to a current and two former executives. The plan was to work down the book gradually as they found opportunities to sell the assets, these people said. The problem: No one was buying. The position was too large and illiquid and couldn’t be reduced without a loss. Drew and Macris decided the bank could hold the trades to maturity and that the risk of being forced to liquidate them under duress was low, according to the former executives.
Unable to unwind Iksil’s bets, the bank tried to hedge them this year with other trades, exacerbating the losses, Dimon said on May 10. Iksil had amassed positions in securities linked to the financial health of corporations that were so large he was driving price moves in the $10 trillion market.
One thing they did not anticipate was, well, reality. And the fact that in the absence of the Fed backstopping the world, holding a position to maturity would inevitably lead to massive losses on the book of a firm whose sole path to profitability for the past 3 years has been courtesy of its position as the only real tri-party repo bank, and the right-hand of the New York Fed (where Jamie Dimon is still a Class A Director). Also explains why the estimate of a $5 billion loss, which Zero Hedge calculated first, on the day of the JPM announcement, will also likely be very, very conservative, when all is said and done, and why the JPM's decision to stop its stock buyback implies a breach of the Fed's stress test loss parameters, meaning the total loss could be orders of magnitude higher as also calculated here previously.