Is JPM Staring At Another $3 Billion Loss?

Tyler Durden's picture

"[The trading loss] plays right into the hands of a whole bunch of pundits...."


                                                         - Jamie Dimon

There are a lot of moving parts in the Dismal tale of Dimon's demise. The starting point is that Bruno Iksil in the JPMorgan CIO Office, under the premise of hedging the bank's credit portfolio's tail risk had placed various tranche trades (levered credit positions with various risk profiles) in the only liquid tranche market that still exists - CDX Series 9 (an 'orrible portfolio of credits with an initial maturity at the end of 2012). These positions were low cost  (steepeners or equity-mezz) but needed a certain amount of day to day care and maintenance (adjusting hedges and so on). As the market rallied, the positions required increasing amounts of protection be sold to maintain hedges (akin to buying into a rally more and more as it rises). His large size in the market left a mark however that hedge funds tried to fix - that was his index trading was making the index extremely rich (expensive) relative to intrinsics (fair-value).

This is the 10Y IG9 credit index (dark blue) and its fair-value (light blue) and the difference or skew (orange). What is clear is that the index remained massively rich to its fair-value through this period (red oval) and it was not until the last two months or so that the skew (red arrow) began to compress as perhaps Iksil got the nod and more and more people realized the arb...(or understood from where the technical pressure was coming in the index rallying)...

Hedge funds began to try to arb this position and got frustrated at the lack of convergence -  and this is how we initially got to hear about Bruno Iksil - the London Whale - since those funds suggested someone was 'cornering' the index market in credit.

Critically - this is akin to looking at the 500 names in the S&P 500 - weighting them and seeing the S&P 500 index should trade at 1200 but it is trading at 1400 so you sell the index 'knowing' that the index is mispriced - (this never occurs in stocks since they are instantly and everywhere arbed between the index and its components - but can occur in credit because of illiquidity or in this case flow - what we call 'technicals').

This was very evident when one looks at the net notional being soaked up by the Whale and this 'hedge' position had clearly grown extremely large as it became a momentum trade not a hedge (at which time we suspect Iksil started to lose control). In early April, as news of this broke across the market, the credit and equity markets were beginning to quiver again at European contagion and US macro data and as a proxy for the volatility JPM must have been feeling we can see very significant (2-3 sigma) swings in the credit index they held. This would more than likely have triggered a risk manager to come along and look over the trader's shoulder - suggesting humbly that he exit/hedge/don't panic.

This is IG9 10Y spreads (upper pane) and their rate of change (lower pane) - (h/t @swaptions for idea) and as is clear the 3-sigma multiple day move likely scared a few risk managers (and Iksil) into fessing up...

Evidence from the HY market suggests that the trader used more liquid on-the-run indices to hedge as the spread of the HY18 credit index blew notably wider relative to intrinsics and net notionals dropped modestly. The market calmed down a little and it appeared from net notionals and the index skews that he tried again last week to unwind some more of the huge position that had clearly tripped various risk limits and VaR controls. This is where we find ourselves now - the net notionals remain huge (and implicitly on JPM's shooulders), 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.

As is evident, IG9 credit index and the S&P 500 have moved in a very correlated manner - and IG9 net notionals (the amount outstanding in IG9 CDS) has risen alongside these moves as JPM built a bigger and bigger longer and longer credit position. The red vertical arrow shows the current dislocation if one assumes the cessation of Iksil's unwind efforts stalled IG9's selloff - which is the $3bn loss that remains to be seen and the black dotted line is an indication of the kind of notional unwind that would occur - which with a market moving as it is - would be highly disjointing.

Of course, the situation is far worse because 1) any efforts to unwind such a huge position will lead to the market yawning wide and swallowing him in illiquid bid-ask spreads; and 2) the rest of the world knows their position - so why would the hedge funds not push their position. Perhaps this explains why JPMorgan's CDS has remained relatively wide while its exuberant stock price shot up on stress-test ebullience - only to plummet back to CDS reality this evening. Critically, JPM will need to use whatever method they can to hedge this now over-hedged and over-long position - which likely means credit instruments such as JNK, HYG, HY18, and IG18 will all get their share of strange attraction as the trader mispriced not just the basis risk (the volatility between the hedge and its underlying) but the attraction of running with a trend when you have a bottomless pit of money to cover it - until now.

It is already evident in the on-the-run liquid indices - HY18 for instance has exploded wider twice now - in line with the net notional reduction and hedging moves from JPM's IG9 position...

This chart somewhat relates to the IG9 skew chart above in that it represents how far above 'fair' the spread of the index trades relative to the underlying names - the spikes show that there was huge technical demand for the index protection relative to the underlying risk of the portfolio.

and perhaps there was already concern in the market with regard JPM's counterparty risk or exposure from hedgies' trades as CDS has been far less exuberant than stocks...


Of course noone knows for sure what exact positions Iksil had on - though it is clear what hedging he needed to do to manage his hedges. As Peter Tchir ( @TFMkts ) noted this evening - perhaps this mark-to-model irregularity is what the Fed discovered and gathered all the banks last week to ascertain just who has what exposure to whom? As we tweeted earlier, perhaps Iksil just got carried away - and please understand that while CDS do indeed provide leverage, so do many other financial instruments - it is not the instrument that caused this - it is the trader as "you don't hedge risk when you bet on momentum continuing you idiot!"

Addendum - VaR is almost entirely useless as a risk statistic in regard to the kind of highly non-linear positions that we are talking about here and so the doubling of JPM's VaR suggests the tail-risk (or conditional VaR) is considerably larger.

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Central Bankster's picture

We already have seen people buying to cover their Nat Gas contracts to raise equity against other trades, thats for sure.

chump666's picture

I wish the Hulk would squash Bernanke's head like a pea. 

He encouraged risk taking/spec trades as the global economy falls apart, thus Wall Street buying up and cornering corp CDS's and every other derivative you can think of...warning shot was the liquidity pull on the TVIX a little while back. 

This is just the beginning.

adoyi's picture

All hail TYLER, the all seeing eye on the zero hedge pyramid. You have saved us ur believers from being turned to sheeple and royally fucked by these banksters.

You deserve a Nobel Prize in a special category- Standing up for the little guys I.e. Those who cared to listen.

ghenny's picture

Go Jamie.  This is great news.  Now we may finally get some really serious financial regulation and even perhaps Glass Steagal back.  This might even embolden Holder to start prosecuting all the nice boys that brought us the great 2008 meltdown. Who knows.  We live in very interesting times. 


UGrev's picture

I'd poke it with a stick, but all I have is this gun...

ghenny's picture

Great stuff. Go Jamie.  KIng of the crony capitalists.  Jamie may get us Glass Steagle back after all and Holder may start doing some serious prosecuting for a change.  This gives him great air cover.  Thanks pal.  Who would have thought you'd be helping us 99% to finally put you in and your illegal online betting buds in the pockey .

youngman's picture

This is much bigger than Jamie ...he lost all of his Credibility last well as JPM....the so called leader 1 bank..the best.....but also the US Banking system lost in the eyes of the they see we still are playing at the casino...we did not learn or change anything after the 2008 crash...the end of the world they told we will see monies and business leaving the USA...going closer to home...more security...looking for honesty...The USA just lost bigtime because of the Greed of the bankers ...just to eek out another .25% or something.....lost billions today in stock values...and probably trillions in the future in business deals....

Waffen's picture

Is this really a big deal? We are talking about JP Morgan here.

WatchingIgnorance's picture

Where's MDB and Max Fisher to call us dumb and retards and tell us about the green shoots everywhere?

Hehehe . . . oh yeah, they gave their money to Dimon.


(or in their case . . . worthless)

Tijuana Donkey Show's picture

MDB is Jamie Dimon, and Max is the Bernak. Didn't you get the memo?

sof_hannibal's picture

and Robert Brusca, PhD is a Fed Reserve Twitter Bot

williambanzai7's picture

This reminds me of the Chinese gambler scenes in Luck.

Gloomygus's picture

This article is a technical masterpiece, and I applaud you. However, I am not a hedge fund trader. Lately I have been immersed in the science of deceit. At present the Fed has its back to the wall, as all the Feds do, and it is facing huge political blowback for bailing out its friends in '08 and really everyday thereafter. And so the Fed will refuse to defray its closest confidants losses for this very public and lamentable and confessed mistake, only to offset these losses with QE3 as the economy weakens for all sorts of unanticipated reasons in a few short weeks. This obvious error was no error at all - it provides political cover for a far more harmful (to ordinary people anyway) policy to appear on the horizon shortly. For such smart people, please don't ignore the obvious.

Gloomygus's picture

This "mistake" was no mistake at all. It is the first step in a sequential set-up. You're being set-up (again).

streetcrawler's picture

It's going to be like the helicopter scene from Margin Call.

joe6px's picture

What is the connection between BofA and MS.Chase?  Other than the Fed..  I think student loans and Eur debt.  Print off Eur and buy back college loans to win 2012 election, no other hope but to buy off the young voters.  No jobs so eat the student loans to win.

James_Cole's picture

Looks like it might be a bad week for Iksil. 

Cursive's picture


LOL.  His punishment will be all-night clubbing with "The London Whale Trader" Alex Hope.

Corn1945's picture

What the hell do they care?

It's like gambling in Las Vegas with someone elses money. 

The trend is your friend's picture

time for jamie dimon to get in front of congress and appese the crowd

AlaricBalth's picture

"I'm sorry Congressman, I do not recall that sequence of events."

slewie-the-pi-rat's picture

time for jamie dimon to get in front of congress


more like time for the organ grinder to get in front his stable of monkeys

Nobody For President's picture

Alaric - that is not a lie:

"I'm sorry Congressman, I do not recall that sequence of events." 


That is plagiarism.

urbanelf's picture

Where are the god-damned Silver Bears?

Chaffinch's picture

I need those Bears to tell me what the hell IG9 and HY and stuff means!
But I get the main part of the story which is that Jamie Dimon has got something to worry about - yes?
; )

xela2200's picture

HY --> High Yield

IG9 --> Credit index


He reeks.

Chaffinch's picture

Thank you Xela. CDS I think I understand already (some kind of insurance on someone else's debt, but the insurance never pays up because the insurance company never admit that a default has occurred - right?). Is '9' as in IG9 a reference to a time period - like September? Or 9 months from now?

urbanelf's picture

Honestly, I'm feeling a bit Silver-Bear-dissillusionment.  Those cartoon characters claimed to have inside info, but didn't have the clarvoyance to see this coming.  Cartoon bears used to be the most reliable news source.  Now what?

Chaffinch's picture

I guess they have to hibernate over the winter.

Piranhanoia's picture

If they haven't done an update,  carry on as last instructed.

sumo's picture

My guess: the cartoon bears had a contact close to Bart Chilton.

What the bears didn't get and refused to believe is that Chilton is controlled opposition. He is there simply to deflect public anger away from the CFTC. He is not there to do anything useful about markets. The bears got played badly.

On a related note: at long last Ted Butler has recognized that Gensler - the smiling ex-Goldman sociopath, key member of the PPT, ally of Corzine - may not quite deserve the effusive praise that Butler gushingly bestowed in the past.

It's like Charlie Brown finally decided not to kick the football. Better late than never, Ted (you chump).

vamoose1's picture

 to  sumo.


    chilton  is  classic  repressive tolerance    right  out  of  marcuse   one  dimensional  man,  and  lets  not  get  me  started  on  the  foul  ferret  fensler.

mendolover's picture

Wow I wish I could understand all this shit!  This must be how these bastards get away with this shit.  Not enough people that matter can understand any of this.

cherry picker's picture

I don't understand it either, and if it is not biology, physics or chemistry and this difficult to make light of, it is obvious many of the players don't understand it either.

For this alone, it shouldn't be.

Hubbs's picture

Me too. The more crooked the corkscrew gets, the deeper you can twist it into the cork.

Chaffinch's picture

Thank you Mendolover, Cherry Picker & Hubbs (sounds like the name of a law firm!) - I am glad I am not the only one here who is struggling!

SamuelMaverick's picture

I have been here two short years and I am still learning the lingo.  The first six months were a brutal learning curve with me having to continually look up the definitions of abbreviations every day.