The Volcker Rule & The London Whale: "Dear Big Media, Get A Clue"

Authored by Chris Whalen via The Institutional Risk Analyst,

"It is not down in any map; true places never are."


"Moby Dick"

Herman Melville

News reports that prosecutors have dropped their case against Bruno Iksil, the former JPMorgan (NYSE:JPM) trader many know as the “London Whale,” comes as no surprise to readers of The IRA Iksil, who resurfaced earlier this year, has been living in relative seclusion in France for the past few years.

In previous comments posted on Zero Hedge, we dispensed with the notion that the investment activities of Iksil and the office of the JPM Chief Investment Officer were either illegal or concealed from the bank’s senior management.  The fact is that Iksil and his colleagues at JPM were doing their jobs, namely generating investment gains for the bank.

The outsized bets made by the “whale” in credit derivatives contracts resulted in a loss in 2012, but the operation generated significant profits for JPM in earlier years.  As veteran risk manager Nom de Plumber told us in Zero Hedge in 2012:

“This JPM loss, whether $2BLN or even $5BLN, is modest in both absolute and relative terms, versus its overall profitability and capital base, and especially against the far greater losses at other institutions. In practical current terms, the hit resembles a rounding error, not a stomach punch.  As either taxpayers or long-term JPM investors, we should be more grateful than sorry about the JPM CIO Ina Drew.   If only other institutions could also do so ‘poorly’………”

When JPM and other large banks began to implement the Volcker Rule after the passage of the 2010 Dodd-Frank law, the activities of Iksil and his colleagues in New York began to come to light. Principal trading, which is now outlawed by the Volcker Rule, creates enormous opportunities – and conflicts -- for banks that act both as traders and lenders.  We wrote in ZH in 2012:

“[D]ear friends in the Big Media, it is time to get a collective clue.  The real problem with CDS trading by large banks such as JPM is not the speculative positions taken by traders like Bruno Iksil, but instead the vast conflict of interest between the lending side of the house and the trading side, whether the trader is on the arb desk or, in the case of Iksil, working for the CIO trading for the bank’s treasury.”

When caught in the act, the bank naturally cast Iksil’s activities as being somehow illicit and against company policy.  But in fact his trading activities had been understood, blessed and even directed by the JPM’s senior management going back years. Far from being a hedge for other exposures of the bank, in fact the strategy of the CIO’s office was to generate returns as the bank’s internal hedge fund.

When as early as 2010 discussions reportedly occurred about “hedging” Iksil’s illiquid credit derivative positions, presumably those involved understood that this was a risk position taken as part of a deliberate investment strategy. That Iksil apparently believed that he could not be bullied by other counterparties because of the fact of trading for JPM speaks to how he viewed his activities, which were entirely visible to other market participants.

The JPM CIO’s office under Ina Drew ran an active trading strategy, making markets around positions on a continuous basis to provide live valuations and generate short-term returns.  The fact that big banks no longer trade their investment books illustrates the diminution of liquidity that has occurred since the adoption of the Volcker Rule. But for the banks, the legacy of the London Whale and the larger implementation of Dodd-Frank has left a deep mark on risk managers and those concerned with maintaining internal systems and controls at large banks.

But now Iksil has accused JPM's Chief Executive James Dimon of laying the ground for what was eventually a $6.2 billion loss, Reuters reports.  In an account on his website, Iksil also blames senior executives at the bank for the investment strategies that led to those losses.  Iksil’s account now sounds an awful lot like what we heard from his former colleagues in New York some six years ago.

At the time, JPM’s counsel had already mandated the elimination of the managers and traders in the CIO’s area as part of implementing the Volcker Rule, leading to a number of redundancies in New York.  We know about the Whale because of the implementation of the Volcker Rule.  But the key event that broke the scandal open was the public statement by Dimon, this in response to persistent press queries from The Wall Street Journal and Bloomberg News, that the rumors of losses in the CIO’s office were “a tempest in a teapot.”

But for the public statement by Dimon, which required additional clarification and disclosure, the activities of the CIO that might otherwise have been dealt with in the fine print of JPM’s earnings release.  Instead, JPM was forced to not only enhance disclosure of the CIO’s trading results, but then went through a firestorm of congressional hearings, regulatory questions and litigation that continues to this day.  We recall sitting in the analyst presentation at JPM’s HQ dealing with the London Whale as Ken Langone glared at the assembled audience of Sell Side analysts.

In his congressional testimony, Dimon attributes the bank’s loss to a modeling error, but in fact the exposure was simply ignored.  Notice that at no point has the financial media or regulators questioned the company line about what actually happened and when. Iksil’s statements seem to take us back down that road and, specifically, to suggest that senior management at JPM was actively aware of the strategies taken by the CIOs office years before the big losses occurred.  Our old pal Nom de Plumber commented over the weekend:

“In the end, the London Whale disaster reflected the mis-marking of generic Index CDS trades, which then-CFO Doug Braunstein ignored.   The problem was not complex risk modeling or market risk measurement.   The quants tried to re-jigger VaR measurement of the trades, to avoid breaching risk limits-----for CIO trades which Jamie specifically demanded of Ina Drew......regardless of preceding protests from risk managers like John Hogan and Robert Rupp.”

Nom de Plumber tells The IRA that Ina Drew was essentially running a hedge fund directed by Dimon and other senior managers, a fund that was largely kept outside of the bank’s risk management and reporting procedures. Consider the bizarre situation in 2011-2012 when counterparties of Iksil facing the JPM commercial bank were unable to make margin calls, but the JPM investment bank was making margin calls on these same counterparties for positions in the very same indexed credit derivatives.

Bruno Iksil has waited for the proverbial concrete to harden over the past few years before coming forward with his latest accusations. This makes it difficult or impossible for Dimon and his lieutenants to change their story now.  It will be very interesting indeed to see if anyone from the financial media or even the regulatory community picks up the new trail illuminated by Iksil’s statements.

The episode involving the London Whale illustrates how difficult it is to learn the truth about the inner working of large banks.  Big banks profit by exploiting information and conflicts found between the world of credit and the world of securities.  Indeed, the CIO's office generated big returns for JPM over the decade or so that Iksil was with the bank. 

But the London Whale episode also shows in graphic terms why the Volcker Rule prohibitions against banks trading for their own account need to be preserved and strengthened.  There is a fundamental conflict between a bank acting as a lender and trading credit derivatives. 

More, if the CEO of a bank – any bank – can short circuit the internal controls of his institution in order to enhance returns with a bet at the credit derivative roulette table, then by definition that bank cannot be safe and sound.


Paul Kersey gigadeath Wed, 08/09/2017 - 06:20 Permalink

"God's chosen do not lose."

Tell that to Madoff's victims. By the way, Dimon and Buffett, who are not "God's
chosen", but whose banks have been fined billions of dollars, have never personally lost a dime.

As usual, Chris Whalen is the best. However, I find it hard to believe that he has faith in regulators actually doing anything to Dimon. Most bank regulators are owned by the TBTF banks. When have we ever seen a TBTF CEO punished in any way?

All the banking rules in the world mean nothing if they are not enforced. The Glass-Steagall Act did nothing to stop billionaire Citigroup CEO Sandy Weil when he violated that law by acquiring Traveler's Insurance. Treasury Secretary Robert Rubin and Fed Chairman Alan Greenspan fixed everything for him.

In reply to by gigadeath

Doom Porn Star Wed, 08/09/2017 - 05:24 Permalink

"But the London Whale episode also shows in graphic terms why the Volcker Rule prohibitions against banks trading for their own account need to be preserved and strengthened.  There is a fundamental conflict between a bank acting as a lender and trading credit derivatives. More, if the CEO of a bank – any bank – can short circuit the internal controls of his institution in order to enhance returns with a bet at the credit derivative roulette table, then by definition that bank cannot be safe and sound. " Restore GLASS-STEAGAL.

East Indian Wed, 08/09/2017 - 05:37 Permalink

A junior bankster bets bank's "money" in a casino without the big bankster's knowledge and permission? He wont go to jail, he would be found dead along a canal, under a bridge. This guy is alive and in jail, so his opreations had the blessings of the top guns.  Edit: Sorry, he is a bankster, he is too big to jail. 

Last of the Mi… Wed, 08/09/2017 - 06:09 Permalink

And you thought cancer killed indiscriminately. No, my friend, bankers do, by sucking the life out of an economy that will not be permitted to run free and make profits for the unwashed masses. It's important for the velocity of money, especially the QE type to remain near zero.

geekz_rule Wed, 08/09/2017 - 06:30 Permalink

#HostLife  - because we have been turned into "hosts" (food source) (rent payers) for the 1% inbred parasites (leeches) (rent collectors)#PlantationLife - the 1% have re-established the "West Virginia Coal Mine" (circa 1900) experience for us all with debt: Work in the company "mines" (cube farms, whatever), live in the company housing (mortgage), shop in the company store (credit card debt). Cradle to grave slavery to the "Nanny" Corporation.P < P + I  

Iskiab Wed, 08/09/2017 - 06:41 Permalink

I'm not surprised by anything written. The issue with JPM is they failed, and instead of looking at the underlying issues of why the American banking industry is unstable they're looking for a patsy.

One thing when I talk to people about the market that isn't common knowledge outside executives, is how it creates short term pressure on executives. By that I mean they're forced to take long term poor decisions for short term gains.

Let's take the example of JPM. There was already a lot of consolidation in the industry, and it was common knowledge that the real estate securities were shit (lower risk by diversification of different kinds of shit was a joke). What do you do? If you pull back, your earnings will drop and: your investors will be angry, unless you've stacked your board you might be out, your shelf life is short so why care about the long run really, you become a good target for a takeover by those who do make money now from shovelling shit.

The choice is easy, make the most money now and since you don't have a crystal ball don't worry about the future. What's never talked about is the investors got what they wanted, and that was JPMs downfall. The game is stock price is based on earnings now, and your mandate is to increase the stock price, so you give people what they want even if it means in the long term the company won't exist.

ThrowAwayYourTV Wed, 08/09/2017 - 09:17 Permalink

I like Dimon, he's a relaxed thinker, like a chess player. I think he should run. I'd vote for him.I've noticed in my life that people whos eyes are a little closer together than most are very intelligent people, for some reason. Don't know why. Anybody else notice that?

Give Me Some Truth Wed, 08/09/2017 - 07:58 Permalink

Re: Note how at no time has the press questioned the JP Morgan company line that ...Right. The press no longer questions any "company line," especially when the "company line" is that of our government. The MSM view seems to be that if they say it it must be iron-clad gospel truth.One quick example: Unemployment is 4.3 percent. JP Morgan apparently has achieved government status and can't be bothered with any uncomfortable questions. Another point I make here all the time. It's not just the stories the press runs, it's the thousands of stories they COULD run but never do.One quick example on JPM. Ted Butler - the godfather of silver manipulation theories - has received much attention in the alterantive press and on precious metal sites with his allegation that JP Morgan has surreptitiously somehow achieved a massive hoarde of physical silver. Per his theory, the "bullion bank" rigs the price of silver much lower than it would be otherwise through shenananigans in the COMEX "paper markets." The bank then buys physical metal at greatly discounted prices. This theory has almost become accepted fact in the silver community. What's bizarre to me is that, as far as I know, no member of the press has ever asked Jamie Dimon a simple question. The question could be worded any number of ways ..."Does JPM  own a large amount of physical silver? "How many tons of silver does JP Morgan own? Where is it all stored? In what form  (bars, Silver Eagles, etc)?"Mr. Dimon, are you familiar with Ted Butler's  theories about JP Morgan holding a massive quantity of physical silver? Is he correct? Would you comment on  his theories? Is he wrong? Can you prove he is wrong?"IN corporate documents, does JP Morgan reveal all of the physical silver it owns? Do shareholders deserveto know this information?Simple questions that ought to be asked and answered, but never have. Is every reporter in the world a   wuss that is terrified of asking tough questions to powerful people? I thought  tough-minded cynics and skeptics were supposed to go into this profession. Anyway, the press not doing the job it is supposed to do should also be a story. Someone needs to investigate why the alleged investigators never actually investigate, especially the big and powerful.   

otschelnik Give Me Some Truth Wed, 08/09/2017 - 08:26 Permalink

I'm not in the fin world and have poor grasp of derivitive markets and how to abuse them.  From a perspective of john q. public, it seems to me that Jamie Dimon is the Deep State / MSM unofficial spokesperson for the TBTF banks.  Always impeccably quaffed, speaking in simple axioms, toasted on teevee.  Go to CNBC today and see the silver sage of JPM telling the public 'we should acknowledge our problems and fix them' and offering personal advice on 'how to achieve a fulfilling life.' Dimon looks like a life style coach or yoga instructor.  If the banking world is full of cuthroats you wonder how a guy like that ever made it to the top? 

In reply to by Give Me Some Truth

Give Me Some Truth Wed, 08/09/2017 - 08:21 Permalink

Ted Butler has repeatedly in print (where he reaches a decent-sized audience) called JP Morgan "crooks" with specific reasons why he attaches this label to the "bank." Butler's charges, as far as I know, have never been rebutted or challenged by anyone at JP Morgan. It seems to me he could be sued for any number of reasons. Heck, he's practically begging them to sue him.Then he would be able to face them in court and his lawyers could ask questions of people who are under oath and demand discovery of all kinds of documents.Anyway, it's interesting - some might say revealing - that JP Morgan has NOT brought suit against Butler, or even issued any kind of strongly-worded statement of rebuttal (providing evidence that his claims are bogus). The "bait" Butler has offered has not been taken.It's also revealing that no mainstream media organization has ever asked Dimon or spokespeople for the company about Butler's charges. As far as I can tell, it's just "understood" that you don't ask hard questions of JP Morgan.If some reporter for the WSJ or Bloomberg or CNBC happens to be reading this post, feel free to prove me wrong. I've offered a few sample questions you could ask in the post above. If Butler's theories about JP Morgan are "kooky" or "ridiculous" prove it. 

sandhillexit Wed, 08/09/2017 - 13:28 Permalink

restore Glass-Steagall.  "Pecora" is a name every high school senior should know.  nothing more dangerous for America than a boy from the Bronx with a chip on his shoulder. (Weill: The share price went from $50 to $2.  That is all anyone will remember about Sandy)  Wish Trump understood that they will never let him join the club, it's a Manhattan thing.   (remember when the Cardinal turned his back on you, DJT?  you gave a classy performance anyway)so he should just fix the problems.