James Dimon. (AP Photo/Mark Lennihan)
J.P. Morgan’s CEO Jamie Dimon once sarcastically complained that all his traders would need to talk to a psychiatrist in order to comply with regulations. Now, in the absence of strict regulations, every trader on the street is psychoanalyzing Dimon’s every word in order to try to make money off J.P. Morgan’s very large mistake.
Back in February, Dimon famously told Fox Business that because of the Volcker Rule for “every trader, we are going to have to have a lawyer, a compliance officer, a doctor to see what their testosterone levels are, and a shrink, ‘what is your intent?’ ” But now it is J.P. Morgan’s intent in a $100 billion bet that has sent the financial media abuzz with questions. The $2 billion loss that J.P. Morgan has incurred related to this position has only further fueled the speculations about what, exactly, J.P. Morgan was trying to do with this trade.
Bloomberg reported in April that a J.P. Morgan trader dubbed by the media as “the London Whale” had a $100 billion trade that was so large it was distorting the market. Specifically, this trader is said to have sold $100 billion worth of credit default swaps on a group of high-grade North American companies (the NA IG CDX Index). What that means is that J.P. Morgan made a $100 billion bet that investment-grade corporate debt would remain strong or get stronger and that the companies would be free from defaults.
This position is huge for the market in which it trades. Lisa Pollack at FT Alphaville pointed out that the total outstanding notional across the entire market for this index for March was nearly $150 billion. This is interesting because back in February, Dimon said that at J.P. Morgan, “we don’t make huge bets.”
It remains unclear whether or not Jamie Dimon was lying back in February; whether this $100 billion trade is a bet, or if it would be considered a hedge. Hedges are offsetting trades that are placed to reduce your overall risk. Quite clearly, J.P. Morgan has failed to reduce its risk and admitted as much this past Thursday when Dimon held an after-hours conference call. He explained that this trade was part of “a strategy to hedge the firm’s overall credit exposure,” but that instead, it was “riskier, more volatile and less effective.” Hence, the $2 billion loss, with potential for more to come.
In the quest to figure out what this trade is all about, many hypotheses have been raised, including one idea that this is a curve trade and another that this was a way to reduce the cost of a different hedge. The problem here is that neither of these hypotheses are describing hedges—they are describing bets. Or in Wall Street parlance: proprietary trades.