London’s ‘Whale’ Loses $2 Billion for JPMorgan

Losses could grow to $3 billion, says CEO Dimon

JPMorgan Chase & Co. chairman and CEO Jamie Dimon (Photo: AP) JPMorgan Chase & Co. chairman and CEO Jamie Dimon (Photo: AP)

In a hastily arranged conference call on Thursday, CEO Jamie Dimon of JPMorgan Chase was forced to apologize to analysts for $2 billion in surprise losses incurred by the bank's chief investment office in London. Dimon said that the office suffered an “egregious” failure and that losses from volatile synthetic credit securities could mount by another $1 billion in this quarter or the third.

Bloomberg reported Friday that Dimon, who had lobbied at the head of a group of Wall Street CEOs on May 2 in a closed-door session with the Federal Reserve to limit U.S. financial reforms, said, “There were many errors, sloppiness and bad judgment.” He also said of the losses, “These were grievous mistakes, they were self-inflicted.”

The chief investment office in London, which according to an April report by Bloomberg was “transformed” into one that took higher risks, is run by Ina Drew from New York, but the switchover from risk protection into risk—and profit—pursuit was led by Achilles Machris and supervised by Dimon himself. The report mentioned that only a week earlier, Bruno Michel Iksil, a London-based trader in Macris’ group, came to public attention after moving markets with his massive trades.

Iksil has variously become known as “The London Whale” and “Voldemort,” after the powerful villain in the Harry Potter series, because his credit derivative positions have become so huge. That policy, while earlier defended by Dimon, who dismissed media criticism of it as “a complete tempest in a teapot,” backfired and will cost the bank—and perhaps additional banks—dearly.

The BBC reported that Dimon acknowledged the trades were "riskier, more volatile and less effective” than previously thought. He added, "These were egregious mistakes. They were self-inflicted and this is not how we want to run a business. It could get worse. This could go on for a little bit."

Shares of JPMorgan Chase fell 7% in after-hours trading, and dragged not only Goldman Sachs, Citigroup and Bank of America along with them but also European banks: Barclays fell 2.85%, Deutsche Bank was down 2%, and BNP Paribas dropped 2.6%.

Robert Peston, business editor at the BBC, pointed out in an opinion piece that, even though the loss was not large enough to consume all of the bank’s profits for 2012, the fact that Dimon was surprised by the losses—and their magnitude—could result in a powerful argument for tightened regulation of banks.

Peston said, “It is the surprise factor—the shock evinced by Mr. Dimon—that will reignite the debate about whether regulators need to take more decisive action to curb the complexity of investment banks, to better prevent this kind of accident.” He pointed out that just a few weeks ago the bank had “rejected the suggestion that there were serious dangers here”—thus giving the loss even more impact.

Saying that the loss would boost the case in the U.S. for those arguing against a weakening of the Volcker rule, he added, “In the U.K., it may mean revisiting whether the proposed ring fence between retail banking and investment banking is protection enough for essential banking services.”

Peston also pointed to the ongoing review by Moody’s of global banks, which are trying to convince the ratings agency that they do not deserve downgrades, perhaps of multiple notches, that would make it more expensive for them to borrow and also cut their profits. “JPMorgan's accident won't strengthen their case that they are less risky institutions than Moody's fears,” he concluded.

While originally the chief investment office was supposed to protect against risk, providing hedges that would insulate against such things as interest rate movement and currency fluctuations, Iksil’s trades under Machris were something else altogether—aimed at bringing in higher profits for the bank. Machris spearheaded the move into corporate and mortgage-debt investments, and Dimon had defended the move in April, saying, “Every bank has a major portfolio and in those portfolios you make investments that you think are wise.”

Filings revealed that the value of securities held by the chief investment office and treasury—the two are not broken out separately—since 2007 had more than quadrupled, going from $76.5 billion to more than $350 billion. The largest increase came in 2009, when filings showed the CIO to have made “significant purchases” of government-backed mortgage securities, asset-backed securities and corporate securities, as well as U.S. Treasury and government-agency securities.

In its 10-K report for 2009, filed in February 2010, the bank said, “These investments were generally associated with the chief investment office’s management of interest-rate risk and investment of cash resulting from the excess funding the firm continued to experience during 2009.”

In its April report, Bloomberg cited three former JPMorgan employees as saying that profit rather than risk management drove the purchases, and one, a former senior executive at the bank, also said that Dimon himself ordered some of the trades.

On Thursday Dimon continued to defend the unit’s new focus, saying, “I wouldn’t call it ‘more aggressive,’ I would call it ‘better.’ We added different types of people, talented people and stuff like that.” He added that until recently those people were both successful and careful.

Simon Johnson, a former chief economist at the International Monetary Fund (IMF) who now teaches at the Massachusetts Institute of Technology, said in the report, “It’s classic Wall Street hubris, which we’ve seen so many times before. What’s particularly ironic here is that Jamie presents himself, and is believed by others to be, the king of risk management.”

Dimon conceded Thursday that the losses and their timing play “right into the hands of a bunch of pundits out there” who are defending the Volcker Rule.

"These losses underline the need for a strong Volcker Rule to prevent risky proprietary trading," Americans for Financial Reform said in a statement. "Regulators need to get the rule done, and they need to get it right. The trades that led to these losses were described as ‘hedges’ designed simply for risk reduction and not proprietary risk-taking."

Craig Pirrong, a finance professor at the University of Houston, said in the report that “he’s [Dimon] got a lot of egg on his face right now. Any chance they had of getting a relative loosening of Volcker rule, anything of that nature, that’s out the window.”

An unidentified executive at the bank said that Dimon was not told of a shift in strategy at the chief investment office, nor did he know how massive the losses were until after the company’s earnings report on April 13. No one has yet been fired, although Dimon has said to analysts that he will take “corrective actions.”

Frank Partnoy, a former derivatives trader who is now a law and finance professor at the University of San Diego, said in the report, “It’s a major event that confirms a lot of investors’ worst fears about bank risk.”

He added that a major cause for concern is “that at a large, supposedly sophisticated institution, even something called a ‘hedge’ can contain all kinds of hidden risks that the senior people don’t understand.”

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