Sound familiar? It should. Credit default swaps based on housing mortgages created the tinder that was ignited by rising home defaults to create the conflagration of the 2008 financial crisis.
Trading in derivatives such as credit default swaps were designed to hedge against risk. But as we know, banks and other market players used these tools to create products that seemed to take the danger out of risky bets and reaped huge rewards – right up until the moment they didn’t. Banks and other businesses were stuck on the wrong side of the trade, trapped with a mountain of debt they couldn’t pay.
Speaking on a Thursday conference call – which the Financial Times’ Alphaville called “the most excruciating bank conference call we’ve ever heard” – Dimon said JPMorgan’s losses stemmed from trades designed to hedge against risk, but those trades went awry due to “errors,” “sloppiness” and “bad judgment.” It doesn’t help that, just a month ago, Dimon decried the build-up of credit default swaps at JPMorgan’s London office, first reported by the Wall Street Journal, as a “tempest in a teapot.”
The losses of the past six weeks were mitigated by successful hedges that played out, Dimon said, but the bank expects its losses to exceed $800 million by the end of this quarter. And it stands to lose a further $1 billion more due to market volatility.
Still, some nagging questions remain, such as whether the losses were contained only to JPMorgan and not any other major banks.
As CNNMoney reports, CLSA analyst Mike Mayo pushed Dimon on whether he thought other banks could be in the same situation. “I don’t know,” Dimon sighed. “Just because we’re stupid doesn’t mean everyone else was.”
Not a comforting response, given the lemming-like cliff dive of the big investment banks in the run-up to the credit crisis.
Mayo was most discomfited by the fact these lapses in judgment occurred inside the JPMorgan’s Chief Investment Office, or CIO, which manages $375 billion in securities. “Here is a key point: this loss occurred in a risk-mitigation unit and not a risk-taking one,” Mayo wrote in a note to investors. “The bigger issue is who was watching the CIO office? We think this raises issues about checks and balances at a $2tn bank that has performed better than peers.”
Mayo told CNN’s Katy Byron: “It’s like if you say to your wife, ‘Honey I went out and bought insurance on a house last month,’ and you come back a month later and say you lost $100,000 on the insurance policy.”
Mayo said it’s clear the losses weren’t the result of one bad trade, but a break down on several levels. “(It) raises the issue – are these big banks too big to manage? There should be controls, overseers, checks and balances,” he said.
And the loss raises the specter that lessons from the credit crisis have yet to be learned. “Our financial system is still not under control,” Mayo said. “The problems that led to the financial crisis are brought up again when something like this happens.”
Dimon said new risk modeling tools brought out in the first quarter have been shelved as a result of the losses. The loss comes at a time when banks are fighting the Volcker rule, due to come into force on July 21, which will curtail bank’s ability to trade with their own money.
Meanwhile, as the Economist reported last month, efforts to better regulate derivatives trading have been half-hearted and ill-funded.
JPMorgan’s loss suggests that derivatives trading remains a hazardous business, a “risk management” tool that has yet to be tamed.