Jamie Dimon’s failure

By Felix Salmon
May 14, 2012
"loves crises" -- is out; it seems the buck for the $2 billion trading loss in her unit has stopped with her.

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Ina Drew — the JP Morgan executive who famously “loves crises” — is out; it seems the buck for the $2 billion trading loss in her unit has stopped with her. And slowly, a few shapes are beginning to emerge from the fog of what exactly happened here.

For one thing, it’s becoming increasingly obvious that Drew got paid her eight-figure salary in return for being able to pull off a very neat trick: turning hedging operations into a profit center.

Drew’s Chief Investment Office quadrupled in size between 2006 and 2011, reaching $356 billion in total, and it’s easy to see how that happened. On the one hand, it was incredibly profitable, with the London team alone, which oversaw some $200 billion, making $5 billion of profit in 2010, more than 25% of JP Morgan’s net income for the year. At the same time JP Morgan accumulated enormous new deposits in the wake of the financial crisis, both by acquiring banks and by attracting big new clients wanting the safety of a too-big-to-fail bank. Historically, JP Morgan has served big corporations by lending them money, but nowadays, as the cash balances on corporate balance sheets get ever more enormous, the main thing these companies want from JP Morgan is a simple checking account — one where they can be sure that their money is safe.

With lots of deposits coming in, and little corporate demand for loans, it was easy for all that money to find its way to the Chief Investment Office, which could take any amount of liabilities (deposits are liabilities, for a bank) and turn them into assets generating billions of dollars in profits.

But the CIO does much more than just provide profits for JP Morgan. In contrast to the bank’s lending book, the CIO is nimble. Loans, as a rule, have to be held to maturity: that’s the essence of relationship banking. Investments, by contrast, can be sold at any time. Of course, an investment which can be sold at any time has another name: it’s a trade. Thus did the CIO become home to big traders, making huge bets and huge bonuses.

In the past couple of years, of course, that raised its own set of problems: how could this group of traders possibly be Volcker-compliant? The answer lay in Drew’s love of crises: her incredibly valuable ability to prevent losses and even make profits when the world is falling apart. In that sense, the CIO was one big hedge, and in a narrower sense the CIO was the go-to office whenever JP Morgan saw a risk which needed hedging.

Mark Dow has an intriguing thesis this morning:

We know that over the last 2-3 quarters of 2011 we were gripped by the fear of a European financial meltdown and a second recession in the US.

We know that that the Fed’s swap lines and the ECB’s LTRO reversed this market view and crushed credit spreads lower, hurting those who had been buying protection in the previous months.

Against this backdrop, it seems likely to me that the aggressive selling of protection we heard about in April 2012 was actually the unwinding of the hedge that had been accumulated in 2011 and was by then deeply underwater.

In other words, Jamie Dimon, like everybody else, was worried about a Europe-induced financial crisis at the end of 2011, and so he told Drew to put on positions which would protect against such a crisis. She did so — only this time around, the crisis never happened, and Drew’s positions had to be unwound.

That’s where things seem to have gone very, very wrong. Drew prided herself on turning every hedge into a profit center — having her cake and eating it too, basically. We’re deep in the realm of speculation, here, but it’s entirely possible that Drew positioned the CIO, at the end of 2011, to profit from a European meltdown. When that meltdown didn’t happen, simply selling those positions would involve realizing a substantial loss. And so rather than selling the positions, Drew decided to put on new, profitable positions which would offset the old hedge. Enter Bruno Iksil, the London Whale, and his enormous trade.

Iksil’s trade was fundamentally bullish, which would make sense for a trade designed to offset a fundamentally bearish hedge. Of course it wasn’t a perfect offset — there’s no such thing as a perfect hedge. Traders making multi-million-dollar bonuses don’t get paid to design perfect hedges, in any case. Iksil was being paid to put on a trade which would make money for the CIO, even as it was also hedging existing positions.

As with all imperfect hedges, however, especially when they’re big and public, the market can always move against you in exactly the way you don’t want. We don’t know the details of Iksil’s trade, but let’s say that the big underlying position was a bearish position in cash bonds, while Iksil’s trade involved a bullish position in the CDS market. In April, the cash and CDS markets stopped mirroring each other, and started behaving very oddly — you’d see bullish moves in cash bonds, combined with bearish moves in the CDS market. That combination, it seems, turned out to be the one thing that JP Morgan wasn’t hedged against, and the losses in the CIO started mounting rapidly.

How did Iksil’s trade go so horribly, massively, wrong? Partly it’s because his position was so big and so public. When hedge funds worked out what he was doing, they managed to get the word out, using stories in Bloomberg and the WSJ. And then it was just a matter of watching the market do what it always does, when it smells blood: I’m told that Boaz Weinstein’s Saba, for one, made a lot of money taking the other side of Iksil’s trade.

Taking a much bigger-picture view, however, what was really going on here was that JP Morgan had hundreds of billions of dollars in excess deposits, thanks to its too-big-to-fail status. And rather than lending out that money and boosting the economy, Jamie Dimon decided to simply play with it in financial markets, just as a hedge fund would. Here’s Bloomberg:

Dimon pushed Drew’s unit, which invests deposits the bank hasn’t loaned, to seek profit by speculating on higher-yielding assets such as credit derivatives, according to five former executives. The CEO suggested positions, a current executive said.

It’s always dangerous when a CEO suggests positions for an internal hedge fund to take, because the CEO by definition has no risk manager with enough authority to effectively constrain him. Dimon is powerful and secure enough that he’s not going to lose his job over this. But he probably should. Partly because the bank’s risk-management procedures were so weak that a $2 billion loss could suddenly appear out of nowhere. Partly because Dimon became too cocky, and started thinking that his job was to trade the bank’s billions for profit. But mainly because he’s lost sight of what JP Morgan has to be, in a post-crisis world.

Those excess deposits weren’t gifted to Dimon on a plate so that he could gamble them on the CDX NA IG 9. Rather, Dimon’s job is to take those deposits and lend them productively into the real economy. Every extra dollar in the CIO is a sign of his failure to do that. And the $2 billion loss is really just a symptom of what happens when banks get too much money, and don’t really know what to do with it all.


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Running an unregulated casino is a “trick”? CDS was not invented in order to “hedge” risk, it was invented because it allowed banks to legally engage in accounting fraud.

Posted by Foppe | Report as abusive

It’s not enough that one or a few heads roll at JP Morgan Chase. There needs to be a re-thinking about whether commercial banks can expand their “banking” activities to act like hedge funds.

JP Morgan Chase and its likes (the too-big-to-fail banks) shouldn’t be allowed to act like hedge funds (even though in the current instance the offending transactions don’t look much like hedges against risk).

I keep seeing comments from various commentators on various websites to the effect that JPMC should be able to do what it likes with its “own” money. But truth be told, this is shareholders’ money. What should really happen if JPMC has excess funds is the following: distribute those funds to the shareholders who can then choose to invest in riskier asset classes under their own decision regimens. If hedge fund investments are what they want, then let them make conscious decisions to invest in hedge funds, without any Federal (US taxpayer) guarantee of the investment.

It seems to me that banks have been granted “franchises” and given preferential treatment to serve the needs of the nation’s economy and to facilitate the movement of funds between individuals/entities wanting to have a relatively safe haven for their excess liquidity (aka, depositors) and those needing to borrow those resources. Proprietary trading of the too-big-to-fail banks’ “own” funds has little place in this economic environment, especially after the debacle of the 2007-2008 financial crisis.

Moreover, one would think after the fiasco of the 2007-2008 financial crisis, the too-big-to-fail banks would have learned a lesson about risk management — but, no, here we are again with JPMC losing $2+ billion of its “own” money — and under the leadership of CEO Dimon who is one of those most vocal against limiting the banks’ proprietary trading under proposed regulation/legislation. (As an aside, the too-big-to-fail banks of vintage 2007-2008, including JPMC, are now even bigger than they were at the beginning of the financial crisis.)

The shareholders, bondholders and managements of these too-big-to-fail banks should pay the price for “mistakes” such as JP Morgan Chase’s recent fiasco. However, the US taxpayer remains on the hook just as in the 2007-2008 financial crisis.

It’s time we revisit the separation of real banking activity and everything else that banks want to do. This might eliminate, or at least restrain, much of the burden that is now placed on US taxpayers to correct the ” sloppy” and “stupid” decisions (CEO Dimon’s own adjectives) that have been made by the to-big-to-fail banks in the post-Glass-Steagall era.

See more commentary on the intersection of finance and politics @ http://theviewfromthemiddleoftheroad.blo gspot.com/.

Posted by rg.williams | Report as abusive

“Iksil’s trade was fundamentally bullish, which would make sense for a trade designed to offset a fundamentally bearish hedge”

Note sure I follow the bullish trade argument? Is the implication that the Long CDS on the 5yr maturity of the CDX NA IG 9 put on much before and the 10 yr maturity was a recent (April 2012) trade?

But the net notional outstanding increase on the CDX NA IG 9 happened much before April 2012:
http://av.r.ftdata.co.uk/files/2012/04/1 20406-CDXnaig9-not.jpg
And so the did the skew:
http://av.r.ftdata.co.uk/files/2012/04/C DX-NA-IG-9-skew-over-spread-long-series1 .jpg

More here:
http://cgnotes.posterous.com/cliff-notes -jp-morgan-whale-trade
http://ftalphaville.ft.com/blog/2012/04/ 19/965511/the-curve-trade/

Posted by NikRao | Report as abusive

Dimon assumed he could rewrite the definition of ‘risk’ to read ‘I always win.’ He wasn’t the first CEO to assume this, and he won’t be the last.

Posted by MattF | Report as abusive

Nice article Felix. Great reporting.

I have some sympathy for Drew here, she seems to have done no more than she was told to do, it’s her CEO who told her what strategy to follow. He’s the one who panicked – he clearly doesn’t read your blog Felix! I’ve been saying on here for well over a year now there wasn’t going to be a big Euro crash last year, although there does seem to have been rather a lot of Nationalist wishful thinking about preventing the Euro challenging the USD’s role as the global reference currency in the US markets more generally, and a similar amount of “we hate Europe” machinations going on in London markets. Add the number of zeros people were juggling with and the amount of Testosterone it takes to rise to be CEO of a bank the size of JPM and you have a recipe for bad judgement, which this appears to be a case of.

When dealing with the economics of Europe, you really can’t ignore the politics or the stage in the political cycle each country is in, and their relative sizes and productive capacities. Currently, what Germany says goes, while Greece is almost irrelevant. As Merkel has been avoiding doing anything that might make her less likely to be reelected this year things have gone as they have. But the political will that exists in Continental Europe to make the EU and the Euro work should not be underestimated.

It appears either greed, lack of strategic thinking, an overactive sense of Nationalism, or just blind panic caused Drew’s CEO to tell her to change strategy. He was wrong. And she couldn’t say no to him. A woman doesn’t get that far ahead in this industry by saying no to her CEO.

Posted by FifthDecade | Report as abusive

Dow’s thesis is entirely inconsistent with Dimon’s prior statements. And why is Drew falling on her sword if she was just following orders, and really was this miracle hedger who could turn a by-definition zero-sum operation into a risk-less generator of giant net profits?

None of this fits together, IMO?

More fundamentally, as FS notes, JPM has all this cash to play with since it’s got the explicit Federal guarantee that comes with being a depository institution. As the guarantors, taxpayers have the right to decide if this is the kind of stuff we want firms that we’re insuring to be doing. IDTS. I don’t care if the pond was too small for The Whale to swim in – I don’t want insured firms doing this at all.

Posted by MrRFox | Report as abusive

It was never a hedge, it was a bet. And they lost. So people should get fired. Dimon deserves some credit, as nobody got fired in 2008 (o.k., people did get fired then, but not the ones responsible for the crisis, only low level workers who were laid off when the economy tanked).

“Rather, Dimon’s job is to take those deposits and lend them productively into the real economy”

Felix, it’s 2012. Banks don’t do that sort of thing any more.

Posted by KenG_CA | Report as abusive

I own a small (U.S.) manufacturing business and Chase is our primary bank. When Chase deigns to lend money to my business, the loan is supported by my receivables, my inventory, my house and all the rest of my personal assets.
Foreign receivables are not allowed, nor are U.S. Government obligations. Concentrations, aging, etc. all result in haircuts. Inventory is capped.
This is how careful Chase is to lend a few hundred thousand dollars to a business that actually builds things and employs workers. At the same time, they are making multi-billion bets on credit derivatives.
This system is tremendously broken.

Posted by Ajax420 | Report as abusive

I don’t know where Bloomberg got that $5bn profit figure for 2010, but it’s hard to substantiate. Though JPMorgan’s disclosure isn’t great, the Corporate division, which includes the CIO, earned $670m in 2010 on net revenue of $6.2bn. Even if they made losses elsewhere and whacked in some extra costs from head office, it still doesn’t add up.

Posted by petertl | Report as abusive

@MrRFox – Felix speculates in the piece already, Dimon is secure enough in his position (possibly with his “Fortress Balance Sheet”) that he can afford to throw Drew under the bus and draw a line. He can point to lines about how Drew never met a risk she didn’t like, etc etc.

But I do have a question for those much learned than me, isn’t the job of the Board of Directors to keep CEOs in check? I know expecting BoDs to exert any modicum of control is a quaint and outdated idea but surely that is the answer to Felix’s question of who the CEO’s risk managers ought to be?

Posted by GregHao | Report as abusive

@GregH – OK, if she got a big enough going-away present to take the fall and keep her mouth shut, it might work. In my line of work we sometimes refer to this kind of thing as “obstruction of justice”, but doing it quick, before there is any mention of criminal investigation improves the odds of staying out of a cell. So does being from the right tribe and being a big political donor.

Have to wonder if any board can rein-in a superstar CEO of Dimon’s sort. They get the run of things until they step on a big-enough landmine.

Posted by MrRFox | Report as abusive

GregHao, I don’t know if it’s fair to say Drew was thrown under the bus. I don’t think she was fired for losing money, but more for the political damage she caused. Dimon whines about regulations, saying they are unnecesary, and now he has to eat $hit because he apparently didn’t know what was going on. I doubt that he would have made the statements he did had he fully understood what was happening. She made him look foolish, and that’s why she got the boot.

Posted by KenG_CA | Report as abusive

@MrRFox – I’m sure Drew’s got an iron-clad non-disclosure, non-disparaging clause as part of her severance (er.. I mean retirement) package. The thing is, as the Volcker Rule is still largely unimplemented, what parties might compel her to testify. And really, for me, that’s the issue here, what JPM’s CIO group has done should obviously be illegal but is not.

And if we’ve mostly closed the books on the 2008 financial meltdown without anybody going to jail, neither will this issue.

Posted by GregHao | Report as abusive

@GregHao The meltdown from 2008 is going to be bringing bodies to the surface for a long while yet, methinks. So many of these positions take a long time to unravel, and there’s clearly been an attempt by banks to mitigate the risks – but they will come out eventually. I don’t know if there have been any prosecutions for the crash, but if not, there should have been and there certainly shouldn’t be a time limit on how long cases can be prosecuted for either, since the lead times from action to final effects can be so long.

@KenG_CA I suspect what her ‘crime’ in Dimon’s eyes this time was in not being able to protect him from his own over-adventurousness: previously she had fixed things (like his poor strategies) for him but this was one ask too far. It will be interesting to see how long he stays in the job now, with no wingman/woman to pass the buck to… and perhaps an incredible ego that makes him think he was responsible for everything that worked, and everything that didn’t was someone else’s fault.

Whatever happened to people with ultimate power taking ultimate responsibility?

Posted by FifthDecade | Report as abusive

@5thD – Dimon already has a scheduled retirement date, not all that far away, as I understand it. Maybe he’ll accelerate the timing. And hey, even John (‘What $800 million?’) Corzine hasn’t been charged with anything, nor has anyone at the firm.

@GregH – a grand jury could be formed to investigate the affair and they could compel her testimony – without counsel present – and no confidentiality agreement is going to stop them.

Posted by MrRFox | Report as abusive

@KenG & FifthDecade – that’s the very definition of being thrown under the bus. I quite agree with both about WHY she was thrown under the bus but the fact remains that as of this morning, Dimon still had a job while Drew is “retired”.

@MrRFox & FifthDecade – Hopefully, you’re both right. But specifically, MrR, my implication was that no grand jury would be convened. That’s just how cynical I am.

Posted by GregHao | Report as abusive

GregHao, I think that definition is for somebody who is being set up as the fall guy, and not totally responsible. If Drew hid any details of the bet (it wasn’t a hedge), or how it was implemented, then she’s not being thrown under the bus, but being held accountable (shocking, and somewhat unprecedented, but maybe Dimon’s different). If Dimon knew what was going on all the time (I don’t think that’s necessarily true), then yeah, he threw her under the bus. If Dimon is hiding his involvement in the mess, it will come out, and I’ll be shocked if he isn’t canned also – boards love to pretend they’re not rubber stamps.

I’m just glad somebody got fired for this, without Mitt Romney or Donald Trump being involved.

Posted by KenG_CA | Report as abusive

Chase didn’t loan the money out because they can’t. There are far more lendable funds than there are profitable investments, which is why the treasury rate is so low. Banks are making every prudent loan they can, and (still) more than a few stupid loans. Seriously, when was the last time you heard of someone who couldn’t get a loan, who had a reasonable chance of repaying the loan?

One root cause is the Boomers’ retirement funds. They have to put the money somewhere. Banks could just put it all on deposit at the Fed, but bankers don’t stay employed if they do that. Instead you get schemes like this.

Did anyone else notice how small the profit was? 5 billion profit on 200 billion capital is only 2.5%; not long ago T-bills paid better than this.

Posted by JayCM | Report as abusive

@JayCM: “Seriously, when was the last time you heard of someone who couldn’t get a loan, who had a reasonable chance of repaying the loan?”

How about this month and every month since late 2008?
Here in the USA (on the planet I live on, anyway) commercial lending to small- and medium-sized businesses was the first casualty of the Bush recession. Alex420′s comment above reflects the same experience that I and every other (non-Fortune 500) business owner I know has been facing.

Posted by melior | Report as abusive

@KenG – Ah, I see what you’re saying there. Ya, I guess she probably is largely responsible for executing Dimon’s directions so she’s not blameless but certainly she fell on the sword that was meant for Dimon.

Posted by GregHao | Report as abusive

Is it appropriate at this point in the discussion to note that shareholders approved Dimon’s retaining both chair and CEO titles, along with his $23m pay package?

Posted by Curmudgeon | Report as abusive

+1 to Ajax420.

Posted by Bernanke | Report as abusive

@Curmudgeon Isn’t it true that most of the proxy votes (that usually decide these things) had already been sent in before the loss was announced?

Posted by FifthDecade | Report as abusive

What I want to know is who was on the other side of the $2billion in trades. Every article, including this one, focuses on the $2billion as a trading loss, but their is a flip side of that coin. Someone or some company is $2billion richer and who are they? The money just didn’t disappear. So how about some reporting about that? Who made out like a bandit?!

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