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JPMorgan Chase & Co. (JPM-N) shocked financial markets this week when it announced a $2-billion US trading loss relating to a failed hedging strategy by London-based division of the company.
The announcement is a blow to the reputation of JPMorgan CEO Jamie Dimon, who often touted the company's strength during the financial crisis and attacked proposed regulations that would tame the trading activities of major financial institutions.
Some investors say responsibility for the massive loss leads right to the corner office.
"The board of directors and regulators need to send very strong signal to the banks that this is not going to be acceptable behaviour and you start with a really high profile firing like this guy [Jamie Dimon]," Terry Shaunessy, president and portfolio manager at Shaunessy Investment Counsel Inc., tells BNN.
"The reason people don't like banks is because nobody takes responsibility and nobody is accountable. This guy was put on a pedestal as somebody who got through the bad part of the whole crisis in 2008 and 2009 and he's no different than anybody else, so why should he be treated any differently than [former Lehman Brothers CEO] Dick Fuld and [former Bank of American CEO] Ken Lewis or any of these other guys that hit the wall."
Shaunessy says the announcement plays right into the hands of calls to implement the so-called Volker rule, which would ban the banks from making trades using its deposits.
"This all comes back to accountability, you know the spirit of the Volker rule and this is precisely what they don't want you to do," he says.
The debacle knocked 8 percent off JPMorgan's share price and prompted Dallas Federal Reserve Bank President Richard Fisher, who has called for the breakup of the top five U.S. banks, to say he is worried the biggest banks do not have adequate risk management.
"What concerns me is risk management, size, scope," he said in answer to a question about JPMorgan's trading loss. "At what point do you get to the point that you don't know what's going on underneath you? That's the point where you've got too big."
Dimon conceded the losses, which could rise by a further $1 billion, were linked to a Wall Street Journal report last month about London-based credit trader Bruno Iksil, nicknamed the 'London Whale', who, the paper said, amassed an outsized position which hedge funds bet against.
Iksil, who graduated in engineering from the Ecole Centrale in Paris in 1991, was not available for comment. The Frenchman, and the Chief Investment Office (CIO) where he works, are known by rival credit traders for taking extremely large positions.
A friend and former JPMorgan colleague said Iksil and his team were not carrying out so-called prop trading, where a bank makes bets with its own money, in disguise and its activities were known about at the highest levels.
"The CIO does not do prop trading, let's be clear on that...It involves taking positions in the form of investments, trades, credit-default swaps, or other, with the aim of rebalancing the risks of JPMorgan's balance sheet.
"The information comes from the very top of the bank and I do not even think that the CIO team members at Bruno's level are given the full picture," the ex-colleague said.
The CIO is run by New York-based Ina Drew, who is Chief Investment Officer.
Iksil was brought into the CIO unit to head its credit desk, an asset class it had not previously covered, a person who worked in the unit said. It built up large credit positions over several years through trades which were vetted by management and the losses now likely resulted from a combination of these trades going wrong, the person said.
The CIO desk had grown rapidly in the past five years and was given free range to trade in a whole range of financial products, the only exception being commodities, they added.
Credit market traders said other banks have comparable functions to JPMorgan's CIO. The French banks, Citigroup, Deutsche Bank and UBS were all cited as examples of large treasury functions that hedge credit exposures in similar ways.
JOBS AT RISK
JPMorgan reported that since the end of March, the CIO had made significant mark-to-market losses in its synthetic credit portfolio. Although other gains partially offset the trading loss, the bank estimates the business unit will post a loss of $800 million in the current quarter. The bank previously forecast the unit would make a profit of about $200 million.
Dimon said the problem was with the way the hedging strategy had been carried out, describing it as "ineffective, poorly monitored, poorly constructed".
"It is risky and it will be for a couple quarters," said Dimon, who admitted to having egg on his face due to the loss. He indicated that some people may lose their jobs.
JPMorgan had informed the UK's Financial Services Authority (FSA) of the situation, but this was a regulatory requirement and there was no indication that the regulator would take any action, a source familiar with the situation said.
The loss is a blow to Dimon and the reputation of a bank strong enough to take over investment bank Bear Stearns and consumer bank Washington Mutual when they failed in 2008.
"Jamie has always styled himself as one of the kings of Wall Street," said Nancy Bush, a longtime bank analyst and contributing editor at SNL Financial. "I don't know how this went so bad so quickly with his knowledge and aversion to risk."
The bank's position remains strong. It has been earning more than $4 billion each quarter, on average, for the past two years and had $2.32 trillion of assets supported by $190 billion of shareholder equity at the end of March - a ratio of almost 13 percent. That is four times the industry mean and ahead of 10-11 percent at Citigroup and Bank of America Corp.
In disclosing the loss, Dimon was forced into a major volte face. During an earnings call last month he dismissed reports that Iksil had amassed a huge position that prompted hedge funds to bet against him as "a complete tempest in a teapot".
But on Thursday, Dimon said the bank's loss had "a bit to do with the article in the press." He added: "I also think we acted a little too defensively to that."
Questions over precisely what trades had gone wrong for JPMorgan bounced around London's credit markets on Friday, with the focus on credit derivatives. These financial instruments have been targeted by regulators who say their development played a central role in the financial crisis.
But Dimon and leaders of other large banks have recently pushed back. Last week they met Federal Reserve Governor Daniel Tarullo in New York to question the way regulators run tests to see if banks have enough capital to withstand possible losses.
"The argument that financial institutions do not need the new rules to help them avoid the irresponsible actions that led to the crisis of 2008 is at least $2 billion harder to make today," Representative Barney Frank said in a statement.
The Democrat co-authored the 2010 Dodd-Frank financial reform law designed to avoid a repeat of the recent credit crisis.
Allegations that traders at the banks take outsized risks with bank capital to earn big bonuses have been among the drivers of government regulations since the financial crisis.
JPMorgan says it uses pay formulas to reduce the chance of that happening throughout the bank.
Regulators and lawmakers are now likely to push Dimon for more details about the trades. Those details will guide how regulators now view the issue and its impact on the Volcker rule, said Karen Petrou, managing partner of Washington-based Federal Financial Analytics.
If the trades were meant to hedge against specific risks as opposed to clearly being done as a proprietary bet on the markets, it may not play as clearly into the Volcker rule debate as supporters of the crackdown want it to, she said.
Dimon said he remained opposed to the Volcker rule.
With files from Reuters