Edunology - Saumya Aggarwal

Analysis of JP Morgan 2 billion dollars loss

JPMorgan Chase, the biggest U.S. bank by assets, suffered a trading loss of at least $2 billion from a failed hedging strategy. This post looks at deeper reason and analysis of what triggered this loss.

What happened?

It is believed after the entire loss math that JP Morgan did hedging or rather entered into bets with CDX family of investment grade, popularly known as Markit CDX IG. The Markit CDX North America Investment Grade Index is composed of 125 equally weighted credit default swaps on investment grade entities, distributed among 6 sub-indices: High Volatility, Consumer, Energy, Financial, Industrial, and Technology, Media & Tele-communications. Markit CDX indices roll every 6 months in March & September. Current series is 18.

With index, your exposure is broken into various assets rather than one CDS or company. Since it was Investment Grade, JP Morgan believed these companies would never default or credit spreads would remain low.  Let us look at CDX IG Series 18 movement for 5 years, the credit spreads widended in April and May. If JP Morgan betted against increase in spreads and named it only hedge then trouble was round the corner.

Even if these companies may not default, but from pure trading perspective JP Morgan positions into CDX made a loss due to credit spread widening. Since the size of exposure was huge, losses were also huge.

The results:

1. JP Morgan stock tumbled on New York Stock Exchange. It has been more than 20% loss in stock prices since the news is out.
2. 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.

3. Likely changes in risk management of banks globally. CEO, Jamie Dimon opposition to Volcker rule to ban proprietary trading by big banks may be criticized.

Courtsey: Bloomberg, Markit