JPMorgan’s USD2 Billion CDS Folly
JP Morgan has lost over USD2 billion since April 1 because of credit default swap positions taken by the firm’s London chief investment office.
JP Morgan has lost over USD2 billion since April 1 because of credit default swap positions taken by the firms London chief investment office. And theres the potential that the firm can lose another USD1 billion or more if the markets refuse to cooperate with their position.
Jamie Dimon, JPM president and ceo, said during a conference call that the positions were egregious and self-inflicted. But that was not the most troubling thing he said during the conference call. It could get worse, and its going to go on for a little bit unfortunately.
According to the Wall Street Journal, hedge funds BlueMountain Capital Management and BlueCrest Capital Management have made at least USD30 million taking an opposing position. One trader who talked to the Journal said that JPMs position was so large that it skewed the market and made an opposing position cheap. But other reports have said that fast money moved directly against JPM because its bets were, well, too big not to fail.
JPM sold CDS on the ninth Markit CDS index of North American investment grade corporate, also called the CDX IG 9, which is an off-the-run index of 121 corporates. JPM sold insurance because, in its view the spreads would widen. With the cost of the index risk higher, the firm would be able to turn around and repackage it, or at the very least see higher value on its books.
But that didnt happen. According to Markit, the spread for the CDX IG 9 started this year at 129 basis points. As of May 9, the last day data is available, the spread was at 77 bps. So the value of the risk is about half that of the beginning of the year, with potential losses still to come.
Since the news broke, there has been chatter that this will strengthen the position of regulators looking to clamp down on the so-called Volcker rule, which bans proprietary trading (however they define it). This may be the Game-Changing nail in the coffin of the CDS market, wrote Bill Blain, senior director at NewEdge in his daily morning e-mail. CDS will be stripped, abused and crucified by vengeful legislators. CDS will end up neutered underlying position trading only.
Dimon, during the conference call, maintained that the trades were legitimate portfolio hedging, which would not violate the Volcker rule should it have been in place. But that doesnt mean much to regulators.
The enormous loss JPMorgan announced today is just the latest evidence that what banks call hedges are often risky bets that so-called too big to fail banks have no business making, U.S. Senator Carl Levin, a Michigan Democrat, said in a statement on Thursday.