JP Morgan Trading Loss Balloons to $9 Billion
JP Morgan Chase's (NYSE: JPM) trading loss on credit derivatives may have swelled to $9 billion, according to reports by the New York Times. CEO Jamie Dimon said that the company would update investors in its second-quarter earnings release on July 13 with specifics on the size of the loss and the extent to which the position has been unwound.
The bank's Chief Investment Office (CIO) is responsible for the losses, having invested excess deposits into credit derivatives as a hedge. The derivatives were linked to corporate debt, and the recent deterioration in credit markets has forced the bank to mark losses on these positions.
Unwinding the trade has progressed faster than expected. JP Morgan initially said it would take about a year to unwind the entire position, but the bank has already unwound approximately half of the position in only a few months. The trading loss only furthers calls from politicians to curb bank practices and shrink the biggest banks. If JP Morgan can unwind a losing trade quickly, it may signal that banks have gotten better at quickly exiting from bad trades.
To put the loss in perspective, consider that JP Morgan made $5.4 billion in profit in the first quarter. Thus, the loss would have wiped out all profits. However, the bank will benefit from the widening of spreads on its debt and most likely see a gain due to its debt valuation adjustment (DVA). Companies can book an accounting gain from widening of its credit spread as the cost of paying off the debt falls.
The size of the loss is hard to estimate because it changes on a daily basis. Improvements in corporate credit markets could help to recoup some of the losses on still open positions. Therefore, it may have been wise for Dimon to have avoided giving exact dollar figures in his testimonies and rather to wait for the position to be closed to report precise amounts.
The fallout of this trading loss is bad for all financials -- Financial Select Sector SPDR (NYSE: XLF) -- as it has raised calls for politicians to do more to curb risk-taking by the biggest Wall Street banks. Politicians fear that the biggest banks will take too much risk knowing that the government will bail them out, an implicit guarantee known as moral hazard. One of the biggest sticking points is the Volcker Rule, which prevents proprietary trading. More important is which operations become classified as hedging and market making, and which are purely proprietary trading operations. If politicians act too strictly in restricting market making activities, it could make markets less liquid and cause more market volatility.
Mid-day Thursday, JP Morgan shares were down almost 4%, as well as down more than 20% from the 52-week high.
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