JPMorgan's admission that it lost $2bn in six weeks sends bank stocks tumbling. If America's most profitable investment bank can admit sloppy trading, what on earth are the lesser banks up to?
The market shock started at 5pm New York time when JPMorgan Chief Executive James Dimon held a short-notice conference call to reveal an "egregious" failure in the banking arm that was supposed to manage risk. Instead, the unit lost $2bn and expected another $1bn in losses in the second quarter with continued volatility likely until the end of the year , Mr Dimon told analysts on Thursday.
Why? Mr Dimon had lots of reasons and no firm answers. He blamed "an unbelievably ineffective hedge", "bad judgement", an "egregious" failure in the unit, and Mr Dimon's own failure to pay attention to trading losses and "some stuff in the newspaper and a bunch of other stuff."
The "stuff" Mr Dimon referred to included positions taken by a single JPMorgan trader in London, known in the bond market as "the London whale", who placed bets so large they moved prices in the $10tr synthetic credit securities market (the market trades derivatives that generate gains and losses tied to credit performance without the owner buying or selling the actual debt).
"I know it (the bank's betting) was done with the intention of hedging the tail risk for JPMorgan, but I'm telling you, it morphed over time and the new strategy - which was meant to reduce the hedge overall - made it more complex, more risky," Mr Dimon told analysts.
Market swings and roundabouts
Things started snowballing. Hedge funds took advantage of the volatility stemming from JPMorgan's trades, reportedly made by London-based Bruno Michel Iksil who worked in the chief investment office, the Wall Street Journal reported in April.
"There were huge movements in the marketplace," Mr Dimon said. "These are complex. We made these positions more complex. The strategy was badly executed and badly monitored. I can repeat it 800 times. I'm not going to get into more specifics than that."
'Egg on their face'
The bank's $2bn loss emerged when JPMorgan tried to reduce its position and unwind the portfolio, Mr Dimon said after the bank alerted US regulators in its SEC filing form 10Q.
"It puts egg on our face and we deserve any criticism we get," Mr Dimon said.
Unlike most banks, JPMorgan has been held to a higher standard than many in the US. Like Barclays in the UK, JPMorgan was praised for its performance during the 2008 banking crisis that saw the implosion of Lehman Bros and Salmon Bros. JPMorgan did not need government handouts, so shareholders could be forgiven for wondering: if this massive oversight could occur at the best of the best, what about the rest?
Too big to trade?
JPMorgan shares fell 6.7 per cent in pre-market New York trading, leading a slump in financial shares and US stock-index futures fell.
Regulators and politicians pushing for a tightening of government oversight of banks say it is time to clamp down on the gluttonous banking industry that were once considered too big too fail and now have positions so difficult to unwind they are too big to trade.
The "announcement is a stark reminder of the need for regulators to establish tough, effective standards... to protect taxpayers from having to cover such high-risk bets," US Senator Carl Levin said in a statement.
JPMorgan: 'That's life'
JPMorgan's losses were not the result of a rogue trader - a lone Nick Leeson derivatives cowboy-type, who brought down Barings Bank. JPMorgan's losses were "self-inflicted," Mr Dimon said, causing further worry and jeopardising Wall Street's efforts to get the federal government to loosen a ban on proprietary trading that would let banks bet with their own money.
"It's a major event that confirms a lot of investors' worst fears about bank risk," said Frank Parnov, a law and finance professor at the University of San Diego, California. "That at a large, supposedly sophisticated institution, even something called a 'hedge' can contain all kinds of hidden risks that the senior people don't understand."
JPMorgan's losses are "very unfortunate," Mr Dimon told analysts. "It plays right into all the hands of a bunch of pundits out there, but that's life. I'm not going to deal with that."