The Logic of JPMorgan Chase Whale Trades

The main purpose of this report is to expose the findings and misconduct of disclosing important information of the JPMorgan Chase Whale Trades. This report explicitly details the negligence by the Chief Investment Office in misleading the Office of the Comptroller of Currency of their Synthetic Credit Portfolio. The author’s intention is to inform what went wrong with the trading in the derivatives market by JPMorgan Chase.
The key question the author is addressing is why the CIO deviated from their standard midpoint markings to later assigning more favorable prices. Also, the author is addressing why the OCC was unaware of the losses and the risk associated with the SCP.
The most important information in this article is the deceptive actions committed by the CIO in the London Whale Trades. It became apparent that senior managers downplayed the problems of the SCP and kept describing the portfolio as a risk-reducing hedge, when in actuality it was a massive portfolio losing billions of dollars and had stopped providing credit loss protection to the bank. The whale trades shows how financial institutions engage in high risk trading activities with federally insure deposits and attempted to divert attention from these synthetic derivatives.
The main conclusion s in this article is a combination of poorly executed hedging decisions by the CIO of JPMorgan Chase in their SCP. The CIO failed to alert its regulators of their actions in constructing this portfolio that was filled with complex high risk synthetic credit derivatives. JPMorgan Chase claimed that its SCP functioned as a hedge against bank credit risks, but failed to identify the assets being hedged, test the effectiveness of the hedging activity, or even show how it would lower bank risk. After breaching all five major risk limits on the SCP, JPMorgan ignored the warning signals and dodged OCC oversight. Ultimately, JPMorgan Chase hid over $660 million in losses and falsified information about the portfolio after the public became aware and resulted in portfolio that lost over$6.2 billion by the end of the year.
The key concept to understand in this article is the reasoning behind the decisions made by the CIO of JPMorgan Chase. In the first four years, the SCP produced positive revenues, but in 2012, it opened with sustained losses. To realize smaller amounts of losses, the CIO began to mark the daily value of their credit derivatives in a more favorable manner. Instead of marking it at the midpoint price of the bid-ask spread, they began to mark at more favorable prices to report a smaller daily profit/loss. JPMorgan disregarded the high level of risk of the portfolio and began to omit key performance data from its standard reports to the OCC. The OCC learned of the problems only after JPMorgan was forced to disclose $2 billion in SCP losses in its public SEC filings. By these concepts, the author explains the events that led up to this major fiasco and the reasoning behind JPMorgan’s actions.
The main assumptions underlying the authors thinking are the unethical actions and deliberate misrepresentation of information committed by JPMorgan Chase. The author makes it clear that JPMorgan’s CIO was aware of the situation but decided to hide important information from the public. The reasoning behind why the CIO hid this information is obvious, but the question remains if it was the ethical thing to do. The author suggests several recommendations to substantially reduce the likelihood of any future events like this to happen again. The recommendations include: requiring derivatives performance data, requiring contemporaneous hedge documentation, strengthening credit derivatives valuations, investigating risk limit breaches, investigating models that substantially lower risk, implementing Merkey-Levin provisions, and enhancing derivative capital charges.
If we take the author’s line of reasoning seriously and banks institute these recommendations, banks will reduce the likelihood of running into the same problems of the JPMorgan Chase Whale Trades. The SCP was so large that it gained worldwide attention and opened the eyes of the public. The same thing goes on every day in a much smaller magnitude with banks worldwide. Risky business practices are downplayed and not given the attention they deserve.
If we don’t take the author’s line of reasoning seriously then there is a good chance that events like this will happen again in the future. This multi-billion dollar loss due to credit default swaps could have been avoided with a less aggressive strategy. Banks need to take these recommendations seriously and use them as a guideline to insure their company is taking every necessary precaution to secure their assets.
The main point of view presented in this article is from the Permanent Subcommittee on Investigations. The author’s see these negligent trading activities by the largest financial holding company in the United States as a devastating event that can be used as a learning tool for future companies practicing in hedging activities. The author sees a need to tighten oversight of bank’s derivative trading activities by establishing better valuation techniques, more effective hedging documentation, stronger enforcement of risk limits, more accurate risk models, and improved regulatory oversight.