Human Events Blog

JP Morgan and the $2 billion “Whale Fail”

JP Morgan is the biggest of the big dogs hanging out on the investment banking porch.  Just one of their units, overseen until Sunday by executive Ina Drew, manages $360 billion.  Something went horribly wrong in Drew’s unit, $2 billion was lost, and as a result she and two of her top people have resigned.  The entire staff of the London office might be right behind them, according to Bloomberg News

The Wall Street Journal reports that least one other trader involved in the big losses, Bruno Michel Iksil, has been “stripped of trading responsibilities.”  Iksil’s big credit-market positions earned him the nickname “London Whale,” so the overall crisis has been tagged as “The Whale Fail.”

The complex disaster boils down to a series of investments gone bad.  The London desk of JP Morgan was looking to hedge their bets on bonds and loans, but the hedge – which the New York Times depicts in cartoon form as a series of umbrellas stacked on top of each other – backfired, in part because it become so obvious that it influenced the behavior of other investors.  In a way, the problem was caused by an excess of caution, which led in turn to risky “insurance policy” investments that didn’t work out.

JP Morgan CEO Jamie Dimon denounced this strategy as “flawed, complex, poorly reviewed, poorly executed and poorly monitored.”  I’m not sure “complex” belongs in there as a pejorative – if huge investment strategies were simple, everybody would be implementing them. 

The traders involved in the Whale Fail had significant records of success prior to this catastrophe, so while JP Morgan’s ongoing review may turn up serious flaws in management and oversight, it doesn’t seem as if this failed investment strategy was patently ridiculous on its face, at the outset.  If it had worked out, wouldn’t these traders and managers currently be feasting upon champagne and a sheet cake shaped like the “Monopoly” guy?  Conversely, since the strategy was a gigantic bust, the top priority for JP Morgan’s management team is convincing their remaining investors that such a thing can never happen again.  Their public statements and staffing decisions should be viewed in light of this understandable objective.

The question pressing upon many minds is whether JP Morgan’s loss was a failure, or a crime.  Unlike the scandal at MF Global under Jon Corzine, there doesn’t appear to be any question of misappropriated funds or shady accounting.  The JP Morgan billions were not “vaporized.”  The bank quickly became aware of the problem, and the results, while unpleasant, will not be fatal or provoke a broader crisis.  In fact, if the New York Times was correct in asserting that other investors preyed upon weaknesses revealed by JP Morgan’s strategy, then somebody, somewhere, made piles of money from this deal.

The most common regulatory “solution” bandied about since the Whale Fail made headlines is the “Volcker Rule,” which would limit the size of the investments big banks could make.  However, it doesn’t appear that the Volcker Rule would apply to the sort of “hedging” that got JP Morgan in trouble.  This looks like another case of political opportunism: something terrible involving a lot of zeroes just happened, so clearly we’ve got to add even more regulations to an already titanic pile.  Never mind whether or not the particular regulation in question would have prevented the catastrophe under discussion – once more laws are passed, we’ll all feel better.

The Washington Post notes that “regulators are still working to draft the rules that were put in place by the Dodd-Frank Act of 2010.”  That’s not exactly a testament to the speed, efficiency, and clarity of Big Government solutions.  In fact, the Post quotes Senator Carl Levin (D-MI) inadvertently conceding that the already impenetrable regulatory maze played a role in prompting the behavior that got JP Morgan’s traders in trouble:

Sen. Carl M. Levin (Mich.) said Sunday that the JPMorgan loss only confirms that banks’ pushback against new rules passed after the financial crisis will backfire.

“This was not a risk-reducing activity that they engaged in. This increased their risk,” Levin said on “Meet the Press.”

“So we’ve got to be very, very careful that the regulators here are not undermined by this huge effort to weaken the rule by putting in a huge loophole” that includes the trading that caused the JPMorgan loss, he said.

(Emphasis mine.)  “Pushback” in this context means “banks trying to interpret rules the regulators still aren’t finished drafting over two years later, and taking entirely legal measures to protect their profits.”  Every new regulatory solution will contain “huge loopholes,” especially the regulations passed in an attempt to stitch the previous loopholes closed. 

We’re ultimately talking about the concept of regulating risk out of existence, a mentality that has left us swimming in an ocean of post-bailout government debt.  Success is not possible when failure is legislated away.  The collective weight of these financial regulations is moving us closer to an outright nationalization of the banks, at which point all the “loopholes” would disappear… to be replaced by the usual political obfuscation and scapegoating.

We’re left with a huge bank that lost a small portion of its total assets on bad trades.  A number of high-ranking people are losing their jobs, almost immediately, as top management scrambles to reassure investors.  Traders both inside and outside JP Morgan are studying the incident carefully, because nobody wants to end up like Captain Ahab, snarled in his own harpoons on the side of the next Whale Fail.  That looks like a functioning system to me.  You certainly don’t see that kind of response when the government loses far larger amounts of money.  As the Heritage Foundation pointed out, the Post Office loses more money that JP Morgan did… not just every year, but almost every quarter.  


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