What JPMorgan's $2 billion loss means for the bank and the industry

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Last week, JPMorgan Chase ( JPM ) announced in its quarterly report that its London trading desk lost $2 billion in a risky series of financial transactions that hedged the bank against losses in a basket of credit-default swaps, themselves a hedge against potential losses in the bank's corporate debt portfolio .

The news slammed the bank's shares down 9.28 percent in Friday trading and wiped $14 billion off JPMorgan's total market capitalization

Within days, chief investment officer Ina Drew tendered her resignation, and Bloomberg reports that the entire London trading staff may get the axe within a few days, citing an anonymous insider.

In a statement, JPMorgan chief executive officer Jamie Dimon stated that the unit's strategy was "flawed, complex, poorly reviewed, poorly executed and poorly monitored." In an interview with Meet the Press on Sunday, Dimon said "there's almost no excuse for it."

So what will this particular disaster mean for the largest bank in the United States?

Aside from the loss of market cap, $2 billion in red ink will surely draw regulatory eyes on both sides of the the Atlantic. The New York Times reports that the strategy JPMorgan applied was allowed through a loophole in the Volcker Rule portion of the Dodd-Frank financial reform law called 'portfolio hedging.' This loophole effectively grants banks a carte blanche to take positions in order to offset potential losses across their full portfolio, opening the door for situations such as the one that came to light Thursday.

Politicians who favor tighter regulations - such as Senate candidate Elizabeth Warren of Massachusetts - will doubtless sense an opportunity to make political hay out of JPMorgan's losses. Indeed, Warren has already stated she believes Dimon should depart the board of the New York Federal Reserve as "he advises the Federal Reserve on the oversight of the financial industry." The candidate is one of Wall Street's nemeses, as her rise to prominence largely came on the back of her fierce advocacy for consumer rights and her equally fierce condemnation of the financial industry.

JPMorgan will certainly face something of a leadership crisis, with Dimon's reputation for ironclad management and good stewardship during the 2008 financial crisis deeply shaken. Though Dimon's departure seems unlikely at the moment, much will depend on the post-mortem and any potential leaks from within the bank, especially if the entire London staff is indeed fired.

The bank's competitors will probably feel less sanguine - while some of them likely profited by investing against JPMorgan and making money off its failed hedges, redoubled scrutiny will fall on the whole industry.

The scandal may also hasten a trend in which the biggest profiteers and rainmakers in the mainstream banking sector jump ship for the more profitable and less regulated world of hedge funds. Bloomberg reported last week that more than 20 of Wall Street's Masters of the Universe departed for greener pastures at hedge funds and other firms in the last year. 

The relative opacity and lighter regulatory touch on the hedges means that these traders can get higher offers without attracting public scrutiny, accountable only to management and investors rather than to stockholders and the entire regulatory apparatus which oversees the big bank holding companies. 

This, in turn, could accelerate the rise of the shadow banking system, which plays a major role in the hedge fund industry and the construction and sale of collateralized debt obligations, credit default swaps and a variety of synthetic trading vehicles. Bad bets in the shadow banking system infamously helped bring down Long-term Capital Management, so JPMorgan's $2 billion loss could well have deeper repercussions in the future.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , Banking and Loans , Economy , International

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Daniel Pereira


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