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JP Morgan's Trading Loss: The Essentials

President and CEO of JPMorgan Chase Co. Jamie Dimon drinks water as he testifies before a Senate Banking Committee hearing on Capitol Hill June 13, 2012 in Washington, D.C.

I heard you listened to like, three hours of conference calls about JP Morgan and the London Whale trade today.

This really isn't about me.

That bad? Fine. What's the upshot?

I want to fill you in, but you're going to need some background. Go read this easy explainer. It's easy on the brain.

The highlights:  JP Morgan used complicated derivatives to bet around $100 billion in imaginary bank money that corporate bonds would go down in value - and that there would be a worldwide financial crisis.

The bank said back in May that it lost $2 billion on that trade.

Okay, wait. Before we start, remind me again why I should care? It's been a long time since there was any news on this. 

Because JP Morgan is America's biggest and most trusted bank. It's still profitable - in fact, today it reported a second-quarter profit of $5 billion. But if it's important enough that JP Morgan CEO Jamie Dimon was dragged in front of both houses of Congress, you should probably be informed.

I'm ready. It seems like JP Morgan lost $2 billion on this complicated bet on corporate bonds. I'm not surprised it was caused by derivatives. So what did JP Morgan tell us today that we didn't already know?

A lot. For the first time, JP Morgan revealed the results of its internal investigation into the loss. The bank gave us a better idea of the timing and the real size of their loss, and it also told us how it's responding. The bank also said "sorry" a lot. You can read some of their best, self-flagellating quotes here. But not everyone was totally convinced. One analyst, at least, considers JP Morgan too big to fail and wonders why we should trust the bank again. 

The most surprising thing was that JP Morgan said some of its employees lied to make the loss look smaller - which, if it's correct, would probably be considered fraud. 

So how much money did JP Morgan lose?

Well, first, we have to point out that JP Morgan, as a bank, is still profitably. It brought in $29 billion in revenues in the last three months, and $5 billion of that was pure profit.

But, this trade still lost money. JP Morgan estimates it lost $5.8 billion on the trade this year so far. Around$1.4 billion of that was in the first quarter,  or January through March, and $4.4 billion of that was in the second quarter - meaning April through June.

If other things go wrong - like, if Europe falls apart because of the crisis - JP Morgan said the loss could go up by another $1.6 billion.

So, all told, JP Morgan could lose....

Right now, the maximum number it could lose, according to the bank, is about $7 billion.

Wow. Are they still losing money on it?

Yes. Right now, JP Morgan is trying to reduce the size of its bet, but it's probably not moving fast enough to avoid losses.

Maybe a visual would help. Think of the London Whale bet as an actual whale- a beached, rotting whale that's making a stink in the markets. It can't just be hauled off the beach, right? They have to cut it up into smaller pieces.

That's what JP Morgan is doing. It's cutting up the trade. It moved a big chunk of the trade  into the firm's investment bank. JP Morgan is keeping part of the London Whale trade in its chief investment office, however, because the bank still believes it needs to hedge against a worldwide financial meltdown caused by the European crisis.

Can you give me some details to explain that? How much is JP Morgan moving into the investment bank, and how much is it keeping where it is?

Well, think about how the trade was done originally. The original bet was made by a trader in London, Bruno Iklis, and approved by his bosses, Achilles Macris and Javier Martin-Artajo.

Originally the trade was worth something like $100 billion. That wasn't the actual money that JP Morgan bet, though. The bank did not plop down $100 billion of its own money. Derivatives are like mortgages; they're a promise based on very little actual money and lots of debts. So, if you have a mortgage, you put a little money down and then you borrow a lot of money to make up the difference. So, for instance, if your mortgage is $100,000, you would put down maybe $10,000.

In this case, JP Morgan's "mortgage" on the bet was $100 billion, which is called the notional amount. But the actual cash the firm used - the down payment - was far, far less than that. We don't know how much less.

The remaining part of the bet that's still sitting in the chief investment office is worth $11 billion in notional amount, according to my sources. So the $100 billion in derivatives is now down to $11 billion there.

But we still don't know how much of that $100 billion  was pushed to the investment bank

Why would JP Morgan push its toxic trade into its investment bank? Aren't bad trades like tuberculosis? I would think they would want to quarantine the hell out of that thing and keep it from infecting profits elsewhere. 

In a bank, some divisions are better at their jobs than others. The chief investment office seemed to be doing a good job - in fact, it made $2 billion for the bank at least between 2007 and 2011. But JP Morgan admitted today that the CIO was sloppy and stupid, and that managers didn't check out the trades or stop it. In fact, when the trade started losing money, the traders doubled down, according to the official story handed down in the earnings call today.

When JP Morgan started losing money on the trade, the people who were supposed to be smart about taking risks didn't stop the traders.

The investment bank is more heavily watched. A JP Morgan executive, Mike Cavanagh, said today, "if this [trade] had been risk-managed in the investment bank, it never would have happened."

The traders there also know how to deal with complicated derivatives and have lots of customers. Those customers may want to buy little bits of the Whale trade - a piece of blubber here, some scrimshaw there. JP Morgan's traders now have to sell those little Whale bits to everyone in their Rolodexes.

How did JP Morgan find out about this?

The firm created a team to investigate it around mid-May. That team sifted through something like 30,000 to 40,000 emails and voicemails - some of them in foreign languages - to track down the details of what happened. That whole process revealed that employees had, according to the firm, lied about the size of the losses.

Just so I'm up on this, "lying" means "fraud," right?

Pretty much. We have to reserve judgment until we have facts, and JP Morgan isn't calling it fraud, but it would be shocking if the Department of Justice doesn't get involved. The FBI is already reportedly looking at the loss.

Did anyone get fired?

Yes, four key people: Ina Drew, the executive who oversaw the chief investment office; the London Whale himself, Bruno Iklis; and his two managers. Drew offered to give back her bonus, and JP Morgan is accepting that officer. As for Iklis and the other two, JP Morgan said that they would not get severance, bonuses, or any stock or options they're owed from the past two years of work.

Oy.

Yeah.

About the author

Heidi N. Moore is The Guardian's U.S. finance and economics editor. She was formerly the New York bureau chief and Wall Street correspondent for Marketplace.
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