Reviewing, JP Morgan Chase lost a couple billion dollars via risky derivatives bets in their London office. Now, there are Senate hearings regarding this loss.
It is embarrassing when a big bank loses a couple billion dollars in a few days. It shatters the illusion that the banking industry isn’t one huge government-subsidized casino.
As usual, Congressional financial hearings are one big farce. The Senators are promoting the lie that the financial industry has meaningful government oversight.
Actually, the loss didn’t occur in a few days. The loss was built up over a long period of time. However, the accounting farce became too great. JP Morgan Chase was forced to publicly admit the loss all at once.
How did JP Morgan Chase have a huge hidden loss in derivatives? There are a couple of factors.
JP Morgan Chase’s traders claimed that the price for the derivatives was greater than the market price. That helped them hide loses. If the trade really is profitable, then you might legitimately claim a price greater than the market price. Even in that case, you should report both mark-to-market price and mark-to-model price.
With illiquid derivatives, it’s hard to tell what the price is. Most of the time, it’s based on whatever model the traders are using. That leads to the crazy situation where both sides of the trade can claim an immediate mark-to-model profit.
JP Morgan Chase’s position was so big that they were almost the entire market for these derivatives. Because JP Morgan Chase had such a huge position, the price was inflated, leading to the illusion that the trade was profitable.
When the trades were unfavorable, the traders decided to double down. Instead of admitting the loss, they made bigger and bigger bets, hoping that the market would move in their favor. However, other traders knew that JP Morgan Chase had a ridiculously huge position, and started to bet against them.
When you’re gambling with other people’s money, the incentive is to hide losses. When you’re behind, you should make bigger and bigger bets to try and recover. Whether you lose $5 million or $5 billion, you lose your job either way. Once you’re behind, the incentive is to try and recover, even if it means taking bad risks.
It isn’t much different than a Ponzi scam. In a Ponzi scam, new investors pay off old investors. With the “London whale”, JP Morgan Chase kept financing bigger and bigger bets. New money helped hide the losses on other trades. If they were lucky and the bets did work eventually, nobody would ever know.
With derivatives, it’s very easy to construct a scenario where you make a small return most of the time, and have a huge loss once in awhile. When you’re gambling with other people’s money, that’s a good strategy. Most of the time, you get a decent return and a nice bonus. When it blows up, you get a new job or get a bailout.
JP Morgan Chase received massive direct and indirect government bailout money. They received explicit bailout money via TARP. They receive indirect bailouts via negative real interest rates and quantitative easing. Some of that bailout money financed risky derivative bets.
The Senate hearing is one big farce. The sole purpose of the hearing is to provide the illusion that there’s meaningful oversight of the financial industry. With the ability to literally print money, banksters can always lobby against meaningful reform.