JPM: Some Thoughts and Good Sources

So far only one other report that I have seen tries to explain why the loss may not have grown. The Citi report talks about some of it being reserved rather than recognized losses. That sounds at least in part believable. If they took a charge to reflect where it would trade in fair value, their post release losses would have been much smaller.

Cit also points out how complex the trade was, and it is funny, at least to me, how few people want to talk about how IG9 tranches were weak in April (losing money on their long) while HY tightened (losing money on their short position). While IG9 has continued to do badly, including the tranches, HY has also done horribly, which should be good for JPM. It is also unclear what was taken off and what other hedges may have occurred between April 30^th and May 10^th.

This Zerohedge article does a great job showing how they could lose up to $3 billion more on the trade. I don’t agree with all the assumptions, but as usual was ahead of almost all the other media and analysts. This article, probably more than any other, has lead the market to take changes in IG9 10 year and extrapolate further losses. It also seems that something JPM should have anticipated.

It seems clear from other sources that as early as April 27^th these trades were a big issue, and that by April 30^th they had the full attention of the senior management. And this is the part I don’t understand. Why is everyone so convinced JPM did nothing between the time it was “all hands on deck” and May 10^th when they made the public announcement?

Zerohedge was way ahead of the media on this, but that’s because they think like traders. It seemed like a real possibility the news would spook the market, sending credit spreads soaring. That seemed like a likely and logical outcome of the call. So why not hedge some IG going in? If the market does nothing, it didn’t cost you to cover with IG18. If the market rallied (unlikely but possible) you would have lost because of the hedge, but you could have sold out of the AFS portfolio. If the market tanked, you might be able to sell AFS close to the mark (depending if it was more HY or more rate sensitive positions like high quality mortgages). So from a risk/reward standpoint, putting on some IG18 short wouldn’t cost much if wrong, and could save a lot of pain in the event of the market trying to attack your positions post announcement.

Whether to keep the HY short or not would have been more difficult in my opinion. There was some risk that the position would also get attacked and go tighter while IG was going wider. That in fact happened on the 11^th to a large degree, particularly in Europe. On the other hand, the HY short was probably more important to keep than the IG long, since this really was the original hedge. That may have led them to keep more HY short, since it was the original real position. It is also tough for HY to rally while IG is cratering. It can do it for a day or two, but if IG was going to crater, then HY was likely to follow suit. So keeping the HY short against the IG long would also have been logical post announcement.

So either JPM did nothing for 10 days and then put out an announcement giving the market a free pass to run them over, or there is a lot more going on behind the scenes and the simple estimates, which basically don’t explain the YTD P&L can be listened to.

I think the FT Alphaville crew has done a good job of digging into the details and have been a step or two ahead of others in terms of explaining the situation (though still a step or two behind us).

And of course Bloomberg which was the first to break the story back on April 6^th which led to our very first post on the subject Shorting IG9 vs IG18 on April 9^th, and IG9 Tranches explained from April 10^th.

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