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American Airlines Bankruptcy Helped JPMorgan To $6 Billion Loss

Tickers in this article: AAMRQ JPM

Updated to include testimony from former JPMorgan CFO Douglas Braunstein .

NEW YORK ( TheStreet) -- In the ever more twisted tale of JPMorgan's(JPM) risky trading activities, a Senate report released on Thursday indicates that the bankruptcy of American Airlines (AMRPQ) helped the bank to an over $6 billion loss, known as the "London Whale" trade.

The Senate subcommittee on investigations report -- titled JPMorgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses -- makes the case that the bank's backfired trading strategy escalated on the heels of a $400 million payout from the bankruptcy of American Airlines in late November 2011.

Had American Airlines fallen into bankruptcy just a few weeks later, JPMorgan stood to lose on a trade in complicated credit derivative instruments, potentially exposing a flawed strategy undertaken by the bank, according to the Senate report.

Instead, American Airlines declared bankruptcy on November 29, netting JPMorgan between $400 million to $550 million in trading profits that the Senate report says gave traders and risk managers the confidence to grow the risky "London Whale" trade from about $51 billion in notional value at the end of 2011 to $157 billion by early 2012.

The move proved to be disastrous, eventually causing JPMorgan to hold an unwieldy trading position that has led to over $6 billion in losses, puts the banks ability to manage risk in question and has caused the biggest blemish in CEO James Dimon's career.

Media reports and corporate filings indicate some JPMorgan employees involved in the trade may face criminal probes, while others such as Ina Drew, a well-respected risk manager, have been forced out of the firm.

A Senate hearing on Friday will stoke further inquiry into the failed "London Whale" trade as advocates for Wall Street reform use JPMorgan's surprising loss to make the case for the Volcker Rule, a yet-to-be-finalized a piece of the 2010 Dodd-Frank Act that prohibits banks from making proprietary trades.

"The 'Whale' trades expose problems that reach far beyond one London trading desk," said Subcommittee Chairman Carl Levin, a Democrat from Michigan, in Friday testimony.

The genesis of JPMorgan's "London Whale" trading loss began with the creation of its 'Chief Investment Office' in 2006, a unit set up to hedge the bank from various interest rate, macroeconomic and credit risks.

During the financial crisis of 2008, CIO helped insulate JPMorgan from what was an historic credit crunch, as risk managers such as unit head Drew managed effective hedges to risks ranging from rising and falling interest rates and exposures the bank faced on servicing failed mortgages, according to the Senate report.

In 2011, however, the CIO took on a new dimension, investing heavily in a portfolio of structured credit products such as illiquid credit default swap indices. Those trades, the Senate subcommittee says, turned the CIO unit from a hedge to one making directional bets on markets, with disastrous results.