Banks Are Down but Not Out

As the bank's portfolio bet grew in size in early 2012 and as more troubling events in the eurozone emerged (in Greece, Italy and Spain), senior bank management's directive was to increase the portfolio's hedge (and to reduce risk). That was done, apparently in a poorly executed manner that failed to correlate with the intended strategy, and, to some degree, it backfired. I suspect that the bank, again, was too aggressive and paid up for protection, but it is not yet clear. The same hedge funds that got hurt in 2011 on JPMorgan's trade started to prosper from the trade. And when JPMorgan reversed and started to hedge its bets, those hedge funds pressed their bets and JPMorgan suffered expanding losses.

Both the trades in 2011 and 2012 were clearly proprietary trades and are difficult to justify as portfolio hedges, but I suppose in time (and in light of the large accumulated profits), the bank rationalized it as part of its investment portfolio. By that time, however, it was too late.

That said, in such a period of heated regulatory reform debate and in light of the size of the position, it is terribly disappointing that JPMorgan's management wasn't in closer control of the situation. The second trade (in April) was clearly a hedge made to reduce existing portfolio risk.

Back to Dimon.

Originally, I thought there were two ways of looking at Dimon's role (and in determining the possible impact to his reputation) on these trades.

I put very low odds that Dimon had been disingenuous or was even lying about the role of prop trading at JPMorgan. By all counts, Dimon is honest and forthright. (Look at his self-effacing annual report letters as an example of this.)

For months, Dimon had been arguing to the public and to the regulators that hedging was necessary since loans were a relatively small percent of deposits gathered -- the rest was investments, many of which were not government-backed and many were abroad. So credit, interest rate and currency risks, he argued, needed to be hedged. The problem, as some will note in the coming days, is that in a recent public interview in April, he was less than candid in fessing up to the portfolio's losses, as he cited that concerns about the CIO's large positions was "a tempest in a teapot."