The Mother Of All Short Squeezes Has Commenced

Robert Wenzel writes in Economic Policy Journal Details on the Losing JPMorgan Trade Emerge.  Ben Protess, Andrew Ross Sorkin, Mark Scott and Nathaniel Popp at NYT have an exhausting detailed report on the losing trade that is costing JPMorgan Chase billions in losses.

Of note in their report, the point is made which I made in an earlier post:

 the loss is not a huge threat to a bank as large and powerful as JPMorgan.

Still the trade is fascinating. Here’s what went down according to the NYT crew:

 Last summer the chief investment office began calling brokers at several Wall Street banks, the brokers say. The office was offering to sell insurance on an index of big American corporations like General Mills, Alcoa and McDonald’s — known as CDX IG Series 9. If the companies in the index went bankrupt, JPMorgan would have to pay out, but if the companies continued to do well JPMorgan could rake in the fees from financial firms that bought the insurance…

The strategy initially made money for JPMorgan and its position began to grow, as did an appetite for it among a tight-knit segment of hedge funds  focused on credit opportunities. The large scale of the trade was permitted as a result of an expansion in the limits placed on the size and the scope of securities the unit could trade in that were adopted after JPMorgan acquired Washington Mutual in the financial crisis. Those limits have now been scaled back.

By January, these hedge funds were getting calls nearly every day from brokers representing the chief investment office, according to hedge fund managers and brokers on the calls.

The seller’s identity was not supposed to be known, but the sheer volume of the trade made it hard to hide, and soon enough all fingers in the “small, clubby world” of credit hedge funds pointed to Mr. Iksil’s desk at JPMorgan, according to one fund manager.

“A bunch of us started looking at it and talking about it a lot,” the manager said. “There was agreement that Bruno [Iksil, JPMorgan’s London Whale] was selling.”

There were two ways that JPMorgan could win this bet. If the companies in the index did well, the bank’s cost of insuring the index would continue to fall. JPMorgan could also artificially drive the price lower by continuing to issue more and more insurance — a distinct possibility thanks to JPMorgan’s size and stature.

In January and February, as the price of the insurance continued to drop, lunch meetings and casual conversations between hedge fund managers swirled around the ability of JPMorgan to continue financing this bet.

“A lot of people told me it was a foolish trade,” said an official with a hedge fund that bet against JPMorgan. “The naysayers on this trade said, ‘Look, this guy has unlimited firepower, he can just keep selling and selling and make your life miserable.’ ”

Among the hedge funds that began taking positions against JPMorgan were Blue Mountain, a New York fund; Lucidus Capital Partners, a London fund; Hutchin Hill, a New York fund; and Bluecrest, a giant London hedge fund founded by two former traders on JPMorgan’s proprietary trading desk.

The trade did not at first make money for the hedge funds. In the improving economy early in the year, the hedge funds had to make regular insurance payments. But in late March, doubts about the economy began to swirl, and the index jumped.

JPMorgan began seeing losses by the end of the first quarter, on March 31, but they were not enormous, allowing bank executives to shrug off the early criticisms of the trade. But the trade drew increasing attention as the index continued to spike, multiplying JPMorgan’s potential losses if it had to pay out on the insurance…

In the case of the trade that generated the huge loss, the insurance on the contract does not come due until 2017, so JPMorgan could potentially hold off any actual losses until then. If the economy improves, the cost of insuring American companies could drop again. But now that the London Whale’s trade is public, hedge funds could force the cost of this specific insurance contract up, and with it JPMorgan’s paper losses. This is what appears to be happening now.

The list of the 129 companies in the CDX IG Series 9 index is here.

Bottom line: Given the mark-to-market requirements for banks and the capital requirements, this was an impossible trade for JPM to hide, once it started going against them. Now, it could be very tough for JPM to get out, far beyond the additional billion that is speculated it will cost JPM. This is going to be the mother of all short squeezes. What was The Whale thinking? What was Jamie Dimon thinking? As a senior Wall Street executive quoted by NYT put it: “JPMorgan violated the cardinal rule of risk: Don’t become the market.”

In answer to the question what was Jamie Dimon thinking? Part of the answer resides in greed; part of answer resides in living and working in a leveraged speculative investment bubble, that is the bubble of Manhattan, another part of the answer is failure to understand risk-on momentum investing driven by ongoing expectation of US Central Bank and ECB ZIRP which ceased in March 2012, another part of the answer is in failure to understand risk, and the appointment of a capable risk management officer who has the authority to say no, nien, no more; but most of the answer lies in an understanding of psychopathy, pyscopathic behavior, and psychopaths, which the Bible describes using the word poneros, meaning unreasonable, wicked, destitute of faith in God, and lacking of any conscience or remorse.
The word poneros has broad meaning, it can mean simply bad, or evil, or wicked, depending upon the context. The apostle Paul used the word poneros in 2 Thessalonians, 3:1-2, where he said, “Finally brothers, pray for us, that the word of the Lord may run swiftly and be glorified, just as it is with you, and that we may be delivered from unreasonable, and wicked men,  for not all have faith.” In as much as the Apostle, said “pray for us that the word of the Lord may run swiftly and be glorified”, apparently the apostle was opposed in Thesslonica by men in the community who felt that the city was their territory to manage and did not want any opposition. 
Likewise today, there be many psychopaths. Literature suggests that four percent of the population is psychopathic; yet from personal experience, I believe the number is closer to ten percent; in the financial industry I am certain the number exceeds ten percent.
As I’ve shared many times on this blog, my entire life has been occupied by psychopaths. For example, in 1999, I desperately wanted a change of scenery, so I left to spend a year in a hunting and fishing lodge in Montana. The lodge was something like in Better Homes And Garden Magazine, located four miles from a celebrity town, one mile from a stream and lake, and situated next to both private and public trails, which were great for walking and cross country skiing. I came in January 1999 and the owner took a liking to me, and invited me to stay for an entire year in the master bedroom with sunken tub, for only $450 a month, even though hunting and fishing guests paid $200 a night to stay for expeditions. He had a servant girl, a young eighteen year old native Ameican girl, who knew how to prepare meals. I never had any of her cooking, as I would come down after the guests had gone to bed to fix my meals for the next day and chat with her. It was in the conversations with little Pocohauntus, that I learned my host was a psychpath. He had been married, but continually fought with his wife, and his angry behavior spilled over into the raising of their two boys. The little saint, who had come to know Christ on the nearby reservation, said that she created hand made decorations to go on the doors of several rooms, as the B&B’s owner had punched and kicked the doors in angry arousal with his teens, and that finally the family broke up; these included Babbling Brook and Peaceful Valley. I kept to my self after that, and got along well with all, and when in town, I would see movie stars all the time who had second homes in the hills, and finally left on good terms after a year. So I understand and observe ponerous individuals; they as God’s grace and truth, omnipresent.       

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