Q&A on surprise $2B trading loss at JPMorgan

Associated Press Modified: May 11, 2012 at 6:30 pm •  Published: May 11, 2012
Advertisement
;

NEW YORK (AP) — How can a bank lose $2 billion in six weeks?

That's just one of the mysteries surrounding the news that JPMorgan Chase, widely thought one of the safest U.S. banks, is gushing red ink from bad trading bets. As details slowly emerged Friday, the shares of the nation's largest bank fell hard, as did those of several rivals.

The story behind the loss is complex, and rich in irony. How it's viewed could influence regulators implement a major financial overhaul law called Dodd-Frank. How hard regulators crack down on bank could have a big impact on the stability of the financial system.

Here are answers to some questions about the loss:

Q: How exactly did the bank lose so much so fast?

A: First, start with the irony. JPMorgan says the losses came from a trading portfolio designed to offset losses in the bank's lending business. Instead of offsetting losses, these so-called "hedges" added to them.

JPMorgan extends money to companies through loans and by buying bonds. The bank was worried that it might not get all its money back, so it bought protection. Though it didn't detail how it did this, banks typically buy credit default swaps, essentially insurance contracts that pay out when companies stiff their lenders.

It gets more complex. In the often dizzying, Alice-in-Wonderland world of banking, these hedges are themselves sometimes hedged, and that's exactly what JPMorgan did. The bank apparently thought it had bought too much protection, so it hedged its hedge.

It's that second hedge, basically a bet that companies would pay back their loans, that led to the losses.

Q: How does the "London Whale" figure into the story?

A: News reports before the bank announced its loss said that a trader at the bank dubbed the "London Whale" had invested heavily in an index of credit-default swaps, and that the bets were producing losses. But in a conference call Thursday, Jamie Dimon, the CEO of JPMorgan, said the news reports about London trades were only "somewhat related" to the losses. He provided no other details.

Q: Why are other bank stocks falling on the news?

A: It's not just the size of the bet that's scaring investors, but its complexity. The fact is, not even experts know how precisely big banks make money, and occasionally lose it. Their wagers are largely hidden. The opaqueness, which investors normally shrug off, is spooking them now.

Investors are uneasy also because JPMorgan has a reputation of managing risks better than almost anyone in the business. Investors seem to be asking: If this bank can lose $2 billion in six weeks, maybe others can, too?

Finally, there's the regulatory threat. The loss comes amid heated debate in Washington over just how tightly to regulate banks. "The timing of the JPMorgan announcement couldn't be worse," said Whitney Tilson, head of hedge fund T2 Partners, speaking at an industry gathering in Las Vegas.