A well-regarded U.S. lender once lost a tidy sum on derivatives, and Jamie Dimon had to ride to the rescue.
It wasn't JPMorgan. It was Banc One, a regional lender that piled into derivatives in the early 1990s. Banc One's shares tumbled as the trades went sour, eventually leading to the hire of Dimon as CEO in 2000 - and later, Banc One's acquisition by JPMorgan.
The trades in a number of ways echoed those more recently under focus at JPMorgan (JPM.N). In both cases, the banks came under attack for losses on what they described as hedges but others feared were trades meant to enhance returns.
The banks built large portfolios at little cost, aided by low capital charges backing the contracts. Unlike other assets, such as bonds or loans, derivatives can be traded with little upfront cost, with collateral to back the trades often only collected as the trades move in value.
Fears over losses in derivatives were exacerbated by the opaque nature of these markets, which are now $650 trillion in size. Investors worry that other risks may be lurking on the balance sheets of JPMorgan Chase & Co (JPM.N) and other banks.
Both cases demonstrate that even the most sophisticated banks may not fully understand the risks of certain activities. They also tend to fail to learn from the past.
Excessive leverage and complex credit derivatives were a big factor behind the 2008 financial crisis that led to the Dodd-Frank legislation being passed by Congress in an effort to reduce risks. Until JPMorgan's losses became known in May, bank-led industry groups were gaining ground in trying to head off many key tenets of the derivatives reform regulation.
But Dimon's reputation as a top risk manager has been tarnished from the losses. JPMorgan shares are down about 23 percent since the losses were announced May 10, and the bank faces multiple regulatory probes.
People familiar with the situation say that the unit behind JPMorgan's losses had looser controls than at the rest of the bank, and was able to build up risky positions without triggering alarms.
"You had the smartest guy in the room blind-sided to at least $2 billion," said Michael Greenberger, a law professor at the University of Maryland and a former director of trading and markets at the Commodity Futures Trading Commission.
In Banc One's case the losses came from relatively simple contracts, amortized interest rate swaps.
The contracts were attractive to Banc One as they could be booked off its balance sheet, while the interest gains from lending at long-term maturities and borrowing at a short-term rate were recorded on-balance sheet as net interest income.
Profits from the trades, while they benefited from falling rates, helped Banc One solidify a reputation of superior risk management and investment ability.
"Analysts had attributed income to their lending business
http://www.reuters.com/article/2012/06/04/us-jpmorgan-hedge-idUSBRE8530M320120604?feedType=RSS&feedName=businessNews&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+reuters%2FbusinessNews+%28Business+News%29
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