Published November 20, 2014
A surprise $2 billion trading loss by a division of JPMorgan Chase triggered calls Friday for tougher regulation of banks three years after their near-death experience in the financial crisis.
Stock in the bank, the largest in the United States, lost 8 percent of its value in minutes on Wall Street, and other American and British banks suffered heavy losses as well.
JPMorgan Chase said Thursday that it lost the money in a trading group designed to manage the risks that it takes with its own money. CEO Jamie Dimon said the bank's strategy was "egregious" and poorly monitored.
The disclosure, a surprise to stock analysts, quickly revived debate about whether banks can be trusted to handle risk on their own in the age of "too big to fail."
"The argument that financial institutions do not need the new rules to help them avoid the irresponsible actions that led to the crisis of 2008 is at least $2 billion harder to make today," said Rep. Barney Frank, D-Mass.
Frank, the retiring Democratic leader of the House Financial Services Committee, said in a statement that the revelation runs counter to JPMorgan's narrative "blaming excessive regulation for the woes of financial institutions."
Dimon has been among Wall Street's most outspoken critics of efforts to regulate the financial industry more heavily.
Cliff Rossi, a former top risk executive for Citigroup, Countrywide and other big financial companies, said he drew little hope from the steps Washington has taken.
He said JPMorgan's loss shows that the market for the complex financial instruments known as derivatives is too opaque. He also said the loss demonstrates that banks like JPMorgan are too big to manage effectively.
"This just tells you that we are a long, long way from getting our arms around this whole 'too big to fail' issue," said Rossi, now executive-in-residence at the University of Maryland's business school.
"This is actually worse than Citigroup landing in trouble" in 2008, he said, "because JPMorgan is recognized as one of the better-run institutions."
The head of the Securities and Exchange Commission, Mary Schapiro, told reporters that the agency was focused on the JPMorgan loss but declined to comment further.
Experts and industry officials were skeptical that the trading was designed to protect against JPMorgan's own losses, as Dimon contended in a surprise conference call with stock analysts and reporters late Thursday.
The bank appeared to have been betting for its own benefit, a practice known as "proprietary trading," said Rossi and other former bank executives.
Dimon said the type of trading that led to the $2 billion loss would not be banned by the so-called Volcker rule, which is still being written and is expected to ban certain types of trading by banks with their own money.
The Federal Reserve said last month that it would begin enforcing that rule in July 2014. Bank executives, including Dimon, have argued for weaker rules and broader exemptions.
JPMorgan has been a strong critic of provisions that would have made this loss less likely, said Michael Greenberger, former enforcement director of the Commodity Futures Trading Commission, which regulates some derivatives.
"These instruments are not regularly and efficiently priced, and a company can wake up one day, as AIG did in 2008, and find out they're in a terrific hole. It can just blow up overnight," said Greenberger, a professor at the University of Maryland.
On Friday, bank stocks were hammered in Britain and the United States, partly because of fear that the JPMorgan loss would lead to tougher regulation of financial institutions.
JPMorgan stock was down about 8 percent in early trading on Wall Street. It was down more than $3, and by itself shaved 25 points off the Dow Jones industrial average, which was up about 30 points on the day.
In Britain, shares of Barclays and Royal Bank of Scotland were down more than 2 percent.
JPMorgan stock was the hardest hit, but its American counterparts suffered, too: Citigroup was down 4 percent, and Goldman Sachs and Morgan Stanley each lost more than 2 percent.
Stock analysts said that bank stocks were hurt mostly because of regulatory fear, not because there was reason to believe other banks would discover similar losses.
"The regulatory and political environment is already a headwind, and clearly this doesn't help," Deutsche Bank said in a note to clients.
The trading loss was an embarrassment for JPMorgan, which came through the 2008 financial crisis in much better health than its peers. It kept clear of risky investments that hurt many other banks.
The loss came over the past six weeks in a portfolio of the complex financial instruments known as derivatives, and in a division JPMorgan says was supposed to control its exposure to risk in the financial markets.
"The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought," Dimon told reporters on Thursday. "There were many errors, sloppiness and bad judgment."
Bloomberg News reported in April that a single JPMorgan trader in London, known in the bond market as "the London whale," was making such large trades that he was moving prices in the $10 trillion market.
Dimon said the losses were "somewhat related" to that story, but seemed to suggest that the problem was broader. Dimon also said the company had "acted too defensively," and should have looked into the division more closely.
The Wall Street Journal reported last month that JPMorgan had invested heavily in an index of credit-default swaps, insurance-like products that protect against default by bond issuers.
Hedge funds were betting that the index would lose value, forcing JPMorgan to sell investments at a loss. The losses came in part because financial markets have been more volatile since the end of March.
Partly because of the $2 billion trading loss, JPMorgan said it expects a loss of $800 million this quarter for a segment of its business known as corporate and private equity. It had planned on a profit for the segment of $200 million.
The loss is expected to hurt JPMorgan's overall earnings for the second quarter, which ends June 30.
"We will admit it, we will learn from it, we will fix it, and we will move on," Dimon said. JPMorgan is trying to unload the portfolio in question in a "responsible" manner, Dimon said, to minimize the cost to its shareholders.
He acknowledged that more losses are possible as JPMorgan's traders and risk management officers try to untangle the trades.
AP Business Writer Pallavi Gogoi contributed to this report.
Daniel Wagner can be reached at www.twitter.com/wagnerreports.