A LARGE, mistaken, trading position take by J.P. Morgan, one of America’s leading banks, already costing it more than $2 billion has become a weapon in major battles in Washington and the financial markets.
In Washington a crowd of politicians has used the incident to argue for more government involvement in banking, even if the ideas floated are muddled or counter-productive. In the financial markets the response has been more focused and carnivorous as other financial firms are trying to get ahead of any move Morgan might make to extricate itself from its trade. The company’s share price, already down more than 9% on May 11th after the initial revelations, fell another 2% on early trading when markets reopened after the weekend on May 14th.
Morgan response to the incident has come on multiple levels. Jamie Dimon, its chief executive, appeared on a popular news show on Sunday to acknowledge fault for the trade (“a stupid thing that we should never have been done”), but also provide reassurance (“…but we are still going to earn a lot of money this quarter. So it isn’t like this company is jeopoardised…”). Morgan’s capital position does indeed remain strong and it is projected to earn record earnings for the year.
Internally, Morgan made key executive changes. The head of the department arranging the trade, Ina Drew, abruptly retired. A special committee to direct the response to the trade was established under the bank’s former chief financial officer Mike Cavanagh, often rumoured as the leading candidate to one day succeed Mr Dimon. This will certainly be a trial by fire.
In the financial markets, various obscure indices tied to credit default swaps moved abruptly, as other firms took bets on what comprised Morgan’s trade, and whether it was vulnerable to a squeeze. That raised the possibility of the loss quickly expanding. Under accounting rules they must be constantly marked to market.
A key questions are whether Morgan has the fortitude to withstand the short-term pain of trading-induced price movements that are not tied to the value of the assets underlying the swaps, and how much value in these assets really does exist. So far, Morgan has believed its efforts to minimise the damage from the trade would benefit from keeping information of its components from the broader market. Meanwhile, other banks have begun re-examining their own trading positions to ensure a similar problem cannot emerge.
