Ever wondered why hedge funds remain so popular? Against much sense?
Here’s one suggestion from JPM’s Niko Panigirtzoglou and team, with our emphasis:
Why is the HF industry continuing to attract large amounts of capital [$18.2bn in Q1 up from $3.6bn in the previous quarter] despite disappointing performance? This puzzle is also reflected in HF surveys such as those conducted by Preqin. The performance of HFs has lagged institutional investors’ expectations for every single year since the Lehman crisis with the exception of 2013. At the same time institutional investors reported that they intend to increase rather than decrease HF allocations over the next 12 months.
Steady demand for convexity since the Lehman crisis is clearly one reason behind the inflows into HFs. But we believe there is another reason, which is the quest by investors for alternatives to bonds. Successive QE programs by G4 central banks have withdrawn $8tr of bond securities since the Lehman crisis and have made bonds very expensive as an asset class, inducing institutional investors to seek higher yielding alternatives to bonds even as these alternatives entail illiquidity risk. And HFs have to an extent become an alternative to bonds as the collapse in HF volatility has made HFs look a lot more like bonds rather than equities in recent years. This is shown in Figure 1 where the volatility of monthly HF returns has collapsed to that of the US Aggregate bond index over the past three years. In other words, with an annualized volatility of only 3.2%, HFs are equivalent to a bond rather than equity investment in terms of their second moment.
In case anyone wanted a closer look at Goldman’s trolling of JP Morgan…
Since it’s curiously hard to find on the NY Fed’s home page, given the prominence of Bill Dudley’s recent firebreathing speech warning against complexity and cultural dysfunction in US banks…
Click for the Federal Reserve inspector general’s account of how the NY Fed failed to follow up on the early signs it had uncovered of risks in JPMorgan’s Chief Investment Office. Read more
Hey did you hear the Fed finalised its liquidity coverage ratio rules for large US banks?
Yep, you can read the announcement here. Read more
Federal Reserve fine: $200m
SEC fine: $200m
OCC fine: $300m
UK FCA fine: £137m
JPMorgan shareholders keeping Jamie Dimon as chairman: priceless Read more
This is what JPMorgan investors were treated to on the webcast, after hearing shareholders at the bank’s annual meeting vote against splitting the chairman and chief executive roles…
Message from the CEO of Bloomberg
Dear Client, Read more
…it was just someone using Excel on a laptop who was highlighting cells for a formula and released his index finger from the left-clicky button of his mouse too soon.
Writes Irish stand-up comedian Colm O’Regan for BBC Magazine, in his piece about “The mysterious powers of Microsoft Excel”. As you will likely have guessed, his article was inspired by spreadsheet blunders in Reinhart and Rogoff’s 2010 Growth in a Time of Debt paper. Read more
Mr. Hagan had never previously designed a VaR model. According to JP Morgan Chase, having an employee from a business unit design the unit’s risk model was somewhat unusual, but it did not violate bank policy…
Mr. Hagan told the Subcommittee that he was told the objective of his research was to design VaR models that, when fed into the RWA model, would produce lower RWA results for the CIO, since both he and the CIO traders viewed the bank’s standard RWA model as overstating CIO risk.948
Apologies for all the jargon there. The above is from the Senate Permanent Subcommittee on Investigations staff report on the JPMorgan “Whale trades” that lost the bank over $6bn in 2012.
While the portfolio that lost all those billions was comprised of outsized credit derivatives trades, building up such positions wouldn’t have been possible without a significant change in a key risk model that the bank was using — the Value-at-Risk (VaR) that predicts possible losses over a given time horizon. Read more
Don’t. Just don’t. No “I don’t think we should treat this as regulatory arbitrage” in an email. No cc’ing your personal Yahoo account. And certainly don’t put “Optimizing regulatory capital” in the subject line.
All in, below is a really good example of what not to put in an email, courtesy of Patrick Hagan, the chief quantitative analyst at JPMorgan’s Chief Investment Office from 2007. Read more
FT Alphaville is (still) poring over (and enjoying) the staff report from the Senate Permanent Subcommittee on Investigations on the JPMorgan “whale” trades in its Chief Investment Office that lost the bank over $6bn. It takes
a lot of coffee awhile to get through all 597 pages of exhibits along with the 307-page report, and all the glorious footnotes, so please kindly bear with us.
As it stands, the more we read, the more dirt we turn up. And the uglier we realise this whole episode was, the more we become concerned: if this happened at JPMorgan, where else could it happen?
The below on risk limits serves as a case in point. The tl;dr version in graphs below, but first from the staff report (emphasis ours): Read more
By now, it should be well understood that the credit derivatives book in JPMorgan’s chief investment office was woefully mismarked. Worryingly, the practice of marking at the extremes of the bid-offer, giving the most favourable result, was rubber-stamped as acceptable practice by both the bank’s controller and the outside auditor.
The restatement of first quarter earnings in July 2012 only happened as a result of investigators from JPMorgan’s special Task Force discovering that the traders hadn’t supplied the marks “in good faith”. We’re not sure what place “faith” has in decent account practice. The whole Street seemingly disagreed with the marks, as demonstrated by large collateral disputes. In any case, let us examine this lack of good faith by reviewing some of the things the traders said about their marks. Read more
There were some pretty massive collateral disputes with counterparties that should have set alarm bells ringing around JPMorgan’s chief investment office.
The biggest disputes in absolute dollar terms were with a Morgan Stanley entity (MSCS) and Bank of America (BOA), with several other counterparties out by tens of millions. Read more
Time to start tackling the big question: how were such huge credit derivatives positions allowed to be put on by JPMorgan’s chief investment office (CIO) in a matter of mere months back at the start of 2012? Someone, or several someones, should have noticed that the synthetic credit portfolio (SCP) was headed for a disaster of epic proportions.
Weren’t there risk limits? Despite being a top of the range tool for crisis aversion, and being breached several times, the warning signs around these weren’t effectively responded to. Even worse, they were simply accommodated for. We’ll discuss that in future posts. Here, we want to talk about another tool that could have averted disaster: the marks on the book. The marks should have shown increasingly frightening losses, leading people to ask what the hell was going on. Read more
As we wrote in our last post, the structured credit portfolio (SCP) that ended up costing JPMorgan some $6.2bn was probably meant to hedge something somewhere. But seeing as we can’t be sure of exactly what that was, maybe we should all stop pretending it was anything other than a prop trade. Hedges do not spring forth from good intentions alone, after all.
What seems more likely is that the portfolio had done quite nicely over time, especially in relation to the relatively low headcount needed to run it, so it wasn’t policed as hard as it should have been. Read more
Once upon a time, there waz a big, big bank called Jay Pee Morgan. Also there waz a crysis! Everywon was wery scard. Som of the otha big banks got in trobel. Dis made Jay Pee Morgan ewen biger. So big that is Chwef Inwestment Ofwice hade $350bn dolars. Dis means it waz da sventh bigst bank in the countree if it was all on is own! Al so Jay Pee Morgan was big caus had got a big Bear and also took all the piggybanks dat Washtown Mootowel had. Meanie.
Some da $350bn dollarz froom all da piggybanks was inwested in kredit derivativs. But the stwange ting waz, none of the grown-ups seem to no why… or wha phor. Silly grown-ups!
* * * * *
Seriously, it’s that awkward trying to figure out what the structured credit portfolio (SCP) of JPMorgan’s chief investment office (CIO) — that lost the bank some $6.2bn — was meant to be doing or hedging. Read more
It’s going to take awhile to go over the report of the Senate Permanent Subcommittee for Investigations. There are 1,654 footnotes and we wouldn’t want to miss a single one.
This, however, is one of our favourite exhibits thus far. Not that it’s shocking. More that it’s kinda like a famous artifact that we never thought we’d get to see: Read more
A grateful hat tip to the FT’s Shahien Nasiripour for constructing and sending us the following basic spreadsheet.
It shows the discrepancy between the Fed’s estimates of how the largest banks would perform in its latest stress test scenario, versus how the banks themselves said they would fare (click to enlarge): Read more
Frankly we’re bored of this, but:
That question deserves some serious thought, don’t you think? Read more
A lot of people think you can just throw a bunch of chaos into a situation and walk away. That is not the case. The most you’re going to get outta that is mayhem. Good disaster, like really muah [kisses fingers], should be catastrophic and that, my friends, takes preparation and patience.
In the case of the synthetic credit portfolio of JPMorgan’s CIO, they had a good three months to build positions that would subsequently cause billions of dollars of losses. Our previous post outlined how, according to the bank’s Task Force Report, the CIO was going to unwind profitable high yield shorts at the beginning of 2012. Instead, the unit ended up building those positions further, along with long positions in the Markit CDX.NA.IG.9 index that were meant to hedge and finance them. Read more
If it’s alright by you, FT Alphaville has a confession to make. This whole London Whale thing, the billions that JPMorgan lost as a result of the actions of its Chief Investment Office primarily in the first quarter of 2012… we kinda made a cottage industry of trying to figure out what the trades were. Not that it was just us, mind you.
Naturally, we had been hoping that we’d finally get some answers when the Task Force Report came out last week. The report has revealed in painful detail how a large, well-respected bank can get so much wrong. There were bad risk management practices, model deficiencies, spreadsheet errors, complacent management and more. But trade details? That’s left for us to piece together from various scraps. Read more
Spreadsheet errors sure are a fun, but serious, topic. The last time FT Alphaville dove into JPMorgan’s Task Force Report on its losses in synthetic credit thanks to the bank’s Chief Investment Office, we took you through the blunders around their shiny new VaR model (that didn’t work). This time we want to introduce you to the spreadsheets with valuation errors. Read more
Oh, my, my, my. From JPMorgan’s Task Force Report into the London Whale with its billions of losses in synthetic credit, this footnote:
74 Late on April 6, [JPMorgan CFO] Mr. Braunstein also received an e-mail from Mr. Venkatakrishnan, via [JPMorgan CRO] Mr. Hogan, stating that Mr. Venkatakrishnan had noticed that the notional exposures at CIO were very large, totaling about $10 trillion in each direction.
The Task Force Report into the billions of dollars of losses racked up by JPMorgan’s Chief Investment Office has revealed a number of things, not least of which are some impressive spreadsheet errors.
Impressive enough, perhaps, to be worthy of inclusion in the European Spreadsheet Risks Interest Group’s list of Horror Stories.
(Yes, there is such a group and a massive H/T to reader Justin Cormack for informing us of it. Justin, we hope you don’t want to work for JPMorgan.) Read more
This one paragraph, describing the nature of the curve trade that JPMorgan’s Chief Investment Office had in the Markit CDX.NA.IG.9 index by the end of January, fills us with mixed emotions. There’s a bit of “oh, they did think they were doing that?” and a bit more of “‘but why?? WHY?”. Read more
JPMorgan’s Whale report just keeps on giving: from the blow by blow account of internal P&L swings after the first articles were published about the CIO’s trades, to discussion on how achieve the firm-wide goal of reducing risk-weighted assets.
Let’s start with the former, shall we? Read more
JPMorgan’s Chief Investment Office was given an edict to try to reduce risk-weighted assets, as part of a firm-wide initiative in the face of regulatory changes, and also to shift the synthetic credit portfolio to be more in keeping with the more bullish view of the economy that senior management held. All confirmed by the bank’s own Task Force Report out on Wednesday.
It appears there was a key moment, when the bank was caught off guard by the default of a “significant corporate issuer” in mid-January. Did it change the course that the portfolio otherwise would have taken? Read more
It’s history, JPMorgan Task Force Report style. Or rather, it’s a mostly oral history, lacking in technical detail, and it’s not all independently verified. Oh, and heavily reliant on one guy. All of which is prominently outlined in this footnote… Read more