JPMorgan Chase & Co. Chief Executive Officer Jamie Dimonsaid the firm suffered a $2 billion trading loss after an“egregious” failure in a unit managing risks, jeopardizing WallStreet banks' efforts to loosen a federal ban on bets with theirown money.

The firm's chief investment office, run by Ina Drew, 55, tookflawed positions on synthetic credit securities that remainvolatile and may cost an additional $1 billion this quarter ornext, Dimon told analysts yesterday. Losses mounted as JPMorgantried to mitigate transactions designed to hedge creditexposure.

“There were many errors, sloppiness and bad judgment,” Dimonsaid as the company's stock fell in extended trading. “These weregrievous mistakes, they were self-inflicted.”

The chief investment office was thrust into the debate over U.S.efforts to ban proprietary trading when Bloomberg News reportedlast month that the unit had taken bets so big that JPMorgan, thelargest and most profitable U.S. bank, probably couldn't unwindthem without losing money or roiling financial markets. Dimon, 56,had transformed the unit in recent years to make bigger and riskierspeculative trades with the bank's money, five former employeessaid.

Dimon had defended the unit as a “sophisticated” guardian of thebank's funds on an April 13 conference call, calling news coverage“a complete tempest in a teapot.” On May 2, he led fellow WallStreet CEOs in a closed-door meeting to lobby the Federal Reserveabout softening proposed U.S. reforms that might crimp theirprofits.

Yesterday, he said the timing of the trading blunders “playsright into the hands of a bunch of pundits out there” who arepushing for a strict version of the proprietary trading ban namedfor former Federal Reserve Chairman Paul Volcker.

Given Dimon's resistance to the ban and new regulations, “he'sgot a lot of egg on his face right now,” said Craig Pirrong, afinance professor at the University of Houston. “Any chance theyhad of getting a relative loosening of Volcker rule, anything ofthat nature, that's out the window.”

The chief investment office's push into risk-taking was led byAchilles Macris, 50, according to three former employees, BloombergNews reported on April 13. He was hired in 2006 as its topexecutive in London and led an expansion into corporate andmortgage-debt investments with a mandate to generate profits forthe New York-based bank, they said. Dimon closely supervised thetransition from its previous focus on protecting JPMorgan fromrisks inherent in its banking business, such as interest-rate andcurrency movements, they said.

'Wall Street Hubris'

“I wouldn't call it 'more aggressive,' I would call it'better,'” Dimon told analysts yesterday. “We added different typesof people, talented people and stuff like that.” Until recently,they were careful and successful, he said.

“It's classic Wall Street hubris, which we've seen so many timesbefore,” said Simon Johnson, a former chief economist at theInternational Monetary Fund who now teaches at the MassachusettsInstitute of Technology. “What's particularly ironic here is thatJamie presents himself, and is believed by others to be, the kingof risk management.”

Bloomberg News first reported April 5 that London-based JPMorgantrader Bruno Iksil had amassed positions linked to the financialhealth of corporations that were so large he was driving pricemoves in the $10 trillion market.

The $2 billion loss occurred in London under multiple traders,according to an executive at the bank, who spoke on the conditionof anonymity. Dimon wasn't immediately told about their shift instrategy and didn't know the magnitude of the losses until afterthe company reported earnings April 13, the executive said. As theposition deteriorated rapidly, the bank gathered internal analystsand examiners to investigate, and Dimon grew more distressed by theday, the executive said.

While no one has been fired yet, Dimon told analysts he willtake “corrective actions.” The bank is keeping employees involvedon hand while it deals with the transactions, and some are likelyto lose their jobs afterward, said an executive with knowledge ofthe situation. The bank is also reevaluating its risk-monitoringteam within the chief investment office, the person said.

JPMorgan risks losing more money now because other marketparticipants will figure out what the bank has to do to unload itsposition, said Charles Peabody, an analyst with Portales PartnersLLC in New York. Costs from the trades may affect earnings throughthe end of the year, he said.

“When there's blood in the water, the sharks are going to attackthat animal,” said Peabody, who downgraded his recommendation onthe stock in March to sector perform. “It could make it verydifficult for them to unwind a trade.”

JPMorgan shares, which closed at $40.74 yesterday in New York,fell 7 percent to $37.91 by 11:33 a.m. in Frankfurt trading. Thestock had advanced 23 percent this year before the losses weredisclosed.

The cost of insuring debt of JPMorgan from default rose.Credit-default swaps insuring the bank's debt climbed 17 basispoints to 124, the highest since Feb. 16, according to datacompiled by Bloomberg. A basis point is equivalent to a hundredthof a percentage point.

Bonds of JPMorgan declined the most in six months, widening thegap in yield between the lender's $6 billion of undated 7.9 percentjunior subordinated notes and the 0.875 percent Treasury due 2018by 16 basis points to 392.2 basis points, according to BloombergBond Trader prices at 10:10 a.m. in London. The price of the note,callable in 2018, fell 2.2 cents on the dollar to 107.84 cents,pushing up the yield to 6.3 percent.

Dimon declined on the call to discuss the specific transactionsor people involved. Synthetic credit products are derivatives thatgenerate gains and losses tied to credit performance without theowner buying or selling actual debt. JPMorgan used the instrumentsto hedge exposure on loans and other credit risks to corporations,banks and sovereign governments. The losses emerged after the firmtried to reduce that position and unwind the portfolio, Dimonsaid.

The bank said losses were partly offset by gains from the salesfrom its available-for-sale credit portfolio, resulting in a netloss for the firm's corporate division, which includes the CIO, ofabout $800 million after taxes. Dimon said losses could widen ornarrow in coming weeks and months, and that he can't estimatepotential costs.

Confirming Fears

As the bank repositions the synthetic credit portfolio, thechief investment office “may hold certain of its current syntheticcredit positions for the longer term,” the firm said.

“Hopefully, this will not be an issue by the end of the year,but it does depend on the decisions and the markets,” Dimonsaid.

JPMorgan also changed how it calculates so-called value at risk,or VAR, a measure of how much the company estimates it could loseon securities on 95 percent of days. The company restated its VARfor the first quarter, previously disclosed at $67 million, at $129million. The bank used a new model for calculating its trading riskin the first quarter that Dimon said was “inadequate.” It isreverting to the old model.

“It's a major event that confirms a lot of investors' worstfears about bank risk,” said Frank Partnoy, a former derivativestrader who's now a law and finance professor at the University ofSan Diego. Concern is “that at a large, supposedly sophisticatedinstitution, even something called a 'hedge' can contain all kindsof hidden risks that the senior people don't understand.”

Iksil may have amassed a $100 billion position in contracts onSeries 9 of the Markit CDX North America Investment Grade Index,counterparts at hedge funds and rival banks said in April. Theybased their estimates on the trades and price movements theywitnessed as well as their understanding of the size and structureof the markets. The positions amounted to tens of billions ofdollars, under the firm's own math, a person familiar with its viewsaid at the time.

The trade on the index probably wasn't a one-way bet, the marketparticipants said. Iksil may have offset it by buying protection onthe same index with contracts that expire about seven months fromnow, the people said. That strategy would pay JPMorgan thedifference between the long-dated contracts and the short-datedones, and the trade would gain when the gap narrows. The hedgewould end in December unless another trade is made to replaceit.

Satyajit Das, the author of “Extreme Money: Masters of theUniverse and the Cult of Risk,” compared the publicity aroundJPMorgan's situation to losses that spiraled at hedge funds likeLong-Term Capital Management in 1998 and Amaranth Advisors LLC in2006.

“A $2 billion loss suggests a position of considerable size,”Das said. “I think you remember LTCM and a few other people likeAmaranth that have had the exact same problem and have learned it'sa bit like hell — easy to get into, not so easy to get out of.”

For the story from April about JPMorgan's chiefinvestment office, see JP Morgan Treasury Takes Big Bets.

Bloomberg News

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