(MoneyWatch) A "flawed, complex, poorly reviewed, poorly executed and poorly monitored" derivatives trading strategy has cost JPMorgan Chase (JPM) $2 billion in the past six weeks and the bank could face an additional $1 billion of losses in the second-quarter, according to CEO Jamie Dimon. The bets were placed in the bank's Chief Investment Office, a London-based unit of the bank that manages risk for the firm.
Given the lessons of the financial crisis, many will wonder how this could happen. The answer is simple: JPMorgan Chase blew it. As a former derivatives trader, this looks like a simple case of bad risk management, followed by an inability to cut losses quickly.
The firm put on a complicated strategy that bet on the improving credit of selected companies. At the time, the trades were widely thought to be placed by a large firm backed with ample capital. The trader behind the strategy became known as "the London whale," though we now know that it was a French-born JPMorgan employee named Bruno Michel Iksil.
As the bet moved against the London Whale, Jamie Dimon brushed it off and even went so far as to say it was a "complete tempest in a teapot," during last quarter's earnings call. In off the record quotes, some JPM employees said the bank had run tests that showed that the strategy worked in any market conditions.
This reminds me when a trader told me that Morgan Stanley's sub-prime bets were 100 percent hedged, except they weren't. Perhaps that's why Dimon called the mistake "egregious" and "self inflicted" and vowed to "learn from it ... fix it and move on."
Nobody should mistake this incident as a leftover from the financial crisis or an indication that Wall Street hasn't learned its lessons. In fact, this is the oldest story in the business, captured by the 1923 trader's bible, "Reminiscences of a Stock Operator" by Edwin Lefevre.
"Losing money is the least of my troubles. A loss never troubles me after I take it. I forget it overnight. But being wrong - not taking the loss - that is what does the damage to the pocket book and to the soul. The market does not beat them. They beat themselves"