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JP Morgan Trading Loss: Still More Questions Than Answers

Jeff Macke

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It's been four days since J.P. Morgan (JPM) dropped a bomb on the financial world with a hastily arranged conference call announcing an unexpected $2 billion loss in their trading and/or hedging operation.

The issue isn't the $2 billion. The issue isn't really even the degree to which analysts and the media remain ignorant as to precisely what happened, save for the fact that something went very wrong at J.P. Morgan's Chief Investment Office.

What really frightens the Street is that it isn't at all clear that JPM or CEO Jamie Dimon knows precisely what happened. Dimon has guided the bank relatively unscathed. If anyone could be said to have a grip on what happens in the murky world of derivatives in the banking system, it's JPM and Jamie Dimon.

Here's how Dimon responded on last week's conference call when asked if the $1 billion estimate of potential further losses was "the max that you envision":

"No, that is...I said the volatility could easily be that. Obviously it could be worse than that. We're going to manage this for economics...we want to maximize the economic value of these positions and not panic or do anything stupid. Therefore we're willing to bear volatility—and that's life."

It was a reply commendable for its stiff upper lip, but one that fell short of giving the impression that he has full command of the situation.

Dimon had two more days to ponder the situation, gather some facts, and, presumably, work with his staff on how to craft answers to basic questions regarding the the losses prior to his appearance on Meet the Press. Here, via the LATimes.com, is how the most respected man on Wall Street responded when David Gregory asked, "How did this happen?":

"First of all, there was one warning signal. If you look back from today, there were other red flags. That particular red flag...you know, we made a mistake. We got very defensive, and people started justifying everything we did. You know, the benefit in life is to say, 'Maybe you made a mistake, let's dig deep.' And the mistake had been brewing for a while, so it wasn't just any one thing."

A charitable view is that Mr. Dimon wasn't fully aware of the details regarding the specific trade in question. A cynic could argue Dimon isn't now, nor was he ever, deserving of his reputation as the best CEO in his industry, not to mention one of the best in the world.

The most realistic interpretation is the most frightening to all concerned: Jamie Dimon and JPM are the very best in finance, and they simply have no idea how they lost over $2 billion. If that's the case, then all bets are off as to whether or not anything at all has changed since the dark days of 2008.

In fact, maybe the situation at the banks is actually worse off, despite all the attempts at reforms, regulations, and reporting standards. If that's the case then no one on earth has an idea of how large the systemic risk to our financial system may be, but the number is much, much higher than $2 billion.