Conference Room Time?

"I told you. Good day, I'm ok. Bad day, I'm ok. Stop bugging me about my feelings. They're irrelevant."
--Lewis Zabel (Wall Street: Money Never Sleeps)

Last nite JP Morgan (JPM) CEO Jamie Dimon called an impromptu press conference to announce that his firm had lost $2 billion in ill conceived and executed 'hedging strategies.'

The trade gone bad looks to have involved credit default swaps (CDS). JPM was apparently short a ton of high yield CDS (or HYs). Against them, JPM was long a bunch of investment grade CDS (IGs). One puts on a hedge when two asset classes are presumed negatively correlated to the extend necessary to manage potential loss (a.k.a. risk). Hedges don't work when those presumptions don't hold.

Alas, that is what has been happening. As markets rallied over the past couple of months, IGs strengthened with stocks. This drove JPM to sell more HYs to maintain the hedge. The sheer size of JPMs trade attracted the interest of other traders, however, who saw rich the divergences between these CDSs and their fair value. As they acted to capture those riches, those traders were essentially shooting against JPM's trade to magnify the divergence in 'vicious cycle' character.

Losses have been piling quickly. As observed here, $2 billion represents less than one percent of JPM's assets and usually would not be worthy of a press conference. However, Dimon is likely signalling that losses could be much higher before this trade is unwound--particularly now that the cat has been fully let of the bag.

I wonder whether that mahogany conference room at the NY Fed might be busy today...

position in SPX