JPMorgan’s Senior Officers’ Addiction to Gambling on Derivatives

By William K. Black




JPMorgan’s flacks and apologists have, unintentionally, exposed the fact that their cover story – hedging gone bad – is false.  JPMorgan runs the world’s largest gambling operation in financial derivatives.  The New York Times reported the key facts, but not the analytics, in an article entitled “Discord at Key JPMorgan Unit is Faulted in Loss.”  The analytics suggest that the latest JPMorgan cover story – it was JPMorgan’s “Achilles the heel” (based in the UK) who caused the loss – is misleading.

The thrust of the story is that in the beginning JPMorgan’s Chief Investment Office (CIO) was run by a fair princess (Ina Drew) and all was fabulous.  Sadly, Ms. Drew contracted Lyme’s Disease and was unable to ensure peace and prosperity in her land.  The evil Achilles Macris, based in the UK, became disloyal and mean.  He made massive, bad purchases of financial derivatives that caused major losses.  CIO senior officers based in the U.S. (and women to boot) tried to warn Achilles but he screamed at them and refused to listen and learn.  The just king, Jamie Dimon, did not act promptly to save his kingdom from loss because of his great confidence in Princess Drew.

The personal story of Achilles acting like a heel makes compelling journalism, but it obscures rather than clarifies the analysis as to why JPMorgan poses a clear and present danger to the global economy.

We need to begin with context.  It was toxic financial derivatives (not) backed by fraudulent liar’s loan mortgages (“green slime”) that drove the U.S. crisis.  Paul Volcker urged the administration and Congress to bar any entity that received federal deposit insurance from investing in financial derivatives.  The Dodd-Frank Act did so in a provision called “the Volcker rule.”  Treasury Secretary Geithner and Federal Reserve Chairman Bernanke, who exist to serve the interests of CEOs of the largest banks, oppose the Volcker rule.  Jamie Dimon leads the banking industry’s opposition to the Volcker rule.  Dimon has a three-part strategy:  stall the Volcker rule, gut its effectiveness by creating a massive loophole, and get the rule repealed by a future Congress.  The loophole takes advantage of the fact that the Volcker rule was not intended to prevent banks from using derivatives to create (true) hedges.  The current draft of the rule, however, renders the rule useless because it allows banks to call non-hedges “hedges” – it adopts a standard I call “hedginess.”  A systemically dangerous institution (SDI) like JPMorgan has vast amounts of financial derivatives and it can (and does) call any speculative bet it takes in financial derivatives a “hedge.”

The NYT article demonstrates that JPMorgan is speculating, not hedging, and that the current draft of the Volcker rule would render us defenseless against the next financial crisis.  The article misses these analytics and presents a misleading portrayal of the purportedly good years of CIO under Princess Drew.  It turns out that CIO’s profits and losses come from the same practice – gambling on massive amounts of financial derivatives – not hedging.  The NYT misses this key analytical point.  Here is how the article portrays the events:

“But when the losses were mounting in recent weeks, Ms. Drew’s command of the chief investment office was far different from what it had been during her stellar performance of 2008, according to interviews with more than a dozen current and former traders, bankers and executives at JPMorgan Chase.”

The CIO did not have a “stellar performance” in 2008.  It simply had a run of good luck at the gambling table.  Indeed, big wins in gambling indicate a terrible bank operated in an unsafe and unsound manner.  Big wins from gambling in financial derivatives can only come from enormous, extremely risky gambles.  A bank that makes enormous, extremely risky gambles is a bank that desperately needs to have its senior management team removed – immediately – and that is true regardless of how those bets turn out in any particular year.  There is no conceivable social purpose to providing the explicit federal subsidy of deposit insurance and the (much larger) implicit federal subsidy of “too big to fail” that all SDIs enjoy to a bank so that it can take massive gambles on financial derivatives.  The Jamie Dimons of the world know that if they win the gambles they will be made immensely wealthy and that when they lose the gambles massively the federal government will bail them out.  Every gamble a federally insured bank (or an implicitly guaranteed SDI) takes is a gamble with government money.  Bank leverage is always extreme in the modern era; it vastly exceeds the reported (and often inflated) capital.  The government is the true creditor through its explicit and implicit guarantees of the bank’s creditors.

The consequences of the next SDI failure could easily be a global financial crisis.  We have a compelling need to minimize the risk of SDI failures.  Stopping SDIs from investing in financial derivatives should be one of our top, urgent financial priorities.

The NYT business reporters don’t see any of this.  If a bank reports extreme profits in 2008 in must be because its senior officers are brilliant.  The following passage shows how blind the reporters are to the concept that when a bank officer wins a gamble (with our money) she does not demonstrate skill or “steely resolve.”  When she gambles she demonstrates that she poses an improper and wholly unacceptable willingness to put the public at risk.  She demonstrates that she acts in an unsafe and unsound manner and that she needs to be removed.

“Ms. Drew also enjoyed the confidence of her subordinates, according to former employees. Part of her skill, they said, was her steely resolve. One former trader recalled that Ms. Drew counseled a credit trader who had a large bet in bank-preferred securities, which began to lose money during 2009. Instead of folding, Ms. Drew supported the trader who wanted to hold on, ultimately generating $1 billion in profits.”

Notice the word that never appears in this account – “hedge.”  The word that the reporters use is the correct word (“bet”), but they have no understanding that it is grotesquely improper and unsafe for a bank to take “a large bet in bank-preferred securities.”  Notice that when the bank’s bet moved against it and it “began to lose money” in what the reporters aptly call a “losing bet” Princess Drew did not hedge the bank’s exposure to losses.  (A hedge would have capped the bank’s losses, but also locked them in.)  Instead, she continued the bank’s risk exposure on a “large bet” and (purportedly) generated $1 billion in profits.  Assuming those statements are facts, the bet must have been massive, exposing the bank to many billions of dollars of losses.  The reporters and their sources at JPMorgan plainly think that this anecdote reflects well on Drew and Dimon.  It does the opposite.

If the good king Dimon and Princess Drew want to make “a large bet in bank-preferred securities” let them start a small hedge fund that poses no systemic risk and has no explicit or implicit federal guarantee.  They can bet private investors’ money to their hearts’ content – if they can convince wealthy folks to invest in their hedge fund.  The reality is that Dimon is running the largest hedge fund in the world and that, in economic substance, he is gambling with our (federally-guaranteed) money on huge positions in financial derivatives.  If he continues these bets, it is only a question of time before JPMorgan suffers catastrophic losses and we have to bail out the bank’s creditors.  True conservatives support the Volcker rule because they agree that we should not be subsidizing a government sponsored entity (GSE) like Fannie, Freddie, or JPMorgan, to bet on financial derivatives.  The NYT reporters do not even seem to understand the issue, even though it is central to the Volcker rule.

The reporters repeatedly come back to a central theme and meme – the CIO was a gambling operation, not a hedging operation.

“‘No one could really challenge Achilles’s traders,’ a former risk officer said.

Beyond that, the chief investment office was performing well, earning sizable profits for JPMorgan even as other businesses at the bank, like home loans, began to hemorrhage money. Those gains came as the size of the unit’s trades was increasing, but the office’s success blunted questions that were raised about the added risk.

During this time, Mr. Macris gained more latitude to build and expand trades from his desk in London — including the wagers that ultimately went so wrong for the bank.”

If “no one could really challenge Achilles’s traders” then Achilles was not hedging – otherwise the positions would not have posed significant risks and would not need to be challenged.  If The CIO was “earning sizable profits” it was not a hedging operation.  A hedge does not generate “sizable profits.”  Why would the CIO’s purported short-term “success” have “blunted questions that were raised about the added risk”?  That clause is both nonsensical and revealing.  It again reveals that the CIO was not hedging, which would have reduced risk – it was taking positions that “added risk.”  Sophisticated, prudent senior bank managers would never allow short-term reported income to “blunt” “questions … about added risk.”  Any competent banker knows that taking greater risks often leads to increases in short-term reported profits – and catastrophic longer-term losses.  The larger the reported short-term “profits,” the more reason to ask tough questions about risk. The real problem is compensation – the CIO executives where made wealthy when Macris gambled and won, so they had powerful incentives to blunt any warnings about the risk.  The passage does admit that the positions Macris took that caused the growing losses were “wagers” (bets) rather than hedges.  But again, the authors show no comprehension that this admission is exceptionally important because it exposes the “hedginess” lie and shows why Dimon and the entire senior management team at CIO need to be removed from office.

The reporters repeatedly return to the betting description.

“For example, Althea Duersten, who was Mr. Macris’s counterpart in New York and oversaw North American trading, raised objections to Mr. Macris’s outsize bet but was routinely shouted down by Mr. Macris during conference calls between London and New York, former traders said.”

It was not only a bet; it was known to be “an outsize bet.”  Everything written in the article and every statement by the reporters’ CIO sources screams “speculative bet” – not “hedge.”

“The chief investment office continued to post healthy profits in 2011, as it had in 2010 and 2009. But the size of its bets continued to grow, and many of the trades assembled by Mr. Macris’s traders were growing more complex, making them harder to exit when market conditions turned against the bank in 2012.”

I love their use of the word “healthy” as a modifier of “profits.”  The word, and the concept, of “hedging” do not appear.  A bank addicted to gambling on financial derivatives cannot be earning “healthy” profits.  At best, it is enjoying temporary good luck.  The addiction of JPMorgan’s senior officers to gambling led the CIO to take three contemporaneous increases in risk:  “the size of its bets continued to grow”, the trades grew “more complex”, and the derivatives they were betting on were increasingly illiquid and “harder to exit.”  So we have a bank whose senior officers claim not to take any speculative bets, but who in reality not only have been making enormous bets for at least four years and have greatly and contemporaneously increased the risk of those bets along multiple dimensions.  Neither JPMorgan’s senior managers nor the regulators took any meaningful action to prevent this massive, increasing addiction to ever riskier gambling even though investments in fraudulent mortgage-backed derivatives (the “green slime”) drove the ongoing financial crisis.  What would it take for senior bankers and regulators to learn the most important lessons of the ongoing crisis?  The derivatives scandal at JPMorgan did not begin a few months ago – it began at least as long ago as 2008 when the CIO made increasingly large bets in financial derivatives.  A competent investigations would likely show that the bets began far earlier than 2008.

The NYT article ends by explicitly stating that Dimon’s claimed “hedge” that is causing the bank huge losses was actually a speculative bet.

“Undergirding these trades was a bullish bet linked to an index of investment-grade bonds. Unfortunately for JPMorgan Chase, the market has grown much more anxious about corporate credit in recent months. Now, with losses rising as hedge funds and other investors profit from JPMorgan’s distress, the company is trying to unwind the disastrous trade.”

A “bullish bet” means that JPMorgan bet that the bonds would increase in value.  That bet would most likely lose money if investors became increasingly concerned about default risks.  Dimon’s flacks’ original story (promptly supported by the usual apologists (Peter Wallison and Jonathan Macey) was that this investment in a derivative of derivatives whose value derived from investment-grade bonds was a “hedge” for the bank’s exposure to losses in some aspect of its European investments. (The Wallison and Macey apologias conflict on the purported nature of the hedge.)  Note that the hedging story makes no financial sense because both bets are in the same direction.  If credit worries in Europe increase one would expect that credit worries on corporate bonds would likely increase.

JPMorgan is in trouble because Dimon and his senior managers are addicted to gambling on financial derivatives with our money.  The lesson they learned from the ongoing crisis is that they could get away with this.  If they continue to gamble on financial derivatives it is only a matter of time before they suffer catastrophic losses.  It is imperative that the SDIs be shrunk to the size that they no longer pose a systemic risk and can be closed without bailing out their creditors.  The regulators need to replace Dimon with a manager who is not addicted to exploiting federal subsidies to gamble on financial derivatives.

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

30 Responses to “JPMorgan’s Addiction to Gambling on Derivatives”

  1. I think it Curious–that between Wm. K. Black and N.N. Taleb, alone, “We” have, enough, of ‘The Answer’ to, totally, Understand ‘Who’s Zoomin’ Who’..


    and, certainly, No Offence to Jim Grant, Janet Tavakoli, Chris Whalen, and the Other, many, fine, Minds that are, still, left among Us..

    for, They, too, help ‘Light the Path’..

    though, Maybe, We should (again/finally(?)) Think about the Real Costs of of ‘Our’ giving away our Currency, and the Monopoly Issuance thereof, to a Group of Banks–whose Allegiance is, obviously, to no one, but Themselves..

    “…Simply put, I am for liberty. I also care very much about my family and home. I believe all individuals have the right to live their own lives in whatever manner they choose, so long as they do not forcibly interfere with the rights of others to live in whatever manner they choose. I view economic liberties and personal liberties are indivisible, parts of a greater whole. America’s history is certainly not unblemished, but, having traveled over much of the world, the values of peace, prosperity and freedom originating from the Founding Fathers is unlike anywhere else (though my hunch is we will need many “Founding Mothers” this time around!). We are free. Or rather, we WERE free.

    Two hundred and thirty-three years ago, our country was conceived in liberty as promised in the rebellious Declaration of Independence sent to a tyrannical King. This promise was fulfilled by the Constitution. We have forgotten that just a hundred years ago the only contact many Americans had with their government was at the post office. Now?

    Now, the government leaches away a majority of our paychecks and has launched a military empire so vast Caesar would be jealous! The federal government literally stole and outlawed lawful money – gold and silver coin – from the people and has insidiously lessened its purchasing power by replacing it with irredeemable scraps of paper. Furthermore, all of our currency is simply debt, and by forcing Federal Reserve Notes to circulate as legal tender, a yoke of servitude has been placed over the necks of our children. Thirty years ago, the federal government overrode state and local usury laws, resulting in insane 20%, 25%, 30% interest rates. The unelected central banking cartels have manipulated interest rates and enriched themselves, Government Sachs, and much of Wall Street at taxpayer expense. This parasitic process has continued for decades, and has only become plainly apparent to the public in the last year or so….”–Jake Towne

    and, you, too, BR, beyond your own Thoughts, you aid in ‘Profferin’ the Pixels’ — w/o which, Things would be, even, Darker.

  2. Moss says:

    Until something gets enforced against a C suite participant at one of the TBTF or SDI the game will continue.

  3. Petey Wheatstraw says:

    This entire scenario is exactly why another systemic meltdown is inevitable.

    Our economy (hell, our entire political/economic culture, including everything governmental), is essentially a continuing criminal enterprise.


    “ ‘Who’s Zoomin’ Who’..”

    MEH: Very few folks I know have ever used that specific phrase (I also never knew the source, until now. Thanks). Reminds me of an old friend.

    Also, good quote from the Jack Towne fellow.

  4. normal1 says:

    This is all too complicated for the local news to convey to the public, at least in my home town. It doesn’t fit into the story-line that all problems come from over-regulation and the work of a few bad apples. The overall business is sound we’re told, and frankly, that’s an easier pill to swallow than having to dig through all the dirty details. So, let ‘s just set back and let the professionals in business work this out, and if they need to draw on more taxpayer assistance, so be it. They’ll do their part and trickle something down on us.

    In the meantime, Ohio’s proactive governor is taking the bold step to help level the playing field for financial institutions in Ohio. This is vision.

  5. hammerandtong2001 says:

    Terrific article and post: incisive and instructive. And highlighting the real challenge we face as a society contending with destructive risk appetites.

    To highlight the danger, I believe an important insight needs to be added:

    Do we really believe the outsize “bets” are made for enriching individuals? I do not. Those involved are already fabulously wealthy. Rich indeed beyond the measure of their mortal time remaining.

    Then why? Why an agenda of expansive risk for bizarre “profit?”

    And I would contend the feature is an inherent characteristic of the human condition. It is lust. It is a thirst for power. It is a greed for societal oversight, exhibited by an overlord class. And while the example is extreme and morbid, it is for the same reasons why serial killers cannot stop killing.

    It is about power over society. And it is the oldest story of mankind. Written down and covered in history books from the earliest times.

    And it is why regulation and law is needed so desperately. To protect the large civil societies from the risks of predatory banks and speculative indulgence.


  6. dead hobo says:

    I think it’s pretty cool that so many gray haired grannies ans various slick willies have learned how to hedge at Indian casinos, Las Vegas, and Atlantic City. I’ve hedged a few bucks at the slots in Las Vegas and made 30% on $10 once and about 150% on about $5. It’s really sweet to do better than JPM at hedging. I bought some ice cream with my gains. It doesn’t look like JPM will get their ice cream any time soon. Maybe they should hire a few gray haired grannies who have special skills hedging in BINGO to help out.

  7. silverfox8028 says:

    This article and the next are a load of crap for this site… I always read Big Picture because I trust it…but lately there have been more and more of the use of words such as…likely…maybe…I think…has to be true…speculation, etc. If you don’t have the facts – shut up till you do. What really was JP Morgan’s loss?…what percent of income is it?…how much could they have made on the investment?…etc.

    The problem we have is TBTF. No bank…FDIC insured or private… should ever be allowed to control more than 3-4% of the banking resources in the US. Chop them up and nobody would give a f#!k if JP Morgan lost $2 billion or $10 billion as long as the stock and bondholders ate the loss.

    If you got nothing better to post than these type articles…bye…bye!

  8. jnkowens says:

    Welcome Ladies and Gentlemen to the longest running Wall Street show in history. Before we begin, a special announcement:

    Today, the lead role of LTCM will be played by JPMorgan.

    Thank you, and enjoy the show!

  9. NMR says:

    While not buying all this the hedging alibi is nonsense. They made a speculative directional bet and had no exit strategy which is fundamental to hedging.

  10. Petey,

    to your point..”…Our economy (hell, our entire political/economic culture, including everything governmental), is essentially a continuing criminal enterprise…”

    it may help to understand what Williams is reminding Us of, here..

    “…Congress has already gone far beyond the powers delegated to it by the Constitution. In Federalist No. 45, Madison explained: “The powers delegated by the proposed Constitution to the federal government are few and defined. Those which are to remain in the State governments are numerous and indefinite.” That vision has been turned on its head; it’s the federal government whose powers are numerous and indefinite, and those of the state are now few and defined.

    Former slave Frederick Douglass advised: “Find out just what people will submit to and you have found out the exact amount of injustice and wrong which will be imposed upon them. … The limits of tyrants are prescribed by the endurance of those whom they oppress.”…”

    and, also, I’ve, always, found Aretha to be a workable counter-point to, Today’s, “Wall Street”–at least, she had (a) Soul..~

  11. number2son says:

    True conservatives support the Volcker rule because they agree that we should not be subsidizing a government sponsored entity (GSE) like Fannie, Freddie, or JPMorgan, to bet on financial derivatives.

    And this, my friends, is why the GOP and the phonies it offers up as “conservatives” is beneath contempt.

  12. martin66 says:

    Seems to me the Volcker rule was meant to be an easier pill to swallow by the TBTF banks et al than a full return to Glass Steagall. Given that the latter was pretty clear on the issue of who can and cannot risk their balance sheets, and appears to have protected both the American public and the banks for 60 years or so, maybe …

  13. AHodge says:

    most excellent
    it is in fact even much worse than this?

    1 there is no solid evidence, they actually made all that earlier high risk money
    2 I hear fairly reliably they dealt with their own hedge fund and at DIFFERENT INTERNAL PRICES
    3 That is initial evidence of the prostitution of the old good JPM riskmetrics marking
    4 the long risk on position is the near equal leveraged substitute for actual banking or investing.
    5 but without actually supplying anyloans or investments?
    6 this is also clearly them betting on a bailout rather than a good risk. Jamie has said as much about ecpecting Europe to “Do the right thing…or a really terrible outcome, blah blah. somewhat like Bill Gross bad bet last year

  14. AHodge says:

    probablydealt only a small part with their own fund,
    but the price mismatch a huge red flag for the whole thing

  15. MikeDonnelly says:

    Humans respond to incentives. So if the Bank is loaded up with risk and returns a massive profit in good years and massive taxpayer supported losses in bad years and execs do not fear a clawback. You would be crazy not to follow this model.

  16. AHodge says:

    Bailout nation
    these guys are addicted to bailouts. i first learned this from a wise morgan stanley guy in 2008
    when they all just stood tight in Fannie and Freddie paper it usually works of course
    . they will just try to sit tight and wait for uncle sugar,
    or oncle sucree, the European Union–who hasnt been panicked quite badly enough–yet

  17. inessence says:

    Let the debate begin…silverfox8028 versus William K. Black. Who you gonna “bet” on?

    Good riddance silverfox8028……….

  18. A says:

    It’s quite simple: nothing gets in the way of power & profit….nothing.

  19. mathman says:

    To MEH, Petey, et al:

    How are we supposed to STOP this madness with a “captured” government using martial law tactics (even protesting costs you jail time, and money, time, possibly reputation, etc.)? That’s the question. i give a lot of credit to the OWS movement, but i don’t see any meaningful changes at the Congressional level. Writing to “our” legislators is pointless and VOTING is completely meaningless (especially after Obama caved).

    Any ideas?

  20. Petey Wheatstraw says:


    I’ve had an idea simmering in the back of my mind for a while now regarding how to bring about the reestablishment of our legitimate form of government. Now, all I need is 40 hours and my own forum to get started, and a buttload of dedication to that task, and that task only, for the foreseeable future.

    It’s a huge problem, living life blissfully ignorant and/or apathetic regarding it is much easier than fighting the evil giant. I guess that’s why there is so little resistance or even concern.

    If I can gel the idea, I’ll let y’all know.

  21. DeDude says:

    “The Jamie Dimons of the world know that if they win the gambles they will be made immensely wealthy and that when they lose the gambles massively the federal government will bail them out”

    No it’s worse. The Jamie Dimons and other sociopaths who run big companies know that if things go wrong they can simply bail out of the company they run, and go live on a tropical island for the rest of their lives. All they have to do is to bribe a few politicians and a few pension fund managers then they can safely run their little control fraud scheme all the way to the end. No matter what they will win and they don’t give a damn who the heck loses if things to wrong.

  22. TacomaHighlands says:

    Bill, you are da man! Superb analysis especially since it seemed to me that the NYT spun their article in such a way as to leave readers feeling that the fail was so related to a female CIO who couldn’t control her traders because she was so frail she got sick and couldn’t be in her office refereeing da mens. I hope to see a lot more of your posts here on TBP. You made it crystal clear, and I thank you for it, that it’s a gambling story of some wins and outsize losses by an institution that has no business at the gaming table. It’s certainly not a poor hedging story with a subtext of poor leadership by a female CIO at a time of sickness.

  23. biscuits says:

    Who are you, Jamie Dimon?
    “If you got nothing better to post than these type articles…bye…bye!”

  24. eliz says:

    Barry, When I click on “Read the rest of this entry >>” I end up in the “Mobile” mode. When I click “Standard” to switch back, it takes me back to the blog main page. Please pass this on to your WP guys and gals to fix. Mucho gracias.

  25. eliz says:

    p.s. When I logged on to post a comment, it switched back to the “Standard” mode.

  26. farmera1 says:

    In the meantime the speculation on how big a black hole JPM may have fashioned goes on.

    $2, billion, $7 billion, do I hear $30 billion. Who knows, in reality I’m sure JPM doesn’t even know. But you can be sure it is bigger than $2billion and less than infinity.

  27. eliz says:

    @mathman – I see the only way out is to create alternatives to participation in the mainstream paradigms. Creating intentional communities, worker cooperatives, buying local, energy from the sun, wind & water, etc. Live simply. Live creatively. Live lightly. Live healthfully.

  28. [...] law and economics professor at the University of Missouri-Kansas City is blasting JPMorgan Chase and its top executives for making huge gambles on risky derivatives, which resulted [...]

  29. [...] in 2008 is wasn’t hedging then, either. It was making a bet that turned out to be correct. Here’s a detailed look at the pros and cons of the issue, which comes down on the side that JPM was investing or betting, [...]

  30. [...] JP Morgan’s Addiction to Gambling on Derivatives [...]