Billions gone

One Cent’s Worth
By MARC MEWSHAW  |  July 11, 2012

Full disclosure: I'm pretty dumb. I never made it past Algebra II. I'm one of those people who'll sometimes get into a verbal tussle with a cashier because I think I've been shortchanged whereas in fact simple caveman arithmetic is beyond me. So I guess it stands to reason that I'm too unsophisticated to understand a story that I've been following ever since it broke in May: JPMorgan's $2 billion loss at the hands of a rogue trader named Bruno Iskal, or as he's now known, the London Whale.

Did I say $2 billion? Actually, the figure could be as high as $9 billion. That's quite a discrepancy — a gap wide enough to fit the GDPs of the 20 lowest-grossing nations combined.

I've been wondering: how could a bank, whose sole raison d'etre is keeping track of money — or so I thought but maybe I'm just being dumb again — not know how many billions it's in the hole for?

Beginning in 2010, Iskal began betting that a certain type of corporate debt wouldn't default. He sank $100 billion into that bullish position, plunking down such an ungodly chunk of change that it sent reverberations throughout the market. Smelling blood, hedge funds took the other side of the bet. When Iskal's position began faltering, he scrambled to retrench but wound up digging his own grave.

The reason no one knows yet how much money JPMorgan is on the hook for is that it takes a long, long time to unwind a position of such stupefying proportions — or, in plain English, to fob off $100 billion worth of crappy bets. It might take months, and by then the bank will have bled a lake whose volume is anyone's guess.

Let's get this straight. Iskal bet the farm on a wildly rosy prognosis of a certain asset class's prospects. Based on that hunch he bought himself a shitload of credit-default swaps. Massively overvalued market? Check. Reckless use of highly complicated derivatives that mask risk? Check. Sound familiar? This is 2008, right?

Nope. This is 2012 we're talking about, the post-bailout world, and those funds Iskal was gambling with weren't his employer's, nor its shareholders' — they were its depositors'. And since those deposits were FDIC-insured, they belonged to all of us, no matter where we bank personally. As Mark Williams, a professor of finance at Boston University, puts it, "Essentially, JPMorgan has been operating a hedge fund with federal insured deposits within a bank."

For banks, staking billions of other people's money on an outrageously reckless bet is a win-win. "If they make money, they profit," Williams says. "If they lose, then you have FDIC-insured banks being bailed out by taxpayers."

So this is what our $4.76 trillion of bailout money bought us: A shiny new steel-reinforced safety net to catch the Big Five banks when their drunken-sailor brand of capitalism blows up in their face again. In other words, license to carry on as before.

In case that message is unclear, consider this grim irony: Iskal headed up the bank's risk-management office. Just how serious can JPMorgan be about mending its pre-financial crisis ways when the very man tasked with pruning risk was instead feeding it megadoses of Miracle-Gro?

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