The JP Morgan ‘hedging’ fiasco

Ina Drew - Senate Hearing (Source: CNNMoney)

“The strategy was flawed, complex, poorly executed, and poorly monitored.” – Jamie Dimon on the scheme that cost the firm over $6.2 billion last year.

Right before a series of hearings related to the failed hedging portfolio, the Senate released a 300-page report two days ago that revisited significant missteps in the risk-management process at JP Morgan that led to catastrophic losses in the first half of last year, as well as casting a dark shadow over former Chief Investment Officer Ina Drew. The heavy losses sustained by JP Morgan where from a complex derivatives portfolio that was build to hedge against credit risk in the Firm’s Chief Investment Office (CIO) and “in its capacity as a lender.”[1] The Senate report claims that JP Morgan failed miserably in heeding repeated warnings from its internal risk controls (more than 330 of them throughout the first four months of 2012), misled investors in a conference call in April 13 of that year, and withheld information from regulators. It also criticized authorities at the Comptroller of the Currency, which were tasked with guarding against such excessive risk-taking, for not pursuing the incoming red flags.[2] In January of this year, JP Morgan also released a document that highlighted some of the mistakes that were mentioned in the Senate report and widely acknowledged that senior management should have done better at handling the complexity, size, and riskiness of the portfolio.[3]The firm’s report directly placed the blame for the debacle on the traders that executed the flawed strategy, the “London whale” among them, while harshly admonishing their superiors for allowing the trades to ever materialize.

However, it remains unclear whether management actively sought to mislead investors, or was simply unaware of the true nature of the losses. Democratic Senator Carl Levin, who led the Senate probe into the trades, is convinced that the former is in fact the case. After the report was released, he stated that the bank’s communications and securities filings “misinformed investors, regulators, and the public.” Yet by the time Jamie Dimon characterized the losses as a “tempest in a teapot”, the portfolio had reportedly lost $719 million[4], a fraction of the final amount. Given the difficulty of estimating losses in such a complex derivatives portfolio, it seems exaggerated to assume that both Douglas Braunstein, the CFO at the time, and Dimon were knowingly issuing false statements and thus breaking the law. Furthermore, on May 10, 2012, the bank’s Controller completed a special assessment that concluded that the CIO had “accurately reported the value of its derivative holdings” in line with best industry practices, while conceding that the firm had aggressively priced the derivatives in the portfolio to minimize their regulatory capital.[5]

It is also surprising that the Senate subcommittee decided to try and galvanize public opinion by characterizing the losses as a clear violation of the Volcker Rule, contradicting a previous statement by the CIO[6], and by dismissing the scheme as a “make believe voodoo magic ‘composite hedge’”[7], even when such a rule has not been finalized and does not represent law under which the Securities and Exchange Commission currently operates.

Though the media will focus on the obvious errors that occurred throughout this episode, and the particularly egregious decision to tweak the firm’s value-at-risk (VaR) metric to allow for the trades[8], it is only responsible to properly take into account the specific circumstances surrounding the bank’s errors and disclosures. It must also be said that JP Morgan, despite the trades and tarnished image, reported record profits and higher revenues for the year.[9] Still, the Senate findings will ensure that the pressure remains on Dimon to never let similar mistakes happen again. Expect the authorities to speed up the implementation of the Volcker rule, and to continue to paint the financial sector as a ‘runaway train’ that needs stiff regulations to function, let alone thrive – regardless of the validity of such claims.

-- Andrés Muñoz

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[1] JP Morgan Chase & Co. Management Task Force, Regarding 2012 CIO Losses, CIO Reports, http://files.shareholder.com/downloads/ONE/2369390770x0x628656/4cb574a0-0bf5-4728-9582-625e4519b5ab/Task_Force_Report.pdf, p. 2

[2] Permanent Subcommittee on Investigations, JP Morgan Whale Trades: A Case History of Derivatives Risk and Abuses, United States Senate, March 15, 2013, p. 3

[3] Regarding 2012 CIO Losses, p. 8-9

[4] JP Morgan Whale Trades, p. 4

[5] JP Morgan Whale Trades, p. 6

[6] JP Morgan Whale Trades, p. 236

[7] JP Morgan Whale Trades, p. 36

[8] Jessica Silver Greenberg, JP Morgan Faulted on Controls and Disclosure in Trading Loss, Dealbook, http://dealbook.nytimes.com/2013/03/14/jpmorgan-faulted-on-controls-and-disclosure-in-trading-loss/

[9] JP Morgan, Form 8-K, CIO Reports, http://files.shareholder.com/downloads/ONE/2369390770x0x628654/23d47648-fb16-4f84-b9f2-47c60d158be0/4Q12_CIO_Report_-_Form_8K.pdf

SAMSUNG S 4

Today, Samsung unveiled its newest smartphone, the Galaxy S 4, right here in New York’s Radio City Music Hall. The Samsung S 4 is the latest smartphone to be previewed and has yet to come out into retail, with a release date set sometime in late April. The phone is the work of new technology, new logistics and a sleeker design. The S 4 has a 5 inch screen and is .31 inches thin. It runs on a faster chip and has a 13-megapixel camera that allows rear and front cameras to take simultaneous photos and videos. The phone will connect to next-generation LTE networks and has capability to connect to higher speed Wi-Fi networks. New software features includes a function that lets users control the smartphone screen with their eyes. Users can also wave their hands to scroll up and down a Web page or accept a call, or hover their fingers to preview the content of any media without having to open it. The phone also includes temperature and humidity sensors, as well as one designed to automatically monitor one's health. Perhaps the most apparent change is the introduction of the Samsung Hub, the Samsung version of iTunes, where users will be able to purchase and download music, books and other media.

The introduction of this new phone puts Samsung back on top in the leader of innovation of smartphones. They have raised the bar once again. This is great for Samsung, especially after the poor iPhone 5 earnings. The new technology will help boost Samsung’s initiative to increase its market share in the United States. The WSJ reports that Samsung ended last year with a leading 30.3% share of the world-wide smartphone market, up from 19% at the end of 2011. Apple's market share was essentially flat, as the company held on to the No. 2 spot with 19.1%, up from 18.8% in 2011. The increase in market share from the S 3 was heavily indicative of Samsung’s new technological advances. I believe that Samsung will not have the iPhone 5 moment, where the hype exceeded the earnings, because they have incorporated new, innovative and never-before-seen technology into this smartphone. Great earnings are in store ahead for Samsung. And even if Samsung doesn’t do too well, they will still have me as a customer!

New Pope for a New World

Today, the Catholic Church made the decision to modernize and recognize the changing realities of the world. By electing Jorge Bergoglio, now Pope Francis I, as head of the church, the cardinals have shown that they understand the prevalence of the developing world and the need for changes in the papal order. In addition, the support for Pope Francis was magnified by the swiftness of the decision, coming after only 2 days in the fifth round of voting in what was thought to be one of the most wide open papal races in recent memory. The selection of Pope Francis is a crucial one for the church as it moves forward because it gives new hope to members worldwide by thinking outside the box and selecting not only the first Jesuit pope, but also the first from Latin America.

Through his name selection alone, Pope Francis showed that changes would be coming to the Church. By taking the name of St. Francis of Assisi, a man who gave up his wealth and worldly lifestyle in service of the church, Pope Francis shows that he understands that he must continue his goals to improve the developing world in order to restore the honor and stature of the Catholic Church. In a world now defined by a global marketplace and the exchange of goods and ideas across all borders instead of a few solitary superpowers, the Catholic Church has realized that drastic changes were needed in order to stay relevant. The selection of Pope Francis recognizes the growing importance of Latin America, both economically and socially, while symbolizing an upheaval of the status quo.

-Varun Sawhney

American Auto Sales Rise

            The sale of automobiles has been one of the most consistently reassuring economic indicators during the past few years, as automobile sales in the United States has steadily increased from their 2009 bottom. Although car purchases rose by 3.7% in February, they did move at a slower pace relative to last year. This fact reflects the notion that the possibility of job cuts and tax hikes amid budget debates in Washington have somewhat slowed consumer confidence regarding their job security, and, in turn, their disposable income. However, Ford’s U.S. sales chief came out and stated that the strength of this industry, determined by low interest rates and pent-up demand, have the potential to weather any storm that may arise from the sequester recently implemented. Many buyers have, therefore, been gradually returning to the market in order to purchase new vehicles.

Most American auto manufacturers saw sales surge, whereas many foreign car companies saw their sales in the U.S. decline. For instance, General Motors and Ford reported increases by 7.2% and 9.3% respectively, while Honda and Nissan witnessed their sales decline by 2% and 6.6% respectively. Performances this past month definitely make a statement for American car companies that, just a few years ago, needed government bail-outs. Additionally, it serves as a testament to the fact that American manufacturing is not completely over. Not only are these corporations producing valuable cars, but also their products are selling more than imports. Ultimately, the news regarding automobile sales in the United States finalizes a great week for the American economy, with a new record for the Dow, great reports about the services sector, and a positive direction for American car manufacturers.

-Matheus Silva

Swiss Shareholders Gain Control of Executive Pay

On Sunday, 68% voted in favor of giving binding control over executive pay to Swiss shareholders. This would allow shareholders to vote on the compensation given to board members and corporate executives for any company listed in Switzerland. The initiative would also pose limitations to signing bonuses, severance packages, side contracts, and rewards for buying or selling companies.

                  

Discontent over exorbitant executive salaries has been growing. Last month, public outcry prevented pharmaceutical company Novartis from giving its chairman $76 million for an exit package. Outrage over UBS’ hefty losses in 2008 along with its large bonuses also contributed to the plan, which was spearheaded by Thomas Minder, the head of a Swiss company Schaffhausen. Minder’s stated that his goal was not to reduce salaries, but wanted shareholders to take responsibility for remuneration. It is unclear when the plan will actually be implemented.

                                     

Although this would close the tremendous compensation gap between top executives and average workers, there could be drawbacks as well. Many doubt the effectiveness of the policy and believe that companies will just find creative ways of compensating executives, rather than reduce their salaries. This initiative could potentially prevent international talent from taking executive positions in Swiss companies. Opponents also argue that it could damage the country’s competitiveness and that Switzerland may no longer be as an attractive region to locate companies.

Will this initiative prevent large companies, such as UBS, from taking huge risks? Executives may possibly implements more risk control measurements to prevent trading losses in an effort to save their own salaries.

            
-Diana Hong

                                                                                     

The Once Invincible

Coach Arsene Wenger (above) should have a happier summer

     This past Monday, Premier League team Arsenal F.C published its financial statements for the first half of the season, posting a profit of about 17.8 million pounds.
     While profits from this period are just half of those from the previous period, Arsenal fans can rejoice in the fact that the reduced income is due to an increase in player investments. Over the past six months, the team brought on the likes of Lukas Podolski, Santi Cazorla, and Olivier Giroud, and the club also announced extending contracts with the talented Jack Wilshire and Theo Walcott.
   Although the increase in spending is and should be considered a good thing for Arsenal as a football team, major problems still exist. The team has failed to win a trophy for seven years, and sit at fifth place in the current Premier League table, one spot away from Champions League qualification. Should Arsenal fail to qualify for the Champions League, the team would suffer a huge hit to television broadcast revenue and home ticket sales, most likely prompting the sale of valuable players. The club's estimated wage bill of 155 million pounds per year would not be sustainable with any less fixtures for the team. Having a losing team with such a high wage bill would also put management under even more scrutiny for signing lackluster players to expensive deals.
    While Arsenal does have its fair share of problems going forward, there still exists hope for the Gunners faithful, The team reported a cash reserve of 123 million pounds with plans of having a strong summer transfer period. A sponsorship deal with Emirates in excess of 100 million pounds will also strengthen the club's finances for several more years.
    Still, fans are growing impatient over a perceived lack of investment in the team. As a Liverpool fan, I had to sit and watch as Xabi Alonso, Mascherano, and Fernando Torres all left Liverpool for greener pastures (maybe not so green for Torres). For Arsenal, the loss of Cesc Febregas, Samir Nasri, and Robin Van Persie has not been balanced out, with management sitting on the cash they made in those deals (each being a historic sum in its own right). After this most recent financial report, the promise has been made to the fans for improvement. Now we will have to wait and see if Arsenal will do what it financially takes to reclaim its place as the Invincibles of England.

-Aureen Sarker (Photo Credit: Arsenal F.C)

Italy’s Political Fallout

After the election that took place on Monday, Italy finds itself in political gridlock. The center-left, led by Pier Luigi Bersani, hold a majority in the lower house while the center-right coalition, led by Silvio Berlusconi, won enough seats in the Senate (117) to deprive the center-left of the majority it needed to govern. Beppe Grillo, a former satirist turned populist-politician, received 25.5% of the popular vote and won 54 seats in the Senate in what is perhaps the clearest demonstration of the dissatisfaction by the Italian people with the electoral system. Mario Monti, the outgoing technocrat that led the government after Berlusconi resigned in the midst of a crisis in 2011, received a lowly 10.5% of the votes for the lower house and 9.1% for the Senate, corroborating the displeasure that the public has for the austerity measures and tax hikes enacted under his government that managed to quell some of the fear ever-present in the marketplace.

SX5E - Euro Stoxx 50 Index (5-day performance)

The effects of such a result were clearly observable in the markets. In the immediate aftermath, the Euro Stoxx 50 Index, a Blue-chip Index containing 50 “Supersector leaders” from 12 European markets, fell sharply after initial projections had the center-left with a majority in both chambers were proven wrong. The FTSE 100 in London closed 1.3% lower and the MIB stock Index in Milan closed 4.9% lower. Even more worryingly, Italian 10-year bond yields rose by about half a percentage point to 4.86%, 62 basis points below the premium commanded by Spanish debt – their narrowest margin in 4 months. Unsurprisingly, the spread on 5-year Italian credit default swaps, or the cost of insuring Italian government debt, rose to 290 basis points from 245 basis points a day earlier. According to Market Watch, this means that it now costs $290,000 annually to insure $10 million of Italian debt against default for five years, versus $245,000 on Monday[1]. The euro fell to $1.3018, its lowest level since January 7.

So what does this mean for the Eurozone? After all, more than 50% of voters cast their ballots unambiguously against the Euro, against further austerity measures, and in favor of increased spending and lower taxes. In the now likely scenario that Bersani finds himself unable to form a coalition that communicates the clear message that Italy is committed to the austerity measures and the euro, then the uncertainty and anxiety that plagued Europe for the most part of 2011 might return. If Italy’s borrowing costs start to rise, a weak government could prevent it from reaping the benefits of a European Central Bank government bond-buying program, which could prove disastrous for the region. With this scenario in mind, European leaders have already started to pile pressure on Italy’s rival parties to form a stable government.

Let’s hope that they do.

-- Andrés Muñoz

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[1] William L. Watts, "Investors Now Fear a Default by Italy more than Spain", Market Watch, http://blogs.marketwatch.com/thetell/2013/02/26/investors-now-fear-a-default-by-italy-more-than-spain/