Courtesy of Pam Martens.
One year ago this week, Ina Drew, head of the Chief Investment Office at JPMorgan which oversaw the synthetic credit derivatives portfolio that eventually blew up $6.2 billion of depositors’ money, told her traders “phones down,” signaling that she was halting all trading in those instruments. What Drew should have much earlier told her traders was: “unplug algorithms; plug in brains.”
Despite a multitude of formulas for measuring risk, multiple layers of oversight management, 28 members of a risk management team with titles like Managing Director, Executive Director, and Vice President, it somehow didn’t occur to any of these folks that the number one criteria for a trading investment is that you need to be able to get out of it.
London Whale was the nickname given to the JPMorgan trader, Bruno Iksil, as a result of the outsized bets he was making on one particular illiquid credit default swap index known as the 10-year Markit CDX North America Investment Grade Index Series 9 or in trader lingo, the IG9. Throughout the documents released by the Senate’s Permanent Subcommittee on Investigations are references to the traders needing to “defend our position.”
What “defend our position” actually meant was: we need to get more exposure to this losing trade to prop up the price of the losing trade so that when we price the total position (mark to market) we won’t have even bigger losses to show our bosses. An “unplug algorithms; plug in brains” analysis of this theory for managing depositors’ life savings is: we will be taking on more risk in the position we can’t get out of so that we really, really can’t get out of it.
One of the first, inviolate rules that a rookie stockbroker learns is “cut your losses short.” Also expressed as “don’t get married to the trade.” The JPMorgan traders broke the most basic of all investment rules and the easiest one to understand. The purpose of cutting losses short is to “defend the principal” so that it will be there to participate in profit-making trades in the future. “Defend our position” was an exercise of ”defend our ego”; refusing to admit that what the traders originally thought was a brilliant trading strategy was now a position capable of losing $415 million in just one day and $6.2 billion (that we know of) in the aggregate. JPMorgan has stopped reporting losses on the position.
So what can the average American learn from this. One overarching message is to understand what is and is not a liquid investment and how to align one’s liquidity needs with appropriate investments.
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