I Was Wrong About JPMorgan Chase

Three federal agencies are currently looking into JPMorgan Chase's (NYS: JPM) $2 billion-plus trading loss: the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Federal Bureau of Investigation.

The FBI? Really?

The political, regulatory, and media pile-on has begun. Initially, I was right there, ready to rain punches on a Wall Street bank -- again -- recklessly endangering our financial system. While there are, of course, still questions that need to be answered in the matter, the way in which the inquiry is now moving is starting to look less and less like a balanced, thoughtful investigation and more and more like a witch hunt.


The Tale of the London Whale
Here's what we know about the trading loss so far: A trader working in JPMorgan's London office named Bruno Iksil placed an enormous bet in the derivatives market. Derivatives, if you recall, are those nasty little things that lay behind much of the chaos we experienced in the 2008 financial meltdown. Derivatives "derive" their value as investments from the value of one or more underlying assets, like stocks, bonds, or an index.

Credit default swaps are a type of derivative and were part of Iksil's bet, which he made on "CDX.NA.IG.9" -- a credit-default-swap index that tracks a basket of corporate bonds. But Iksil's bet was so big it was moving the market, hence Iksil's nickname, "the London Whale," bestowed on him by annoyed hedge-fund managers also taking positions on CDX.NA.IG.9.

"Sloppiness and bad judgment"
When these hedge-fund managers stopped complaining, wised up, and began betting against Iksil's position, JPMorgan's losses began to mount. CEO Jamie Dimon initially wrote off the market rumors as "a tempest in a teapot" but finally had to admit to the losses.

His mea culpa was intense. Suddenly, Dimon was all over the news explaining how his bank had made an "egregious" mistake, caused by "sloppiness and bad judgment." He eventually accepted the resignation of, among others, Ina Drew, one of his most-trusted lieutenants and the person in charge of the office where Iksil worked: the bank's chief investment office.

Let the shrieking begin
An SEC inquiry into something like this is a given, as is an investigation from the CFTC -- the regulatory agency responsible for overseeing the derivatives market. But the FBI? The Bureau investigates criminal matters. Well, maybe the Department of Justice knows something the rest of us don't. Or maybe this trading loss has moved from being a purely business concern to that of a political football. Did I mention that Dimon has also been asked to testify before Congress on the matter?

First out of the shrieking-commentary gates were the politicians, who, with details of the trading loss still emerging, immediately began to beat the drum for even greater regulation of the banks. As it stands now, the world awaits the final draft of "the Volcker Rule," part of the 2010 Dodd-Frank financial-reform act.

Among other things, the Volcker rule aims to stop banks from trading on their own behalf, as many have accused JPMorgan of doing here. Dimon says his bank was hedging its portfolio, not engaging in proprietary trading.

But as the Volcker Rule has yet to be completed, by definition the jury has to be out on whether this trade violated any trading restriction. It's clear, though, that something went very wrong. Dimon himself admitted that the trade morphed into something it wasn't meant to be, something that -- Volcker Rule or no -- violated JPMorgan's own trading principles.

A little perspective, anyone?
But the most important thing to remember here is that the Volcker Rule, as with everything else in Dodd-Frank, is designed to control systemic risk, the kind of risk that can turn the problems of a single bank, like Lehman Brothers, into a cascading nightmare that threatens the entire financial system. But that's not what this was.

A $2 billion-plus write-off sounds like a lot, but it's not to JPMorgan. With total assets of $3.4 trillion, it's the biggest bank in the U.S. In the past 12 months, it's made $90.49 billion in revenue, and $17.45 billion in profit. Unless losses multiply dramatically, this write-off won't endanger the bank and therefore won't threaten the stability of the financial system.

No one has been tougher on JPMorgan and Jamie Dimon than Dimon himself. And while he was required to report this loss to the SEC, he didn't have to go out of his way to announce it the way he did. Maybe it was just smart, getting out in front of what might have been a PR nightmare if someone else had found out first, but I think his public self-flagellation did more harm than good.

Certainly, none of the other big U.S. banks facing life under the Volcker Rule wanted to hear about something like this. The CEOs of Goldman Sachs (NYS: GS) , Morgan Stanley (NYS: MS) , Bank of America (NYS: BAC) , and Citigroup (NYS: C) must all be in a state of perpetual cringe right now. Maybe Dimon ought to be given the benefit of the doubt here. Maybe he was just being straightforward to a fault, which seems to be his management style. Dimon said this loss would play right into the hands of Wall Street's critics, and so it has.

There will always be risk-taking in banking; the question is how much is tolerable. This is tolerable. While you're waiting to see how the Tale of the London Whale ends, learn about some delightfully straightforward bank stocks, including one Warren Buffett could have loved in his earlier years, in our special free report: "The Stocks Only the Smartest Investors Are Buying." Take a minute and download your copy while it's still available

At the time this article was published Fool contributor John Grgurich thinks an all-expenses paid junket to the City to figure this all out is justifiably in order, but he owns no shares of any of the companies mentioned in this column. Follow John's dispatches from the bloody front lines of capitalism on Twitter, @TMFGrgurich. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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