J.P Morgan Chase /quotes/zigman/272085/quotes/nls/jpmJPM said late Thursday it has suffered trading losses of $2 billion in recent weeks, sending its shares and those of rivals like Bank of America /quotes/zigman/190927/quotes/nls/bacBAC and Citigroup /quotes/zigman/5065548/quotes/nls/cC tumbling in after-hours action.
The specific derivatives approach that got the bank into trouble over the past six weeks involve synthetic credit positions.
Such transactions can be used to “transfer the economic risk but not the legal ownership of the underlying assets,” according to the “J.P. Morgan Guide to Credit Derivatives,” published in 1999.
The guide runs to 88 pages of dense and arcane discussion of risk management, credit default swaps, collateralized debt obligations and synthetic securitizations.
Synthetic credit agreements can help banks and other loan originators reduce the amount of capital they have to hold in reserve against loan losses.
They can also make it easier for loan originators to diversify risk, without having to notify the borrower, since that could harm the “relationship” with the borrower.
The approach also makes it possible to spread risk from loans which can’t be packaged in more traditional collateralized debt obligations, such as credit lines.
However, the losses and market gyrations they’ve sparked are certain to re-ignite the debate over moves to restrict banks’ ability to trade their own funds for profit and their use of derivatives, commonly known as the Volcker rule.
And J.P. Morgan CEO Jamie Dimon may regret, even more than the losses, the ammunition they give to regulators, who have yet to actually draft the rule.
-Tom Bemis
