ABACUS, London Whale: Frenchmen Take the Fall for Wall Street’s Crimes

By Pam Martens: August 13, 2013 

Qu’est-ce que c’est? Frenchmen? 

Jamie Dimon, Chairman and CEO of JPMorgan Chase, Testifying Before Congress on the London Whale Trading Losses

In the quintessentially American male testosterone epicenter known as Wall Street, Frenchmen are dropping like flies. Not so much the American CEOs in Wall Street’s corner offices. The only handcuffs these guys are seeing are the golden ones. 

Fabrice Tourre, the 34-year old Goldman Sachs salesman from an elite educational background in France, was found guilty of six counts of securities fraud in a Manhattan jury trial that ended 12 days ago. The case was a civil suit brought by the Securities and Exchange Commission. One of those counts was for “aiding and abetting” Goldman Sachs in the fraud. Goldman Sachs did not stand trial, in the technical sense although it certainly has in the court of public opinion, because it settled its charges with a payment of $550 million. Not only did the corporation not stand trial, but neither did the American hedge fund owner, John Paulson, who, according to the SEC, plotted with Goldman Sachs in this same deal, known as ABACUS, to create a bundled pool of assets designed to fail so that he could make  $1 billion betting against it (known as shorting). Investors lost approximately the same $1 billion that Paulson’s hedge fund made. 

Now, according to U.S. and international media reports, another Frenchman, Julien Grout, is about to be indicted by the U.S. Justice Department on criminal charges for his alleged role in mispricing derivatives and hiding trading losses in the JPMorgan Chase London Whale matter. Another employee, Javier Martin-Artajo, is likely to be charged as well according to reports. 

The actual employee known as the London Whale, Bruno Iksil, also a Frenchman, has been cooperating with prosecutors and may escape charges or receive a lesser charge than the other two, according to reports. Iksil received the moniker, London Whale, after taking outsized positions in an illiquid derivatives index and effectively becoming the market. Unfortunately, after the market turned against him, his positions were so large he had no exit strategy. JPMorgan has acknowledged losing $6.2 billion on the bets. 

Despite barrels of newsprint ink and acres of deforestation devoted over the past year to the London Whale story, the press has failed to adequately enlighten the public as to the significance of this story. If it had, we would not still be debating the wisdom of restoring the Glass-Steagall Act to separate Wall Street casinos from banks holding insured deposits. 

The significance of JPMorgan losing $6.2 billion in wildly speculative trading in illiquid derivatives in London is as follows: it was not using its own capital and trading within its investment bank – it was using insured deposits of savers and trading within the FDIC insured bank. That’s not rumor, or speculation. That is a fact presented by the U.S. Senate’s Permanent Subcommittee on Investigations and conceded to by JPMorgan.

On March 14 of this year, the Senate’s Permanent Subcommittee on Investigations released its 307-page report — “JPMorgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses.” The report stated: 

“The whale trades case history offers another example of a financial institution engaged in high risk trading activity with federally insured deposits attempting to divert attention from the risks and abuses associated with synthetic derivatives. The evidence uncovered by the Subcommittee investigation demonstrates that derivatives continue to present the U.S. financial system with multiple, systemic problems that require resolution.” 

Translation: things are just as dangerous today as they were in 2008 despite five years of investigations, hearings, Dodd-Frank legislation and regulatory rulemaking (read foot-dragging). 

Senator Carl Levin, who chairs the Senate Subcommittee, and Senator John McCain, ranking minority member, confirmed at a hearing on March 15 of this year that insured deposits of the bank were used for the speculative trading that reached into the hundreds of billions of dollars in notional (face) amounts.  

Levin said: “JPMorgan’s Chief Investment Office rapidly amassed a huge portfolio of synthetic credit derivatives, in part using federally insured depositor funds, in a series of risky, short-term trades, disclosing the extent of the portfolio only after intense media exposure.”  

McCain stated: “This case represents another shameful demonstration of a bank engaged in wildly risky behavior. The ‘London Whale’ incident matters to the federal government because the traders at JPMorgan were making risky bets using excess deposits, portions of which were federally insured. These excess deposits should have been used to provide loans for main-street businesses. Instead, JPMorgan used the money to bet on catastrophic risk.”  

According to documents released by the Senate to the public, as of the close of business on January 16, 2012, JPMorgan’s Chief Investment Office held $458 billion (notional) in domestic and foreign credit default swap indices. Of that amount, $115 billion was in an index of corporations with junk bond ratings, which the insured bank was not allowed to own to comply with safety and soundness requirements. 

To get around that, according to the Office of the Comptroller of the Currency, JPMorgan “transferred the market risk of these positions into a subsidiary of an Edge Act corporation, which took most of the losses.” An Edge Act corporation refers to the ability of a bank to obtain a special charter from the  Federal Reserve. By establishing an Edge Act corporation, U.S. banks are able to engage in investments not available under standard banking laws.  

Did the young Frenchmen trading risky derivatives in London make the policy decision at JPMorgan’s offices in New York to allow young Frenchmen in London to use insured deposits of an FDIC-insured bank in the U.S. to place wild bets on hundreds of billions of dollars in derivatives?  Did the young Frenchmen decide to keep the bank’s regulators in the dark about this trading activity? Did the young Frenchmen hold an earnings call with the public and bank analysts and engage in a serious pattern of misinformation? 

All of those decisions, according to the in-depth report from the Senate Subcommittee, which looked at 90,000 documents and emails and interviewed key personnel, were made by top management at JPMorgan – none of whom are being indicted according to current information. 

Top management at JPMorgan, according to the report, engaged in the following misconduct:

 “The CIO [Chief Investment Office] whale trades were not disclosed to the public in any way until April 2012, despite more than $1 billion in losses and widespread problems affecting the CIO and the bank, as described in this Report. On April 6, 2012, media reports focused public attention on the whale trades for the first time; on April 10, which was the next trading day, the SCP [Synthetic Credit Portfolio] reported internally a $415 million loss. The bank’s communications officer and chief investor liaison circulated talking points and, that same day, April 10, met with reporters and analysts to deliver reassuring messages about the SCP. Their primary objectives were to communicate, among other matters, that the CIO’s activities were ‘for hedging purposes’ and that the regulators were ‘fully aware’ of its activities, neither of which was true.” 

Let those last five words sink in: “neither of which was true.” 

The veracity of JPMorgan’s CEO, Jamie Dimon, has also been called into serious question by the Senate report: 

“In the April 13 earnings call, in response to a question, Mr. Dimon dismissed media reports about the SCP as a ‘complete tempest in a teapot.’ While he later apologized for that comment, his judgment likely was of importance to investors in the immediate aftermath of those media reports. The evidence also indicates that, when he made that statement, Mr. Dimon was already in possession of information about the SCP’s complex and sizeable portfolio, its sustained losses for three straight months, the exponential increase in those losses during March, and the difficulty of exiting the SCP’s positions.” 

When the indictments are handed down in the dog days of summer, expect to see a big media push from JPMorgan to cast this in the light of a few rogue traders long gone from the bank with new controls to make sure it can never happen again. 

It would be wise in that regard to consider the investigative findings of Carl Levin’s Subcommittee. The Subcommittee found that “the whale trades were not the acts of rogue traders, but involved some of the bank’s most senior managers.” 

As for criminal indictments because these young men allegedly mispriced the derivatives to understate losses, the Senate report adds this: “Recorded telephone calls, instant messages, and the Grout spreadsheet disclosed how the traders booking the derivative values felt pressured and were upset about mismarking the book to minimize losses. Yet an internal assessment conducted by the bank upheld the obviously mismarked prices, declaring them to be ‘consistent with industry practices.’ ”

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