"Were the hedge funds being mercenary? I don't think so," says Grant, a former UBS managing director who worked on unwinding a real-estate portfolio that produced a $60 billion loss. "It's pretty much Trading 101 not to have too large a position that would go against you. Even seasoned traders get caught out this way. That's how the mighty have fallen."
Given the size of the loss, Grant suggests that J.P. Morgan was making multiple trades in multiple indexes, and may even have been trading in the tranche space, where firms slice up the index into various buckets with different default rates. According to Morningtar's Kobayashi-Solomon, after dislocating the market, the London Whale likely began trading sub-indices, or tranches of the index, to stabilize his hedge. "This is like a huge knot or ball of wool that is all twisted together. Now what they're trying to do is go in and untwist those knots and that is going to cost them money," Kobayashi-Solomon says of J.P. Morgan's clean-up efforts.
Many have noted that J.P. Morgan made changes to the London office's Value-at-Risk model in January, which some have suggested was done to disguise the amount of risk that Iksil was taking on. Only after Dimon dismissed the scope of the Whale's trades and J.P. Morgan sent a team from New York to London did the firm discover that the London trade had grown out of control, Kobayashi-Solomon says, noting that Iksil was found to have a daily VAR of $60 million, the amount he could lose in a single trading day. "It's just an enormous risk position," the market strategist adds.
Dimon told lawmakers, "In January a new model was put in place, allowing them to take more risk; but it was not done for some nefarious purpose." He noted that models are updated all the time. Specifically, sometime in 2011, the chief investment office in London had asked to update its models, partially due to the new capital-weighted risk rules under Basel III, he said.
Dimon then added that the past could not predict the future, so models had to be updated to reflect liquidity, concentrations and concerns about Europe. While the change did effectively increase the amount of risk the unit was able to take, he acknowledged, it had to be approved by the bank's model review group.
But that change in the VAR Model may be the biggest reflection of a lack of risk management by J.P. Morgan, according to the buy-side chief risk officer.