Wednesday, May 16, 2012

The Chart You've Been Dying to See (or maybe not)

Here's the chart related to the offending credit default swaps that caused the egg on the face of JP Morgan Chase and CEO Jamie Dimon, courtesy of Felix Salmon and Scotty Barber @ Reuters.


This chart shows the spread on the CDX NA IG 9 index (i.e., the synthetic index on which JP Morgan’s Bruno Iskil was selling enormous amounts of protection) minus the spread on the index’s constituent bonds.

Three things jump out here. First, the basis is negative, not positive. That means that the obvious trade was to buy the underlying bonds and hedge by buying protection on the index. That obvious trade, if held to maturity, should always make money. Iksil was funding that trade, by selling protection on the index.

Second, the chart is going up and to the right. Since Iksil was selling protection, that means the market was moving against him. Or, to put it another way, the obvious trade makes money when it expires at zero, and as the chart moves towards zero, Iksil loses money on a mark-to-market basis.

Finally, the move doesn’t seem to be all that huge — only about 30bp in this quarter. Which doesn’t seem remotely enough to cause a $2 billion loss. Still, Iksil managed it somehow.

And CEO Dimon and the other big-bucks risk management overseers @ JPMC missed the obvious risk of the transactions, with Dimon calling it a "tempest in a teapot" a month ago when the story started to surface.  Maybe these guys aren't as smart as they think and would have the world believe.