The encyclopedia · Trading & Investing · Financial decision · 2012
JPMorgan's 'London Whale' racked up a $6.2B loss on a trade too big to understand
Trader Bruno Iksil built a credit-derivative position so large it moved the market. A flawed risk model masked the danger until JPMorgan had lost $6.2 billion.
JPMorgan Chase · 2012-05-10
What happened
In early 2012, JPMorgan Chase's Chief Investment Office — the unit that managed the bank's own investments, run by Chief Investment Officer Ina Drew — built up a huge portfolio of credit default swaps, derivatives tied to the default risk of companies. One trader, Bruno Iksil, took positions so large that other market participants noticed and started trading against him, earning him the nickname 'the London Whale.' The book was meant to be a hedge; it had become a massive, concentrated bet.
The danger was masked by the bank's own risk measurement. The CIO had recently switched to a new Value-at-Risk model that was inadequately reviewed and implemented — a flaw widely reported to involve a spreadsheet error that understated the risk. As the euro-area debt crisis rattled credit markets in the spring of 2012, the positions began to lose money fast. CEO Jamie Dimon first dismissed the problem as a 'tempest in a teapot,' but the hole kept growing.
JPMorgan disclosed about $2 billion of losses in May 2012; by mid-year the total had been revised to roughly $6.2 billion. The bank paid $920 million in fines to US and UK regulators, Dimon's 2012 pay was cut in half, and Ina Drew stepped down. An internal investigation found the CIO's judgment, risk management and oversight had all failed, and that the position had been 'flawed, complex, poorly reviewed, poorly executed, and poorly monitored,' in Dimon's own words.
Why it happened
- A position grew so large it moved the market and invited other traders to bet against it, turning a supposed hedge into a concentrated loss.
- The new Value-at-Risk model was changed and rolled out without adequate review, understating the true risk — a flaw traced to a spreadsheet error.
- The CIO operated with wide latitude and weak oversight; risk limits were not granular enough and were breached without effective escalation.
- Senior management initially downplayed the problem, delaying recognition of how bad it had become.
The lesson
A risk model is only as trustworthy as its inputs and its review. When a position grows large enough to move the market, the model that says it's safe may be the most dangerous thing on the desk.
Aftermath
The London Whale became the textbook case on model risk and the dangers of complex, poorly understood derivatives positions inside a large bank. It strengthened the case for the Volcker Rule, which restricts proprietary trading by banks, and led to tighter model governance and stress testing across the industry. JPMorgan absorbed the loss — it remained highly profitable — but the episode dented its reputation for risk management and cost the bank nearly a billion dollars in fines.
Sources
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