JPMorgan’s future losses at the mercy of an obscure index

NEW YORK, Thu May 17, 2012 – It’s the biggest parlor game on Wall Street: Estimating how large JPMorgan Chase & Co.’s trading loss will be from a hedging strategy that went wrong.

The biggest U.S. bank by assets has already disclosed $2 billion of paper losses, and CEO Jamie Dimon said it could lose another $1 billion or more.

The losses will grow, some traders say, because it appears JPMorgan has only sold a small portion of its position, leaving it vulnerable to price swings in a thinly traded market. Others are not so sure the bank will suffer much more than it already has. Dimon said the bank won’t rashly sell, and any additional losses could arise throughout the year. A JPMorgan spokeswoman declined comment.

The source of JPMorgan’s problems is an obscure group of indexes that track the performance of corporate bonds. One of the indexes, the Markit CDX NA IG Series 9 maturing in 2017, is essentially a portfolio of credit default swaps – basically contracts that protect against default by a borrower.

This particular index is tied to the credit quality of 121 North American investment-grade bond issuers, including such names as Kraft Foods and Wal-Mart Stores.

JPMorgan used that index, and others, to bet that credit markets would strengthen. Because that position is widely known on Wall Street, many traders are betting the opposite way in the hope of profiting as the bank’s losses increase. The index has been moving against JPMorgan in recent days.

Oppenheimer & Co. used the average of the index in 2011 – 141 – to estimate on a straight line basis a theoretical additional loss for the bank of $5.9 billion. Oppenheimer analysts, however, cautioned that such a large loss was unlikely. “We think the number will be less” than a $5 billion estimate, they said.