JP Morgan debacle as explained through poker
Palisade Financial Posted on Thursday, May 17, 2012 at 03:05PM A number of people have asked me how JP Morgan could manage to 'lose' 2 billion..and counting..dollars. Unlike the MF Global situation of a few months ago, this was no accounting quandary. In this case we know exactly where that money went, which is to the people on the other side of the trade. The people being various hedge funds and other banks. And because JP Morgan has not closed out of the trade, the losses could continue. Unlike the stock market, where you can buy and sell stock instantaneously, the products in question are very illiquid and only traded by a handful of participants, more akin to a game of poker.
Exactly what JP Morgan was trading (corporate bond derivatives) is a bit complex, and I don't think necessary for getting an idea of what happened. Imagine a game of Texas hold em poker (where your cards are not dealt all at once but rather throughout the course of the hand) initiated several months ago between JP Morgan, some other banks, and some hedge funds. JP Morgan was given a pair of 3's, and a few other hedge funds started with two aces. For various reasons JP Morgan believed they had the best hand so threw quite a bit of money in the pot. As the betting continued and more cards were dealt, it became clear to certain hedge funds (in this case early April) that they in fact had the best hands, and with each card were getting better, and JP Morgan in fact had next to nothing. The problem was JP Morgan still thought they had the best hand and matched every time the pot was raised.
Eventually JP Morgan realized they had the worst hand, but instead of folding they bluffed and continued to raise the pot. The other players, knowing the truth, were happy to oblige. So now were at the point that JP Morgan knows they they were wrong, but had already thrown 2 billion dollars into the pot. And because they still own some of these products, the players at the other side of the table are raising the stakes on those products too, which means sooner or later when JP Morgan has to get rid of those products, they'll be at a much worse price.
Moral of the story, if you start off with a bad hand, sometimes it's best to fold.
Reader Comments (1)
Interesting analogy on JP Morgan.
FYI, I believe RIAs aren't supposed to use Testimonials like the one you have on your Our Clients page. Just something that you might want to be careful with if you weren't aware. Maybe this rule has changed so it's something you might want to research.