Bad bets cost bank $2B

How can a bank lose $2 billion in six weeks? That's just one of the mysteries surrounding the news that JPMorgan Chase, thought one of the safest U.S. banks, is gushing red ink from bad trading bets. As details emerged, shares of the nation's largest bank fell hard Friday, as did those of several rivals.

The story behind the loss is complex, and rich in irony. Here are answers to some questions about the loss:

Q:How exactly did the bank lose so much so fast?

A: First, start with the irony. JPMorgan says the losses came from a trading portfolio designed to offset losses in the bank's lending business. Instead of offsetting losses, these so-called "hedges" added to them.

JPMorgan extends money to companies through loans and by buying bonds. The bank was worried that it might not get all its money back, so it bought protection. Banks typically buy credit default swaps, essentially insurance contracts that pay out when companies stiff lenders.

In the often dizzying world of banking, these hedges are themselves sometimes hedged, and that's exactly what JPMorgan did. The bank apparently thought it had bought too much protection, so it hedged its hedge. It's that second hedge, basically a bet that companies would pay back their loans, that led to the losses.

Q: How does the "London Whale" figure into the story?

A: News reports had said that a JPMorgan trader, dubbed the "London Whale," had invested heavily in an index of credit default swaps, and that the bets were producing losses. But in a conference call Thursday, Jamie Dimon, the chief executive of JPMorgan, said the news reports were only "somewhat related" to the losses.

Q: Why are other bank stocks falling on the news?

A: It's not just the size of the bet that's scaring investors, but its complexity. Not even experts know how precisely big banks make money, and occasionally lose it. Their wagers are largely hidden. The opaqueness, which investors normally shrug off, is spooking them now.

Investors are uneasy also because JPMorgan has a reputation of managing risks better than almost anyone in the business. Investors seem to be asking: If this bank can lose $2 billion in six weeks, maybe others can, too?

Finally, there's the regulatory threat. Investors fear that bank profits could be pinched by the so-called Volcker Rule, which restricts trading that banks do with their own money, as opposed to clients' funds. Dimon has been an outspoken critic of the rule, and an impactful one given his skill at navigating his bank in recent years. JPMorgan was the only bank to remain profitable during the 2008 financial crisis. Now that Dimon has been pushed off his pedestal, investors are worried that regulators will be tougher in enforcing the new rule.

Q: Isn't the trading that led to the loss banned already?

A: No. The rule doesn't take effect until July, and even then regulators are suggesting banks will have another two years to comply.

In any case, it's not clear that the trades in question were subject to the rule. In the conference call Thursday, Dimon said the trades that backfired were hedges, not bets for profit, so they wouldn't have fallen under the rule. But some experts have doubts.

Nancy Bush, a banking analyst at NAB Research, said it's not always clear what is hedging and what is gambling.

Sen. Carl Levin (D-Mich.), the chair of a subcommittee that investigated the crisis, put it more bluntly. "This is not a hedge," he said. He called the loss a "stark warning" about the danger of "risky bets" at banks.

Q: How much will the

trading loss hurt

JPMorgan?

A: Likely not much at all, putting aside the impact of tougher regulation. JPMorgan is a big moneymaker. The $2 billion loss, which is before accounting for taxes, compares with $19 billion in net income last year and $16 billion the year before that.

What's more, Dimon said that $2 billion loss will be offset by $1 billion trading bets that have already paid off. Dimon said there are $7 billion more paper gains from trades that he can tap in case losses grow.

Q: Are more losses

possible?

A: Dimon said he is trying to unwind the bad bets in a "responsible" manner to minimize losses, but prices can move against him. That would mean more losses. Dimon has said the $2 billion could become $3 billion, depending on how markets react.