Two days ago we made a simple observation: back in September 2011, Weinstein’s firm SABA Capital hired one of the key JPMorgan prop traders – Maitland Hudson – who “ran JPMorgan’s proprietary trading of derivatives tied to commercial-mortgage bonds” and whose future job at Saba would “focus on relative value trades” – such as, perhaps, IG9 10 Year versus a basket of tranched trades… Our suggestion was that instead of being a brilliant credit trader as he has been called by Bill Ackman, and his antics while in charge of the DB prop desk certainly put theory in jeopardy, perhaps Weinstein is merely a wonderful headhunter: one who knows just whom to hire and when (kinda like Steve Cohen hiring key Pharmaceutical company R&D personnel in a perfectly legal transaction now that expert networks are done, but that is a topic for another day).
Still, the key angle here, and the one we spent most time on Tuesday, is that it was none other than a former (and perhaps disgruntled) JPM employee that is the ultimate reason for the billions in losses that JPM is currently experiencing– “one wonders, did Boaz hire JPM prop trader Maitland Hudson in what is nothing but a fishing expedition, so well known to the hedge fund industry, where one gets a job and a guarantee in exchange for the firm’s entire P&L and positional blotter? Yes, Hudson traded prop CMBS, put with all prop traders sitting next to each other and full updated portfolios instantly available to all, everyone knew what everyone else was doing, something we discussed back in 2009 when we demanded a seating chart of Goldman’s prop and flow traders. In which case did Saba know well in advance of everyone what the biggest CIO prop bet was, allowing it to take appropriate bets?” In other words there was one big caveat: “all this assumes that Iksil and the CIO had the IG9 trade on in September.” According to a just released report from Bloomberg, the answer is yes.
JPMorgan Chase & Co. (JPM) trader Bruno Iksil, known as the London Whale because his bets this year were so large, has been a leviathan of a risk-taker since at least 2010, a person with knowledge of the matter said.
Investigators are examining how long senior executives knew about Iksil’s swelling bets at the chief investment office before losses approached $2 billion. One focal point is why the formula used to calculate Iksil’s VaR was altered early this year, cutting the reported risk by half. The change followed an internal analysis in late 2011 and was approved by top risk executives, said a person close to the bank. About the same time, half a dozen managers typically involved in such decisions moved to new jobs.
“If it was something that had that large an impact, it would have to be agreed to at the very-most-senior level within risk management,” probably including the bank’s chief risk officer, said Steve Allen, a former head of risk methodology for JPMorgan who retired in 2004. “You’re not going to make a change of that magnitude on the basis of one risk manager.”
Iksil was assigned to devise hedges and make trades to counter the risk that a faltering economy might lead to a surge in losses on corporate loans or bonds. By 2010, the VaR on his trading book was about half of that for JPMorgan’s entire chief investment office, which at the time also oversaw more than $300 billion of securities, according to a person with direct knowledge of the CIO’s operations.
Which in turn means that internally, everyone on the JPM prop desk knew about Iksil’s trade: most certainly someone of Hudson’s prominence in the trading hierarchy. And following his retention by Weinstein in the summer of 2011 – the Saba founder himself.
It also explains something else previously noted by both us first, and Reuters recently: that while Saba may have made major profits on its anti-Iksil trade, its performance YTD is really not all that great. Why? Because parallel to the JPM IG9 inverse trade, Weinstein was putting on trades that, ironically, were natural hedges to a position which fundamentally is a levered bearish trade (IG9 blowing out), with a JPM unwind catalyst. Below is a good summary from Value Walk showing that the “star trader” is perfectly fallible (on an occasion when he may not have the benefit of an ex-insider wealk thru).
At the Boys & Girls Harbor conference in February where he announced that he was shorting the index, he also recommended another credit idea.
Weinstein stated that 5-year credit default swaps on AAA rated European countries offered better risk adjusted turns than those from PIIG countries. He mentioned that a basket of Danish, Swedish and Norweigen 5-year CDS were up 228% from June 2011. Portugese, Italian and Irish 5-year CDS were only up 61%.
We were curious how this trade had worked out.
[F]or the AAA rated countries Denmark, Norway and Sweden the CDS changes were respectively 6%, -11% and 38%. That’s an average return of 11%.
The total return from the PIIGS basket has been better than the AAA basket since February. There are clear reasons why this might be the case, as the situation in Southern Europe has deteriorated far quicker than almost anyone expected.
Weinstein’s projection has been wrong in the months since he offered it as advice. But playing CDS isn’t a quick get in and out game.
Weinstein has been wrong in the short term.
Perhaps there were no sov traders that could be poached at major Fed-backed prop desks that could disclose their CDS positions in this one?
One thing to note: we are not suggesting there is anything wrong with what Weinstein did: he merely gamed the system’s weakest link to his best advantage – something a prominent card player is known to. And by hiring a JPM trader, who most likely spent his month-long garden leave in some warm tropical island, Weinstein merely had a full glimpse of JPM’s entire trade blotter. Being smart, and having been in precisely this place before (when he ran DB prop), he knew too well there is no way that Iksil could unwind his monster IG9 position, and as a result started betting against it. And bet. And bet.
And then nothing happened.
So finally, in April, he and his closest hedge fund buddies leaked the news to the press, and the rest is history: like a pack of rabid dogs everyone jumped on the other side of Iksil, resulting in the prop trader finally folding, especially once the global economy tumbled over European concerns. Not even JPM could defy the entire market.
Which brings up three conclusions:
- From this point on, any bank which abuses its Too Big To Fail privilege, by putting on monster market-moving and market-defining prop trades, assuming its balance sheet is the Fed’s balance sheet, will be henceforth fair game for any hedge fund consortium which sniffs out an Iksil-type mega block that with the assistance of the media, would be like taking candy from a baby with bottomless pockets.
- Banks are reevaluating their entire employee separation process: from the signing of NDAs, to the duration of “Garden Leave”, to what information any employee anywhere in the firm is privy to. In fact, we would not be surprised if, in the vein of the CIA, soon every banker had a given clearance level, when it comes to what P&L they can access.
- Banks will be very, very concerned about what departing traders at the heart of massive trades may take with them to the buyside. Which brings the question: how much information about JPM’s prop positions has Maitland, or other recent departures,
And the other point of course, is that one doesn’t have to be a great trader or investor, when just being a gifted headhunter of prop trading “talent” is sufficient to make one millions in profits.
Being lucky also helps.