05/14/2012 02:26 pm ET Updated May 14, 2012

Life Inside The Jamie Dimon Bubble

We are apparently reaching the stage in the JPMorgan $2 billion fail-scapade when the patsies are identified and shamed. JPMorgan co-CIO Ina Drew has already cashed out in the wake of the losses, with two underlings, Achilles Macris and Javier Martin-Artajo, expected to follow. (On Wall Street, women seem to be uniquely positioned toward the front of the line when the guillotine gets to chopping, don't they? Think Zoe Cruz at Morgan Stanley, Erin Callan at Lehman, Demi Moore's character in the movie "Margin Call" ... you know, I'm just pointing this out!)

As Reuters reported this morning, Drew's group seems to have been running some sort of sub rosa trading game when everything went wrong:

One hedge fund manager who previously ran a proprietary (or prop) trading book at JPMorgan said the bank's public commitments to trim balance sheet risk were at odds with its network of trading silos, who were making bets independently -- with only a handful of the bank's most senior executives notified of their vast, complex exposures.

"This (CIO) group was completely separate, completely distinct from the prop trading unit. We had no clue about their prop book and they would have no clue about ours for that matter," the manager said.

So perhaps the axe is falling in the right place. At the same time, the activities that Drew and her cohorts seem to have been engaged in were squarely in line with Jamie Dimon's vision for the company, which was "transforming the once-conservative unit from a risk manager to a profit center."

And under Dimon, did JPMorgan lobby "to obtain special breaks that would allow banks to make big bets in their portfolios, including some of the types of trading that led to the $2 billion loss now rocking the bank?" Oh yes, they did -- specifically seeking out a large loophole to allow for "portfolio hedging."

The New York Times writer Edward Wyatt has a great explainer on "portfolio hedging" and the role JPMorgan played in pushing for it. (Of particular interest is the way the push for portfolio hedging opened a fault line between the various camps of government referees, with the Treasury and the Federal Reserve pushing for this loophole over the objections of the SEC and the Commodity Futures Trading Commission.) But the bottom line is that all "portfolio hedging" seems to be is a game in which banks point to higher investment portfolios to justify other huge outlandish bets, taking on the word "hedge" to provide the illusion that something responsible is happening. Senator Carl Levin (D-Mich.) shows up in the Wyatt piece to declare that "portfolio hedging" is basically "a license to do pretty much anything."

Barry Ritholz says that Dimon's premise, that this bad bet was a hedge, is basically horsecrap:

We first learned of this particular trade when they began to distort credit indices. Any trade so huge that it impacts its markets -- that becomes the market -- cannot be credibly thought of as a hedge. Simply stated, once you are the market, you are no longer a hedge. Sheer size of this trade makes it far more accurate to describe this as speculation than hedge.

Of course, the loss was the tell. A true hedge would have been offset by the underlying position that was being hedged -- so any loss should have been insignificant. Even a minor correlation error should not lead to a $2 billion dollar hit.

Ritholz concludes, "If we are going to define this trade as a hedge, then there is no other conclusion to reach except that everything at a huge bank is a hedge." The scary thing is that Dimon, up until maybe last week, probably believed this. Either that or he is out to sea on how his bank works.

At the very least, it seems that Dimon has spent such a long time inside his bubble -- an opportunity afforded him by JPMorgan's reputation for being the "safe" bank and a media that treats him as if he sprang from the head of Zeus -- that he's come to see the bank as being made of stronger stuff than the actual bulwarks that might guard against this sort of failure. That's what makes Gretchen Morgenson's scoop from inside that bubble so delicious. It seems that just one month ago, Dimon was at a schmancy party, publicly slagging the people who wanted to curtail these sorts of risks -- Paul Volcker of "Volcker Rule" fame and Richard Fisher of the Dallas Fed, who's been a critic of "too big to bail" banks:

During the party, Mr. Dimon took questions from the crowd, according to an attendee who spoke on condition of anonymity for fear of alienating the bank. One guest asked about the problem of too-big-to-fail banks and the arguments made by Mr. Volcker and Mr. Fisher.

Mr. Dimon responded that he had just two words to describe them: “infantile” and “nonfactual.” He went on to lambaste Mr. Fisher further, according to the attendee. Some in the room were taken aback by the comments.

And that is called "getting Gretchen Morgensonned." At this point, I recommend that you pop some corn and bookmark Counterparties' "JPMorgan" tag.

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Peter Goodman: Elizabeth Warren Is Right: Jamie Dimon Needs To Resign From NY Fed