By PETER EAVIS
On Wall Street, bets worth hundreds of billions of dollars are valued using a considerable amount of guesswork.
The dangers of that approach were revealed on Wednesday in the government’s criminal complaints against two former JPMorgan Chase traders.
The traders, Javier Martin-Artajo and Julien G. Grout, may eventually be absolved of all the charges against them. But there is now enough material in the public domain to conclude that a cadre of JPMorgan employees embarked on a foolhardy quest to trade their way out of trouble, and left the bank with $6 billion of losses in the process.
Their trading didn’t take place in a market where large numbers of transactions produced transparent and public prices through the day, like the stock market. Instead, the traders made bets with derivatives, financial contracts that often trade sporadically and in the shadows of Wall Street. They focused on so-called credit derivatives, which allow traders to bet on the perceived creditworthiness of companies. In particular, they took large positions in a credit derivatives product called CDX. NA. IG9, which represents a basket of companies.
In its lawsuits, the government says that the traders deliberately valued such bets to make their losses look lower than they actually were in the early months of 2012.
One way that traders value their holdings is to use pricing data from a range of banks.
If Wall Street brokers are offering to buy a derivative contract at 100 and sell it at 104, the trader might value that contract on his own books at 102, the midpoint between the two numbers……