The Man Who Almost Took Down J.P. Morgan
Thanks to an activist showdown in 2019, investors can now access a public company that is effectively a hedge fund-style investment vehicle, helmed by one of the best fund managers on Wall Street.
A 13% Yield with the Trader Who Beat The “London Whale”
How to Get Private Hedge Fund Results Without the Millionaire Minimum
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If Boaz Weinstein shows his face again at the Bellagio casino in Las Vegas, he’ll be asked to leave.
It’s not often that dens of gambling turn down money. But they make an exception for Weinstein, who counted cards – and figured out how to beat the house – as part of a secretive MIT blackjack team. (The true story was later adapted into the heist movie “21.”)
Weinstein is world-class at more games, too. The first time he entered a poker tournament, he went home with a Maserati. At age 16, he was the third-best chess player in his age group in the United States.
So it’s not a surprise that Weinstein found his calling in the ultimate high-stakes strategy game: exploiting mispricings in financial markets. He spent a decade structuring complex derivative trades, first at Goldman Sachs and later at Merrill Lynch.
Then, he stumbled on the biggest game of all…
In 2011, Weinstein spotted a critical flaw in the credit derivatives market… where the table stakes are billions of dollars. And instead of taking down a blackjack dealer, he went up against the $1 trillion balance sheet of one of the world’s largest banks.
The showdown started when French J.P. Morgan trader Bruno Iksil made a very bad decision.
Iksil managed a credit derivatives strategy for the investment portfolio of the biggest American bank. His job was to hedge the downside risk of the bank’s portfolio, using derivative contracts known as “credit default swaps”, or CDSs.
CDS contracts act like insurance, designed to protect against bond issuers who default on their obligations. Investors buy CDSs for a relatively small upfront premium, which can pay off big when a corporation runs into financial distress. Investors can also buy CDSs on a broad market index, like the S&P 500.
Think of CDS contracts as the credit market equivalent of put options. In the same way that put options protect against downside risk in stock prices, CDS contracts can offer protection against the downside in corporate bond prices.
Iksil was the highest-paid trader in London… well-known for his outsized bets, and profits, in the CDS market. During his hot streaks, he generated profits of up to $100 million for J.P. Morgan, and was one of London’s highest paid traders. His specialty was identifying companies vulnerable to financial distress before the market caught on, buying CDS contracts for cheap and selling at a hefty premium when the risks became clear.
But as Iksil learned the hard way, betting on disaster doesn’t always pay off.
In benign economic environments, most CDS contracts lose money, because the corporate-distress events that push them into the green don’t happen often. Iksil sought to minimize these losses through offsetting trades. That is, he bought CDS contracts on high-risk companies, while simultaneously selling CDS contracts – to collect income – on an index of lower-risk investment grade companies.
Iksil’s hot streak went cold in 2011, when his bets on high-risk companies defaulting stopped paying off. And around the same time, to prepare for the rollout of Basel III banking regulations, J.P. Morgan’s head office in New York instructed the London operations to cut the size of its book. This meant that Iksil needed to reduce his positions, which were designed to hedge against J.P. Morgan’s investment portfolio. That would mean taking an estimated $500 million loss on the roughly $51 billion portfolio.
Iksil’s boss, Chief Investment Officer Ina Drew, didn’t want to bite that bullet. She wanted to bring the portfolio back into the green before unwinding the trades. So she tasked Iksil with making back his losses, pronto.
But haste makes waste. And rather than hitting paydirt, a panicked Iksil dug himself an even deeper hole...
He bought more CDS contracts on high-risk companies. This, in turn, meant selling more CDS contracts on lower-risk investment grade companies. The short position he took was in a contract known as the Investment Grade CDX, which provided default insurance against a basket of investment grade companies.
By November 2011, Iksil’s massive sell orders had pushed the price of the Investment Grade CDX into deeply depressed territory.
Enter Boaz Weinstein, gamer extraordinaire.
Across the pond, on the 58th floor of the Chrysler building in midtown Manhattan, Weinstein spotted an anomaly: a curiously large number of contracts in CDX had been sold short.
By then, he was running his own credit-focused hedge fund, Saba Capital (named after the Hebrew word for “grandfatherly wisdom”). Every day, Weinstein and his team of 30 analysts scanned the prices of more than 18,000 corporate bonds and 600 CDS contracts, searching for mispriced securities.
After alerting his analysts to the unusual trade in the Investment Grade CDX, his team pored over the contract’s trading history… and found that a single seller was on the other side, distorting prices.
Weinstein understood that, when prices inevitably reversed, the guy on the other side of the trade would be forced to pay up to exit his short position. So Weinstein backed up the truck to buy what Iksil was selling. Iksil, though, had a much larger chip stack to bully Weinstein’s $4 billion hedge fund. From late November 2011, when Weinstein started buying, Iksil overwhelmed him with relentless selling pressure. By January 2012, Weinstein’s fund was deep in the red on the trade. So he called in reinforcements.
At an elite hedge fund conference in February featuring a “who’s who” of fund managers, Weinstein told the 300 conference attendees about what he was seeing in the Investment Grade CDX contract. Intrigued, some of them followed him into the trade.
Around this time, word leaked out that the person on the other side of the trade was part of J.P. Morgan’s investment office in London, giving rise to the infamous “London Whale” moniker. In trader’s parlance, a whale is a large investor with enough money to dominate price movements with outsized bets.
The next few months saw an intense arm-wrestling match between Weinstein and his hedge fund cohorts – and one of the largest private balance sheets in modern finance.
Iksil held Weinstein at bay for the next several months, by doubling and tripling down on his bets. His position ballooned in size from $51 billion in November 2011 to $157 billion by March 2012. By then, the story had gained attention from the press, and reporters began raising questions about whether J.P. Morgan was over-exposed in the trade.
In April, J.P. Morgan CEO Jamie Dimon dismissively referred to the situation as a “tempest in a teapot.” This helped drive down the price of Iksil’s short position, and by early May, Saba’s fund was down 20% on the trade. But it was a short-lived reprieve for the London Whale.
Later that month, turbulence erupted across global financial markets as the European debt crisis came to the fore. As concerns about financial stability rose, the price of CDS contracts rose – and Weinstein’s position went from deep in the red into a 9-figure profit in a matter of weeks.
The London Whale was beached – unable to exit his position without taking on massive losses.
The situation culminated in a high-ranking J.P. Morgan executive paying a personal visit to Weinstein in his office on the 58th floor of the Chrysler building…
The executive slid a piece of paper over to Weinstein, asking him to name a price to close out his positions against Iksil. The exact figure Weinstein wrote down remains confidential, but Saba reportedly cleared between $300 and $800 million on the trade.
There is limited public information on exactly how much money other hedge funds made from the trade. But by the time J.P. Morgan unwound Iksil’s full position, America’s largest and most venerable financial institution reported a $6.2 billion loss. CEO Dimon was hauled in front of Congress to answer for the bank’s failure in risk control and oversight. On top of the $6.2 billion trading loss, J.P. Morgan was fined $920 million. And Dimon’s pay in 2012 was cut in half, from $23 million to $11.5 million.
The debacle made front-page news, and invited harsh public scrutiny on America’s largest bank. The press had a field day with Iksil, who was fired. He then vanished, and only in 2017 gave his first public interview after the debacle unfolded. (He claimed that he’d been merely a pawn in the game, and his superiors had pushed him to double down on the trade.)
We’ll never know exactly who is at fault for the “London Whale” trade. But we do know that Weinstein came out the big winner, despite playing the little guy in what was a David vs. Goliath fight.
It was one of the greatest coups on Wall Street… and just one of the many remarkable feats of Weinstein’s storied career.
In his first year trading credit derivatives for Deutsche Bank, Weinstein earned the bank a windfall by profiting from the 1998 Russian default and subsequent collapse of Long-Term Capital Management. When he was 27, he became one of the youngest managing directors in Deutsche Bank’s history, tasked with managing $30 billion for the bank’s internal hedge fund.
He rose to prominence as one of the best derivatives traders on Wall Street, flourishing in the financial fallout from the Dot Com bust. This included substantial profits from the 2000 - 2001 California electricity crisis, the 2001 Enron bankruptcy, and the 2002 implosion of telecoms company WorldCom.
Today, Weinstein manages $5 billion in mostly private money for his hedge fund clients – minimum investment: $500,000 – at Saba Capital Management. But thanks to an activist showdown in 2019, investors looking for lower minimum investment levels can access what is effectively a hedge fund-style investment vehicle managed by Boaz Weinstein, in the form of a closed-end fund, or CEF.