You blink a few times at the screen and realize what you're seeing is not a typo. $6.2B has left your bank due to some rogue trader making untimely bets on the market. That's B as in billion. You call up the modeler who was supposed to make sure this never happens to your bank. The modeler takes a closer look at his model, and realizes that he made a fundamental error in how he calculates one value that caused the dominoes to fall. This is the story of the "London Whale" at JPMorgan Chase in 2012 who cost the bank $6.2B and a breakdown of the Excel error that may have caused the whole thing. This is the Google Sheet if you want to follow along with the Excel error.

Derivative of a derivative

I'm not going to pretend like a know the intricacies of all the financial products involved here, so you can read the Wikipedia article if you want the full details. In 2012, there was a CDS (credit default swap) product called CDX IG 9 that the trader at JPMorgan may have made large bets on, and ended up on the wrong side of the bet. The London trader's name is Bruno Iksil, and it was a classic scenario of a gambler trying to get out of his losses by doubling down on black at the roulette table.

Source: The Fiscal Times

Multiple investigations were taken by the authorities in the U.S. and U.K., the the investigations show that a variety of institutional failures may have facilitated the large bets made by the London Whale. This HBR article by Ben Heineman, Jr. provides a nice summary of all the key players:

* London traders - The traders simply didn't understand the complexity of the derivative products they were buying and selling* Chief Investment Office (CIO) - The head of the CIO didn't monitor the trading strategies and put in the proper controls for the portfolio of products the office was buying. The Value at Risk (VaR) model was flawed (see more below).* Firm-wide Leaders - Not enough oversight by the CFO and CEO (Jamie Dimon) * Board and Risk Policy Committee - The committee was told that everything was fine with the CIO, and didn't get accurate pictures of what risk officers really felt about the risky trades being made.

Appendix of the Task Force Report by JPMorgan

There is a 130-page report created by JPMorgan Chase in 2012 which details what happened internally that led to this debacle. In my opinion, the juicy stuff starts in the appendix starting on page 121 of the report. I read off some parts of this appendix in this episode, but the appendix basically details issues with the VaR models created by one of the quantitative modelers at JPMorgan to more accurately value the complex traders that were happening. Or at least they thought the model was more accurate.

At the very end of the appendix, there's a section called "Discovery of Problems with the New VaR Model and Discontinuance" where the report details the Excel error that contributed to the large inaccuracies in how the model valued risk.

The $6.2B Excel error

This is how the error is described in the report (emphasis mine):

Following that decision, further errors were discovered in the Basel II.5 model, including, most significantly, an operational error in the calculation of the relative changes in hazard rates and correlation estimates. Specifically,