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JPMorgan Chase & Co
When JPMorgan Chase (JPM) made its money-losing multibillion-dollar bets on the corporate bond market, hedge fund manager Andrew Feldstein took the opposite side and won. Feldstein, co-founder of BlueMountain Capital, also profited by helping the Wall Street bank unwind the trades, according to four people with knowledge of the strategy who asked not to be identified because the matter is private. He enabled JPMorgan to unload more than $20 billion of bets on a credit default swap index, two of the people say. In all, BlueMountain may have earned as much as $300 million, according to market participants familiar with the trades.
“Andrew Feldstein is one of the most creative and sophisticated investors in fixed income,” says Sarah Quinlan, founder of hedge fund advisory firm QAM in New York and a former BlueMountain investor. “It is not surprising that JPMorgan would reach out to him to assist in the unraveling of this complicated and very public situation.”
Photograph by Daniel Acker/Bloomberg
JPMorgan Chief Executive Officer Jamie Dimon said on May 10 that the bank could lose $3 billion or more from bad bets on credit derivatives. The bank has said it will provide an update on the loss and its market positions when it reports second-quarter earnings on July 13. Doug Hesney, a spokesman for BlueMountain, declined to comment, as did Kristin Lemkau of JPMorgan.
A former Harvard Law School classmate of Barack Obama’s who played pickup basketball with the future president, Feldstein, 47, has kept a low profile outside financial markets. JPMorgan hired him in 1992 to help the bank develop a business in credit default swaps. Those instruments, which allow investors to buy and sell protection against debt defaults, evolved into a market with more than $62 trillion of outstanding contracts at its peak in 2007.
Feldstein started New York-based BlueMountain in 2003 with Harvard Law friend Stephen Siderow. His flagship fund, with assets of $4.3 billion, has generated annual average returns of almost 10 percent, largely through arbitrage—spotting abnormalities in the price relationships in credit swaps—rather than by wagering that overall credit conditions will get better or worse. “Our objective is to avoid placing any bets on these macro outcomes,” Feldstein said late last year. “We don’t think they’re very predictable.”
One of the trades BlueMountain has mastered better than almost any other hedge fund, according to market participants, involves exploiting price gaps that can open up between indexes of credit default swaps and contracts on the companies that make up the indexes. When the cost to buy protection on the index drops below the average cost of swaps on the individual companies, the fund will purchase CDS contracts on the benchmark and sell contracts on the companies that comprise the index. The fund will turn a profit when the prices of the CDS on the index and on the companies get back in line.
That was the opportunity that hedge funds noticed last year as a trader in JPMorgan’s chief investment office in London, Bruno Iksil—who came to be known as the London Whale—began selling a large amount of CDS on the Markit CDX North America Investment Grade Index Series 9. The index, known as IG9, is tied to 121 companies that were investment-grade when it was created in September 2007. Iksil sold so many CDS contracts on the index that he drove their price far below the average price of CDS on the underlying companies. Hedge funds including BlueMountain, Saba Capital Management, BlueCrest Capital Management, and Hutchin Hill Capital pounced on the price distortion created by Iksil’s bets. Saba founder Boaz Weinstein recommended the trade at a February hedge fund conference in New York.
After JPMorgan announced its loss, the cost of swaps on the IG9 index surged as traders anticipated that the bank would unwind its bets. “When you put on a large trade, it’s hard for people not to notice what you’re doing,” says Scott MacDonald, head of research at MC Asset Management Holdings in Stamford, Conn. “It’s a treacherous landscape to be unwinding the trade in.”
BlueMountain came to the rescue. Because the hedge fund trades so many credit swaps as it pursues its arbitrage strategies, it was in a better position than JPMorgan to take the bank out of a large chunk of its losing bets without tipping off other investors, say two market participants familiar with credit swaps trading. By assisting JPMorgan in unwinding its trades, Feldstein may have helped the bank limit its losses. Just as important, he enabled the bank to take those losses in the second quarter and move ahead with less uncertainty, says Adrian Miller, director of global markets strategy at GMP Securities in New York. And he helped Dimon contain a debacle that tarnished his reputation as one of banking’s best risk managers. Dimon, says Miller, “will be judged by how this problem is rectified.”
“Feldstein is a former JPMorgan exec and likely has a good relationship with senior management,” says Miller. “Since transacting these trades with as little market knowledge as possible is the key to not creating big price fluctuations, who better to go to than a trusted prior colleague?”
The bottom line: BlueMountain may have earned $300 million by betting against JPMorgan in the CDS market, then helping the bank exit its trades.