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The downside of prop trading

As investment banks turn ever more to proprietary trading to make profits amid the market slowdown, their reported earnings are becoming increasingly volatile. This quarter, Goldman made a bundle and JPMorgan took a hit. Next quarter, who knows? Investors and ratings agencies are becoming worried.

October 16 is a day many have marked on their calendars. Employees, investors, analysts, regulators and competitors are all eager, for a variety of reasons, to hear JPMorgan Chase's third-quarter results.

The question they all want answered is: what went wrong? How could a bank that prided itself on its risk management culture suffer a double whammy in its trading and loans businesses which, combined, as David Hendler, banks analyst at independent research firm CreditSights points out, "will probably lop $2 billion or more from pre-tax income which may turn into a substantial loss for the quarter"?

Trading is one of the bank's core businesses, and one of its most reliable performers. It usually brings in roughly $1.5 billion in revenues each quarter. Total revenues for July and August, though, were just $100 million, executives said. And the vast majority of the drop in what Merrill Lynch banks analyst Judah Kraushaar dubbed "oppressive trading results" came from proprietary trading.

It was becoming increasingly likely that at least one firm was going to take a prop trading hit at some point. As Euromoney reported in August, almost all the major US banks and brokers have increased their reliance on proprietary trading strategies to boost earnings, which for two years have been suffering from a dearth of the fee-income investment-banking business that had proved so plentiful in the bull market.

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