Friday, May 11, 2012

Friday, May 11, 2012 - JPMorgan Moving On

DOW – 34 = 12,820
SPX – 4 = 1353
NAS +0.18 = 2933
10 YR YLD -.04 = 1.84%
OIL – 1.51 = 95.57
GOLD – 13.00 = 1581.40
SILV - .15 = 28.99
PLAT – 21.00 = 1471.00

So, let's break down the problems at JP Morgan Chase. The bank lost net $800 million, on a $2 billion dollar trading loss in synthetic credit derivatives. They won't go broke today. JPM made $5.4 billion in profit in the first quarter. Still, a couple of billion dollars is significant, and it raises questions about the regulation of banks, the valuation and suitability of derivatives, the size of the world's largest firms and the systemic risk they may pose to the financial system. For the past few years, JPM has been increasing the size and importance of its proprietary trading desk based in London. Theoretically, a proprietary trading desk trades stocks, bonds, currencies, commodities, derivatives and other financial instruments with the firm's own money – as opposed to using customers' money. If the bank makes money, they keep it and Jamie Dimon gets a big bonus. If they lose big, Jamie Dimon could lose his job, but he gets to keep the bonus. If the proprietary trading department screws up royally and the trades implode and pose a possible systemic threat, then the taxpayers cover the losses, and Jamie Dimon gets to keep his bonus.

Once upon a time, the proprietary trading department of a bank was not the major part of the banks' profits. The bankers made money by traditional banking. Over time, they realized they could play the markets with the banks money, and so the prop trading morphed into something like an internal hedge fund, which accounts for the lion's share of the banks' profits. JP Morgan's internal hedge fund was known as the chief investment office, or CIO. In theory, the CIO was in charge of hedging risk, at least that's what Jamie Dimon has been claiming. That's a load of bull. The CIO had the highest value at risk of any part of the bank's operations. Value at risk is another way of measuring how much the prop trading desk could lose on any given day. Yesterday, during the quickie news conference, Jamie Dimon revealed that JP Morgan had restated its value at risk of the CIO in the first quarter, from $67 million to $129 million. And as fast as you can say WTF, JPMorgan's risk doubled. Risk did not go up 5% or 10%. Their bets were twice as risky as they had claimed.

Now, this is the same industry that argues that they have too much regulation. Either Jamie Dimon has lied to the public about his knowledge of risk, or he is a blithering incompetent dolt who doesn't know what the most risky part of his company is doing. It would be hard not to know. Reporters have been talking about the CIO for a couple of years and the reports have been more intense in the past few months. Several weeks ago there were reports about a London-based Morgan trader making huge high-stakes bets, causing excessive volatility in derivatives markets. When asked about it then, Dimon called it “a complete tempest in a teapot.”

The trader responsible for placing the bets is Bruno Iksil, who also earned several nicknames: the London Whale and Voldemort. Iksil's credit default positions were so large that they caused unusual market movements. Iksil could move markets on his own. The market traders knew it. The Federal Reserve knew it. The SEC knew it. The ECB knew it. Are we supposed to believe Jamie Dimon was the only man on Wall Street who didn't know about the London Whale? He looked the other way. Even after a $2 billion dollar loss, the net loss is only $800 million because the CIO office was making money in other trades. And this is where we get to Dimon's level of awareness. As long as the CIO was making money, there was nothing egregious, there were no errors, there was no risk, there was no bad judgment.

The banks never do anything wrong until they lose money. The banks never need to be regulated until they implode. The banks never need bailouts until they need bailouts. The biggest banks are still so large, so complex, and their desire for profits so great that they remain a systemic risk to the global financial system. So, why do we have proprietary trading departments in banks? Why does – or now we can say why did - JPMorgan pay the London Whale $100 million per year to make risky bets? Because Jamie Dimon didn't consider it to be a big risk. The Whale made money and if the Whale lost too much, he'll go begging for bailouts. Privatized profits and socialized losses. Yes, the same Jamie Dimon that didn't understand the amount of risk, or the one who lied about the risk (it is either one or the other) is the same Jamie Dimon who has been leading the battle against regulation of the banks, and now says: “We will admit it, we will fix it and move on.” Just like nothing ever happened. What the heck, it worked in 2008. There has probably never been a greater reminder that we need to separate the gambling side of banking from the traditional banking. We used to do this in America. It was part of the Glass-Steagall Act. It worked. It didn't stop the big banks from gambling but it didn't support their gambling habit. If the banks gambled and failed, they went bankrupt. With real life consequences, the banks were not quite so reckless.

Maybe, if we separated the traditional bank from the casino, we could actually see banks do something that provides some benefit for the countries that have issued charters which allow the banks the privilege to exist. Maybe then, when people come to the bank and say they want to borrow money to buy a house or a car or a truck or to build a factory, JPMorgan might say yes. Now they look at these crazy schemes and say “no”, and it's not because the ideas are so bad, it's just that they can make so much more money by taking excess deposits and gambling on synthetic credit derivatives. And the more people deposit with the bank and the bank doesn't loan that money out, the more excess deposits they can use for gambling.

The losses here had been mounting for at least six weeks, according to Morgan. Why didn't this come out in the first quarter earnings? Well, it's not the end of the world. Fitch Ratings downgraded JPM this afternoon, and JPM will probably need to post an additional billion dollars in collateral to adjust for the downgrade, but they're still rate AA-. And yes, today's price hit lopped about $13 billion off of market cap. And yes, further losses are likely to occur as the firm unwinds some of its positions. And yes, there are ongoing concerns about the volatility and viability of these synthetic credit positions.

We don't really know exactly how or where the money was lost but there is a chance it disappeared down the same wormhole as Jon Corzine. There is some guesses that the CIO was investing in something called a Credit Default Index, specifically the CDX. IG.NA.9, which would expire in December 2012, right about the end of the world according to the Mayan calendar. The point is there is plenty of time to lose a plenty big amount of money. And the more fun thing to remember is that most of these derivatives are written between the same 20 biggest banks in the world, so if one goes belly up, they all get vaporized.

Actually, there are some fun guesses and one of the most entertaining is that the JPMorgan short squeeze on the silver market is finally coming to bite them in the butt. And there is a good chance the losses could continue. And there is a good chance that some powerful players were propping up the share price today. There was a multimillion dollar stock purchase just before the closing bell.But they can't just keep on keeping on based upon size alone. In fact, too big to fail may have been one of the major reasons for the failure of the London Whale. When Bruno Iksil got so big he was moving markets, people figured out it was him, and they started picking him off, making it more expensive for him to do his trades, forcing him to show mark-to-market losses, and eventually forcing him to unwind his position, which would make them money, which it apparently did.

Of course, the big concern is that the London Whale-dermort was really just involved in simple trading and hedging and we don't know squat about the really dangerous and really complex stuff which will all implode on 12-21-2012. So, don't worry.

That's the simplified version of what happened. If you don't want another global financial meltdown then we should look at changing things. The banks need to stop doing all this incredibly complex gambling which benefits no one. We, the people allow banks to have charters, and there is no good reason to charter this kind of activity. It does no good for our economy – just the opposite. At the very least, we might allow the charter but at least demand that if they are going to gamble, they use their own money. 

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