Thursday, May 10, 2012 - JP Morgan Chase Goes Boom

DOW +19 = 12,855
SPX + 3 = 1357
NAS – 1 = 2933

10 YR YLD + .05 = 1.88%
OIL - .26 = 96.55
GOLD + 4.00 = 1594.40
SILV -.23 = 29.14
PLAT – 13.00 = 1492.00

So, it was a quiet day in the markets, not much going on; the Dow and the S&P managed to eke out modest gains, and this was welcome following 6 days of losses. Back in early April I told you to start getting out of the market, based in part, on the the idea of “Sell in May and stay away”. Sure, enough, May has been ugly, but not every day is ugly. There will be ups and downs. The past six days have been down; today the markets stopped banging their head against a wall, but the headache hasn't gone away. All in all, an uneventful trading day.

And then after the closing bell – boom!

JP Morgan Chase lost about $2 billion on mark-to-market accounting tied to synthetic credit securities after positions taken by its chief investment office were riskier than expected.

JPMorgan’s chief investment office, or CIO has been transformed in recent years under Chief Executive Officer Jamie Dimon, into a unit that makes bigger and riskier speculative bets with the bank’s money, five former employees of the bank said earlier this year. Some of the bets were so big that the bank probably couldn’t unwind them without losing money or roiling financial markets. Losses in CIO’s synthetic credit portfolio have been partially offset by gains from sales, mostly of credit-related positions, in the ‘‘AFS securities portfolio,’’ according to the filing. It's estimated the net loss is around $800 million for the corporate segment of JP Morgan Chase, however, as of March 31, 2012, the value of CIO’s total AFS securities portfolio exceeded its cost by approximately $8 billion.

The bank issued a statement: “This portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed.” JPMorgan said net income in its Corporate unit will be more volatile in future periods.

JPMorgan said it’s ``repositioning'' the synthetic credit portfolio, and that the CIO ‘‘may hold certain of its current synthetic credit positions for the longer term.’’ Which sounds like they are stuck with some nasty trades that they can't dump.

On a rapidly-arranged conference call, Dimon called the strategy “flawed.” Its execution was riddled with “errors, sloppiness and bad judgement,” Dimon said, reminding those on the call that the issues had nothing to do with clients, though readily admitting it “puts egg on our face and we deserve any criticism we get.”

Dimon warned that unwinding the “egregious” and “self-inflicted” mistakes will be rectified, during a period that may entail some increased volatility because the firm will be responsible in getting out of the positions. “We’re not going to do something stupid,” he said. “Volatility will be high, and it could cost $1 billion or more.” During a conference call after the news came out, Dimon said the $800 million loss figure could get better or worse during the quarter. Hopefully, by the end of the year the impact will not be significant, he said.

Dealing with the issue will not impact the firm’s plans to return capital to shareholders via dividends and buybacks in 2012, Dimon said. When asked why the firm decided to disclose the information, he said “it’s not going to stop us from building a great company,” but that JPMorgan wanted to be transparent given that the situation arose so soon after the end of the first quarter.

As for whether the strategy may have run afoul of regulators, the JPMorgan chief said that whether or not the trading was above-board under the Volcker Rule, “it violates the Dimon Principle.” Yea, sure. It didn't violate anything a month ago, as news was coming out that Bruno Iksil, the London based manager of the CIO unit was revealed to be making massive bets in credit default swaps. It didn't violate anything until it turned into a loss.

Here is Dimon's description of the CIO prop desk during the conference call: "I did want to talk about the topics in the news around CIO and just take a step back and remind our investors about that activity and performance. We have more liabilities, $1.1 trillion of deposits than we have loans, approximately $720 billion. And we take that differential and we invest it, and that portfolio today is approximately $360 billion. We invest those dollars in high grade, low-risk securities. We have got about $175 billion worth of mortgage securities, we have got government agency securities, high-grade credit and covered bonds, securitized products, municipals, marketable CDs. The vast majority of those are government or government-backed and very high grade in nature. We invest those in order to hedge the interest rate risk of the firm as a function of that liability and asset mismatch."

Well, that's just a load of bull. Dimon can't claim the proprietary trading desk was just hedging; no, they were gambling and they were gambling big. The CIO’s growing size and market power made it an increasingly important customer to Wall Street’s trading desks and a market influence watched by hedge funds and other investors, the former employees said. Iksil’s positions in credit-derivatives have become so large that some market participants dubbed him “Voldemort,” after the villain of the Harry Potter series who’s so powerful he can’t be called by name.

Shares of JPMorgan, frequently held up as an example of a bank that withstood the bursting of the housing bubble and subsequent crisis better than most, plunged 6.9% to $37.94 in uncommonly high volume trading after hours.

What's next? The last time there was a good trading scandal, the Fed cut interest rates by 75 basis points; I don't think that will happen now. A credit rating downgrade is very possible; likely a two notch cut, which in turn would push up borrowing costs. A two notch cut would force JPM to raise an additional $1.7 billion in collateral. Ouch.

From the Conference Call:

Question: was anybody else doing this kind of trade?

Dimon says he doesn't know. "Just because we were stupid doesn't mean everybody else was."

Wanna bet? JP Morgan Chase has generally been considered one of the bright kids in the banking pool. Now we start the fun part; trying to figure out just how many greater fools are out there. And how much toxic garbage does JP Morgan have on the books and just how toxic is it, and can you trust JP Morgan? And if JPM has problems, what about everybody else – there problems may be even worse. Who can you trust? Well, clearly you can’t trust anybody. And if you cant trust anybody, what happens next? Credit spreads widen. What happens if credit spreads soar? It gets really, really ugly. JP Morgan's losses could grow like a cancer, before you turn around, you might see $20 billion in losses. Remember when Bear Stearns collapsed? Allan Schwarz, the Bear CEO went on CNBC and said everything was fine. Bear had a $17 billion dollar liquidity cushion. One day, everything is fine, the next it isn't, and they're taping a dollar bill on your front door.

The difference is that this time there are no more bailouts. The president promised: no more bailouts, never again. 

Friday, April 13, 2012

DOW – 136 = 12,849
SPX – 17 = 1370
NAS – 44 = 3011
10 YR YLD -.05 = 2.00%
OIL - .81 = 102.83
GOLD – 16.80 – 1659.50
SILV - .88 = 31.60
PLAT – 20.00 = 1581.00

The S&P 500 is now down 3.4 percent from this year's closing high, after falling 2.7 percent over the past two weeks.

Wells Fargo and JP Morgan reported first quarter results; both beat expectations. JP Morgan came in with EPS of $1.31 on $26.7b in revenues; topping estimates of EPS $1.18 and revenues of $24.6b. Wells Fargo posted EPS of $0.75 on $21.6b in revenues, beating estimates of $0.73 and $20.4b. JP Morgan made a big chunk of earnings by lowering their reserves for loan losses by $2 billion. In the last 2 years, JP Morgan has generated $12.3 billion in non-earning earnings, even as non-performing loans increased by $600 million in the last quarter. Or as CNBS said, they “blew expectations out of the water.” Blowing smoke is more like it. WFC - 3.4% JPM -3.6% BAC -5.3% GS -4.4% C -3.5%.

Jamie Dimon, the CEO of JP Morgan said he would fight buyback demands or repurchase claims on mortgage securities that turned sour. Bank of America has already lost a few of these multi-billion dollar battles. JP Morgan is in the same business as Bank of America.

Jamie Dimon briefly responded to questions about the Chief Investment Office, or CIO; that's the proprietary trading division. According to JP Morgan the CIO division uses approximately $360 billion in excess deposits to manage risk, not to make bets for its own accounts. There have been recent reports that the prop trading has increased the size and risk of its speculative bets over the past few years. According to one CIO trader, the division recently wrote $100 billion in protection on a single CDS index. If they aren't using deposits to bet, where are they getting the money to write those kinds of contracts.

If I ever hear another nut job talk about the fundamentals for the banks I think I'll puke. What fundamentals? Aren't fundamentals supposed to have some relationship with earnings and revenue and reality?

And then we had Ben Bernanke talking about financial stability, which must be something like an instructional video from the Captain of the Titanic on iceberg avoidance techniques, or a lecture on sobriety from Snoop Dog. Bernanke wrapped up this week's edition of the Federal Reserve Propaganda Tour by explaining how he couldn't figure out how to forecast the financial crisis of 2007-2009 because it's really difficult to forecast that stuff and then he explained how the subprime problem wasn't the trigger and even if it was it didn't make sense to him. And if we want to avoid a problem like that again, we need more regulation from the Fed. Now, here's the problem of the day: Bernanke forgot to talk about handing out free money to the bankers, and before you could clear your throat, the stock market tumbled. Five days down, two days up, one day down. You've got to take sea-sick pills just to buy a mutual fund. And then the CPI report showed inflation picked up last month, a dangerous gain of 0.3%; the core rate, excluding food and energy was up 0.2%. There is no doubt that if all you people would just stop eating and driving cars we wouldn't have a problem with inflation and the Fed would be happy to pass out free money.

Actually Bernanke skirted the issue in his summation as he praised “backstop liquidity provisions”. Of course, not actually speaking the letters Q & E might be the best indicator the money is on the table; the thing that shall not be named. I think it would be a courtesy to investors if the Fed would just post a daily price for every stock, bond and commodity; that way we wouldn't have to guess and we could spend our time doing something productive.

Sheila Bair, the former head of the FDIC, wrote an article in the Washington Post today. Here's what she wrote:

“Are you concerned about growing income inequality in America? Are you resentful of all that wealth concentrated in the 1 percent? I’ve got the perfect solution, a modest proposal that involves just a small adjustment in the Federal Reserve’s easy monetary policy. Best of all, it will mean that none of us have to work for a living anymore.

“For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.

“So why not let everyone participate?

“Under my plan, each American household could borrow $10 million from the Fed at zero interest. The more conservative among us can take that money and buy 10-year Treasury bonds. At the current 2 percent annual interest rate, we can pocket a nice $200,000 a year to live on. The more adventuresome can buy 10-year Greek debt at 21 percent, for an annual income of $2.1 million. Or if Greece is a little too risky for you, go with Portugal, at about 12 percent, or $1.2 million dollars a year. (No sense in getting greedy.)

“Think of what we can do with all that money. We can pay off our underwater mortgages and replenish our retirement accounts without spending one day schlepping into the office. With a few quick keystrokes, we’ll be golden for the next 10 years.

“Of course, we will have to persuade Congress to pass a law authorizing all this Fed lending, but that shouldn’t be hard. Congress is really good at spending money, so long as lawmakers don’t have to come up with a way to pay for it. Just look at the way the Democrats agreed to extend the Bush tax cuts if the Republicans agreed to cut Social Security taxes and extend unemployment benefits. Who says bipartisanship is dead?

“And while that deal blew bigger holes in the deficit, my proposal won’t cost taxpayers anything because the Fed is just going to print the money. All we need is about $1,200 trillion, or $10 million for 120 million households. We will all cross our hearts and promise to pay the money back in full after 10 years so the Fed won’t lose any dough. It can hold our Portuguese debt as collateral just to make sure.

“Because we will be making money in basically the same way as hedge fund managers, we should have to pay only 15 percent in taxes, just like they do. And since we will be earning money through investments, not work, we won’t have to pay Social Security taxes or Medicare premiums. That means no more money will go into these programs, but so what? No one will need them anymore, with all the cash we’ll be raking in thanks to our cheap loans from the Fed.

“Why should hedge funds and big financial institutions get all the goodies? ”

Brilliant.

Spanish CDS hit a new high. This is credit default swaps, or a type of derivative that is a cross between a bet and insurance that Spain will go into default. Now, more than ever before investor/gamblers are betting that Spain will default on its debt. Spanish and Italian bond yields jump again, IBEX and MIB stock indexes both fall more than 5% on the week. I'm trying to figure out this Euro-mess. Spain owes about a trillion dollars, Ireland owes about $900 billion. Italy – more than a trillion. So they need bailouts from the ECB. So they owe the money to the other Euro countries and the other Euro countries are paying the bailouts and then that money can be used to pay off the Euro countries that are..., wait, wait, my brain just turned into a pretzel.

Oil prices appear to have stabilized — and may even be on their way back down. At least, so says the International Energy Agency’s report for April, which notes that Saudi Arabia and other OPEC countries seem to be pumping out enough crude to offset the oil lost by sanctions on Iran.

As a result, gas prices may have peaked last week, at $3.94 per gallon, and will start to decline for the summer. It’s probably too soon to say for sure — a frantic bit of tension in the Middle East could easily jolt prices back upward. But it does raise a question: If oil and gasoline prices dodrop, will that boost the U.S. economy?

(A 5 percent reduction in the price of crude, sustained for a year, would save the average American about $250 from lower gasoline prices, smaller utility bills, and lower inflation. That’s not bad, though it’s only about one-fourth the size of the payroll tax cut passed this year. So, if lower oil prices won't really juice the economy, then why are we hearing so much talk about the necessity to lower oil prices? This is the big political talking point?)

I read an article on Yahoo Finance this morning about Edward Luce. Luce is the chief U.S. columnist for the Financial Times; he is British but has spent many years in the U.S. Luce took some time off to travel around the U.S. for several months. And he's written a new book Time to Start Thinking: America in the Age of Decline. I have not read the book but it got me thinking. Is America in decline?

He saw a middle-class being hollowed out, declines in once-great cities like Detroit, the loss of manufacturing jobs, busted education systems, and a political system paralyzed by bitter partisanship and an inability to get things done. While not predicting America's collapse, Luce is "skeptical about America's ability to sharply reverse her fortunes." And so that raises the question; if America is in decline, is it too late to pull ourselves back up? Is it inevitable? If it is not inevitable, what should we be doing right now?

He says America is losing its pragmatism - and the consequences of this may soon leave the country high and dry. Luce turns his attention to a number of different key issues that are set to affect America's position in the world order: the changing structure of the US economy, the continued polarization of American politics; the debilitating effect of the "permanent election campaign"; the challenges involved in the overhaul of the country's public education system; and the health-or sickliness-of American innovation in technology and business. His conclusion, "An Exceptional Challenge" looks at America's dwindling options in a world where the pace is increasingly being set elsewhere. While many Americans believe that their country can and should retain its status as a global superpower, Luce sees this as an increasingly unlikely scenario, unless Americans themselves can stand up against the country's increasingly plutocratic character. America has bounced back successfully from the shocks of The Great Depression and the Soviet launch of Sputnik, but Luce wonders if the next crisis in American confidence may knock it off the top-dog position for good.

The world’s largest company, Wal-Mart Stores, has revenues higher than the GDP of all but twenty-five of the world’s countries. Its employees outnumber the populations of almost a hundred nations. The world’s largest asset manager, a secretive New York company called Black Rock, controls assets greater than the national reserves of any country on the planet. A private philanthropy, the Bill and Melinda Gates Foundation, spends as much worldwide on health care as the World Health Organization. The rise of private power may be the most important and least understood trend of our time.

Acrimony and hyperpartisanship have seeped into every part of the political process. Congress is deadlocked and its approval ratings are at record lows. America’s two main political parties have given up their traditions of compromise, endangering our very system of constitutional democracy. Are we looking at something more dangerous than a gradual decline? Is the situation worse than it looks?

Until now we have been able to pass the buck to future generations by saying, "We don't need to raise taxes. We can borrow the money today and trust that the economy will grow sufficiently in the future to pay it off." Have we finally reached the plateau of slow economic growth whereby the old theory of "paying off the debt with future growth" will be insufficient to the task? I can tell you that debt is actually a tax on future growth. In fact it was once considered the actual theft of time.

The most immediate problem facing our nation is the high level of unemployment that persists years after the peak of the financial crisis, leaving the economy operating significantly below capacity. But our national debt, and the spending and tax policies that underlie its growth, will be a major challenge for at least the rest of the decade, as we figure out how to adapt our government and our society to do less with less or whether we might be able to do more with more. Do we have a solution? And if you think you have a solution, do you think you could be heard?

Remember the Super Committee? Twelve politicians, split down party lines; bicameral but ultimately not bipartisan; brought together to hammer out a solution to the debt problem; failed like a North Korean rocket launch.

Teddy Roosevelt said it best: “In any moment of decision, the best thing you can do is the right thing. The worst thing you can do is nothing.” Our nation, for the most part, is sadly accepting of the broken nature of our Congress. Nothing is the new norm in Washington.

Is this proof that America is in decline?

What are the consequences? There has been almost no discussion since around Thanksgiving. The Super Committee has been washed through the news cycle and hung out to dry. Maybe we'll remember it when the automatic cuts hit at the start of 2013 – if they hit. Who knows?

What we do know is that our politicians can't do the right thing? Why? Because they sold out.

The politicians on the Super Committee were supposed to do their work without intervention from other politicians. They did their work or lack thereof, without intervention from their constituents; private citizens were not permitted to address the committee; 250 lobbyists were permitted to address the committee but not private citizens. Money buys access and the average increase for SuperCommittee members was more than $2,200 per day in additional fundraising dollars. Donations rolled in from the PACs, more than $100 million dollars from the top ten industry groups alone.

Is America in decline? I would say yes but I don't want to believe it is too late or inevitable.