Archive for May 29th, 2012
Warren Buffett once said that derivatives are “financial weapons of mass destruction”, and that statement is more true today than it ever has been before. Recently, JP Morgan made national headlines when it announced that it was going to take a 2 billion dollar loss from derivatives trades gone bad. Well, it turns out that JP Morgan did not tell us the whole truth. As you will see later in this article, most analysts are estimating that the losses will eventually be far larger than 2 billion dollars. But no matter how bad things get for JP Morgan, it will not be allowed to fail. JP Morgan is the largest bank in the United States, so it is essentially the “granddaddy” of the too big to fail banks. If JP Morgan gets to the point where it is about to collapse, the U.S. government and the Federal Reserve will rush in to save it. Because of this “security blanket”, banks such as JP Morgan feel free to take outrageous risks. Today, JP Morgan has more exposure to derivatives than anyone else in the world. If they win, they win big. If they lose, U.S. taxpayers will be on the hook. Not only that, but thanks to Dodd-Frank, U.S. taxpayers are on the hook for bailing out the major derivatives clearinghouses if there is ever a major derivatives crisis. So when the derivatives market crashes (and it will) you and I will be left holding a gigantic bill.
Derivatives almost caused the complete collapse of insurance giant AIG back in 2008. But instead of learning our lessons, the derivatives bubble has gotten even larger since that time.
A Bloomberg article that was published last year contained a great quote from Mark Mobius about derivatives….
Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, said another financial crisis is inevitable because the causes of the previous one haven’t been resolved.
“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan in Tokyo today in response to a question about price swings. “Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”
Never in the history of the world have we ever seen anything like this derivatives bubble.
But instead of getting it under control, we just allowed it to get bigger and bigger and bigger.
Now JP Morgan is in quite a bit of trouble. A recent Daily Finance article summarized how JP Morgan got into this mess….
Bruno Iksil, a trader working in the bank’s London office, placed a massive bet in the derivatives market. Derivatives “derive” their value from the value of an underlying asset, like stocks, bonds, currencies, or a market index. The specific type of derivative used in Iksil’s bet was a credit default swap index, known as “CDX.NA.IG.9.”
CDX.NA.IG.9 tracks a basket of corporate bonds. Iksil’s positions on the index were so big (one report put it at $100 billion) that they were moving the market and interfering with other traders’ positions. These annoyed traders — hedge-fund managers — dubbed Iksil “the London Whale” for his outsize bets.
So if the real number isn’t 2 billion dollars, how much will JP Morgan eventually lose?
Morgan Stanley says that the losses could eventually reach 5 billion dollars.
The Independent is reporting that the losses could eventually reach 7 billion dollars.
One author featured on Zero Hedge suggested that the losses could ultimately reach 20 billion dollars….
Simple: because it knew with 100% certainty that if things turn out very, very badly, that the taxpayer, via the Fed, would come to its rescue. Luckily, things turned out only 80% bad. Although it is not over yet: if credit spreads soar, assuming at $200 million DV01, and a 100 bps move, JPM could suffer a $20 billion loss when all is said and done. But hey: at least “net” is not “gross” and we know, just know, that the SEC will get involved and make sure something like this never happens again.
The truth is that nobody really knows. Everybody agrees that the losses will likely far exceed 2 billion dollars, but the real extent of the crisis will not be known until the trades play out.
According to the Huffington Post, JP Morgan recently sold 25 billion dollars of profitable securities to raise some cash. The profit on the sale of those securities will be somewhere in the neighborhood of a billion dollars.
A billion dollars will help, but it will not be nearly enough.
Many are interpreting this move as a sign of panic by JP Morgan.
Meanwhile, JP Morgan CEO Jamie Dimon continues to do quite well. In fact, his 23 million dollar pay package was recently approved by shareholders at an annual meeting.
Wouldn’t you like to do your job badly and still make 23 million dollars?
Right now, JP Morgan is essentially in a “staring contest” with those on the other side of the derivatives trades that went bad. This “staring contest” was described in a recent CNN article….
It’s clear from public data filed with The Depository Trust & Clearing Corporation that JPMorgan Chase hasn’t sold any of its positions yet. The DTCC tracks trading activity and sizes of positions on the IG9 and other indexes, and there haven’t been any big moves since last week.
“Whatever the size was, it’s clearly not something that you can call one or two dealers and sell,” said Garth Friesen, a co-chief investment officer at AVM, a derivatives hedge fund that’s not involved in these trades.
As soon as it becomes clear that JPMorgan Chase is unwinding its position, it will be obvious to players on every major trading desk. Hedge funds will immediately start piling into that index and buying protection, driving up the bank’s losses.
Until then, it won’t cost the hedge funds much to sit and wait.
JP Morgan is desperately hoping that the markets move in their favor.
If the markets move against JP Morgan in a big way it could potentially be absolutely catastrophic for the biggest bank in America.
An excerpt from an email that Steve Quayle recently received from an anonymous international banking source contained some chilling analysis of the situation….
The derivative market that JPM plays in is the CDX.NA.IG.9, when factions within their London office (London Whale) made overly leveraged swaps, hedge funds smelled blood and so did a few banks. You see any moves that JPM does here on out exposes their weakness further. Which they can not afford any more exposure thus they are not buying back any more shares which is the equivalent of cutting an artery in a pool full of sharks. The strategy they are taking right now is to sit through the storm and ride it out as they can do nothing else for any action will make them even more vulnerable. They can not absorb hits in both JPM SLV and CDX.NA.IG.9. Inactivity is not something they want to do it is something they have to do. There is no other choice for them.
So what will happen if JP Morgan loses too much money?
Well, it will beg the U.S. government and the Federal Reserve for money and the U.S. government and the Federal Reserve will comply.
There is no way that they are going to let the largest bank in America fail.
In addition, as I mentioned earlier, Dodd-Frank has put U.S. taxpayers on the hook for future bailouts of derivatives clearinghouses. This was detailed in a recent Wall Street Journal article….
Little noticed is that on Tuesday Team Obama took its first formal steps toward putting taxpayers behind Wall Street derivatives trading — not behind banks that might make mistakes in derivatives markets, but behind the trading itself. Yes, the same crew that rails against the dangers of derivatives is quietly positioning these financial instruments directly above the taxpayer safety net.
One of the things that Dodd-Frank does is that it gives the Federal Reserve the power to provide “discount and borrowing privileges” to derivatives clearinghouses in the event of a major derivatives crisis.
This is what our politicians love to do.
They love to have the U.S. taxpayer guarantee everything.
Our politicians look at us as one giant insurance policy.
Apparently they believe that if anything in the financial world goes wrong that U.S. taxpayers should be the ones to clean up the mess.
But will we really have enough money to bail everyone out when the derivatives market crashes?
That is approximately 3 times the size of the entire global economy.
The U.S. government is already nearly 16 trillion dollars in debt.
How in the world can we afford to keep bailing out the huge messes that Wall Street makes?
Sadly, most Americans have no idea how vulnerable our financial system really is.
It is a poorly constructed house of cards that could come crashing down at any time.
If you still have faith in our financial system you are being quite foolish and you will soon be bitterly, bitterly disappointed.
Echavarren’s Irea brokered the refinancing of a 200 million-euro loan two years ago for a developer. After two more rounds of refinancing, there is about 180 million euros left on the loan and it’s classified as performing, he said, without identifying the company.
“The probability that this loan will be paid when it comes due is zero,” Echavarren said. “There are dozens of similar cases.”
An American bank? Nope. A Spanish one.
The problem is that it’s not just Spain. Anyone remember Kanjorski’s hearing in early 2009 that marked the bottom of the stock market almost to the day?
None of the other things Bernanke or anyone else had done stopped the bleeding. This did.
Why? Because it made it possible to pretend that trash was “money good” and that’s exactly what everyone did.
But is that an actual “recovery”? No.
It’s a lie. A scam. A fraud. A legal one, but a fraud nonetheless.
The Bank of Spain allows loans that are refinanced before turning delinquent and interest-only loans to be considered“normal” or “performing” on banks’ books, according to Manso.
Isn’t that “clever”? Take a loan you know won’t get paid and roll it before it goes delinquent. Keep doing this. That way you can claim the loan is “performing” even when there is a zero chance that loan will be paid as agreed.
It’s kinda like a HELOC here that’s behind an underwater first and the first isn’t being paid. Foreclosure is inevitable and when it happens then HELOC is worth zero. Pure logic says that such a loan should be marked at the recovery value (zero) since statistically once a first goes 90+ the odds of it curing are effectively zero (the borrower would need to make four payments, all at once, to bring it current.)
This is why banks are “allowing” people to live in houses for two, three, even four years without making a single payment. The odds of you getting away with this go up a lot if the mortgage is either private-label and held on the bank’s books or you have a HELOC and the first is underwater. In either case pretending that you’re paying means the bank doesn’t have to recognize the loss, which in turn means that they claim to have “performing assets” when in fact they are not.
The same game is being played in Spain and throughout the rest of the EU — and here.
It won’t work because it can’t.
And when, not if, it comes apart the economic impact is going to be far worse than it was in 2008, because the measures that could be taken to “help” have already been expended.
Spain is considering using debt issued by the government or its bank-rescue fund instead of cash into the Bankia group, using a mechanism that would free it from raising the money from investors.
The government hasn’t made a decision on whether to use its debt to recapitalize the nationalized lender and will decide in two or three months, a spokesman for the Economy Ministry, who asked not to be named in line with its policy, said in a phone interview today. Prime Minister Mariano Rajoy said at a Madrid news conference today the government hadn’t spoken to theEuropean Central Bank about such a step.
Debt, of course, is not cash. It does “improve” a bank’s asset-to-liability ratio.
Well, in theory anyway — note the quotes.
Because the improvement assumes that the debt you put into the bank (“gifted”, if you will, although in this case it’s in exchange for ownership!) is money good.
If it’s not then the paradox is that it will make the situation worse!
Spain has a “wee problem” in this regard in that their government bond yields are going higher. Bond values trade as an inverse of yield. This is likely to drive the yields higher still, and values lower still. The key is whether this continues once the capitalization move is made; if it does, then the rot gets much worse in a big hurry.
In short this is an outright scam to avoid forcing the liquidation of the bad debt and recognition of the losses that have already happened. It is exactly what Paulson .et.al. were doing with TARP and the rest of the mess here in America — we “gave” the banks enough capital to make them “look” good then we changed the law so they could lie in perpetuity about the “value” of their “assets” and until and unless someone forced them to actually pay (e.g. at maturity) they could get away with it.
Let’s assume for a moment that instead of these bank scams we instead had the federal government literally counterfeit $100 bills and mail them to people. Remember, The Federal Reserve is the one who directs the printing of currency at the BEP, so we’ll assume there’s another little shop off the West Wing that has a clandestine printing outfit in it.
But these bills are a bit defective, you see — they aren’t official BEP emissions and the point is to put them into the system without anyone knowing. So what we would do at the same time is pass laws that make the examination standards for “real money” less and less stringent, so the fakes the White House emitted would pass!
That’s what was done in 2009 here in the United States with the FASB threats and it’s what’s being done now in Spain. Rather than force the bad debt into the open, default it, accept the credit contraction that comes with it and clear the slate, making way for actual economic progress, we are instead continuing to shove the old, rotting fish further under the carpet, using up cans of air freshener by the case and praying that nobody notices the maggots.
It’s all a scam and we are reaching the point where this entire mess will go prompt critical. As Spanish bond yields continue to blow out the market will force discipline. Oh sure, there will be those who think Germany will “blink”, but let’s not forget that Germanycan’t, on a sustainable forward basis, carry the entire Euro zone.
Nor should it try.
This is no small gambit either — the Bankia “rescue” is approximately 1/3rd of Spanish GDP. To presume that this will not in any meaningful way impact the Spanish budget deficit is a howler of unprecedented proportion, and using existing government bonds rather than selling new debt to raise the money is an admission that Spain knows they can’t raise the funds in the market on commercially-reasonable terms.
Expect the market to lean into this admission shortly; the odds have just gone up materially that while Greece may be the trigger, it is Spain that will provide the “main charge” for the detonation over in Europe.
Last week, on 21 May, the Financial Times ran a short piece which opened thus: “There has been no official announcement. No terms or conditions have been disclosed. But Greece’s banking system is being propped up by an estimated €100 billion or so of emergency liquidity provided by the country’s central bank — approved secretly by the European Central Bank (ECB) in Frankfurt.” The news barely made it into the U.S. press.
But wait up. A hundred billion Euros? Lent secretly? On unknown terms and conditions? And the entire operation conducted by a bunch of unelected officials and scarcely reported in the media?
Please don’t think that these things happen in Europe but could never happen in the United States. They happen here all the time and on a colossal scale. Remember that Bloomberg fought the Federal Reserve all the way to the Supreme Court in order to establish that the Fed lent over $1.2 trillion to the U.S. banking system and that those loans went ahead unbeknownst to and unauthorized by Congress. Oh, and although I say ‘the U.S. banking system’ what I really mean is ‘any bank that puts its hand out for some cash.’ So the Federal Reserve considered it appropriate to hand over some of your dollars to such not-very-American institutions as the Royal Bank of Scotland, the Belgian bank Dexia, Credit Suisse, Deutsche Bank, the Italian Unicredit, and too many others to name.
Yet nothing happens. When Bloomberg broke its story about the Fed’s secret lending program, a few other news outlets picked it up, but nothing changed. The same people are in charge of the Federal Reserve. They don’t think they did anything wrong. No central banker thinks that the ECB did anything wrong by handing a hundred billion euros to the collapsing banks of a failing country. It’s just the way these guys do business.
Just to be clear, though, there are alternative ways to do business. You might, for example, think that we should follow the following elementary rules: the central bank should avoid printing money and generating inflationary pressures which affect us all; bankers should lend money prudently and with proper due diligence; if those loans go bad, the banks should lose their money; and, over time, those banks are either left to go out of business (if they’re dumb) or encouraged to shape up and improve (if they’re not.) That system even has a name. It’s called capitalism. We had it in America once.
But not any more. We live in a world where moral hazard reigns supreme, where acts of gross stupidity seem to lack consequence. Where central bankers print money and no one cares. Where banks make dumb loans and get bailed out. Where politicians just want to get reelected and know that the media is going to analyze the spin down to the very last molecule and leave the substance well alone.
Take some other recent news items. Facebook’s IPO saw its shares trade up to $45 before falling back to as little as $31, a fall of some 31 percent. It is alleged that Morgan Stanley, one of the banks running the stock offering, revealed data to its institutional clients that it did not share with its retail clients — data that, in effect, called into question whether Facebook’s high valuation could be justified. Morgan Stanley insists it followed every dot and comma of the relevant regulations, and perhaps it did. But retail investors have still lost a shedload of money. And Morgan Stanley and its peers have still made a huge amount in fees. If Morgan Stanley truly did follow procedures, those procedures are plainly inadequate.
Or take JP Morgan’s recent $2+ billion trading loss. That arose in a bank which prides itself on its careful risk management. Which has lobbied vociferously against regulations which would prohibit the kind of activities which led to that loss. A bank which is surely ‘too big too fail’ — and in my eyes, therefore, also too big to exist.
Yet nothing changes. Just ask yourself these questions. Will the Fed never again extend secret loans to dodgy banks? Will Wall Street firms never again run an IPO that destroys billions of dollars in value for retail investors? Will Wall Street so clean up its act that it never again reports billion dollar losses because of dumb-but-greedy trades?
You know the answers. Nothing changes. In Europe at the moment, a calamity is unfolding. The Spanish bank, Bankia, has had its shares suspended as it seeks to apply for yet more state aid. The Spanish government, terrified by the way the ground is moving under its feet, is beseeching the Germans to help them borrow more money, so they can pass that money on to the same unreconstructed banks that lost it all in the first place. And meantime government deficits go on adding to the ever-less-supportable mountain of debt.
The United States is not yet in that position, but the preconditions are all here. An uncontrolled deficit. An out-of-control banking system. And politicians who would rather defer any problem than tell the truth about the mess we’re in.
The 15 freshmen Republican representatives in the House Tea Party Caucus each ran in 2010 on a populist anti-Wall Street message, highlighting their opposition to bank bailouts like the 2008 Troubled Asset Relief Program (TARP) and criticizing Washington for enabling the banking sector as it became “Too Big to Fail.” After winning, all fifteen received significant PAC contributions from the banking industry — and have become a reliable vote and mouthpiece for the financial industry, a ThinkProgress analysis of campaign contributions, voting records and public statements reveals.
It would be nice if they just took money. They did worse.
11 of the 15 co-sponsored this piece of trash; is there any doubt they were bought and paid for?
‘(a) In General- In the examination of financial institutions–
‘(1) a commercial loan shall not be placed in non-accrual status solely because the collateral for such loan has deteriorated in value;
‘(2) a modified or restructured commercial loan shall be removed from non-accrual status if the borrower demonstrates the ability to perform on such loan over a maximum period of 6 months, except that with respect to loans on a quarterly, semiannual, or longer repayment schedule such period shall be a maximum of 3 consecutive repayment periods;
‘(3) a new appraisal on a performing commercial loan shall not be required unless an advance of new funds is involved;
Got it? The fact that the collateral, which was the predicate for the loan in the first place, no longer supports the loan as originally agreed, cannot be used as the reason to place the loan in “non-accrual” (that is, at risk of not performing) status.
But the predicate for the loan being made in the first place was the provision of the collateral; but for that collateral’s actual value the loan would have never been made in the first place!
This is what the so-called “Tea Party” that claimed to be against bank bailouts has supported — literally changing the qualificationson a loan after it is made so that in effect there is no collateral required at all!
This is an attempt to literally approve by legislation the effective counterfeiting of the nation’s currency and you are the victims as your purchasing power will be further destroyed by this bill should it become law.
11 of 15 “Tea Partiers” are co-sponsors.
Fire them all; they’re traitors and mendacious bags of pus.