JPMorgan unit at centre of loss holds $100 Billion of risky bonds..the Black Swan?

The unit at the center of JPMorgan Chase & Co.’s recently revealed $2 billion trading loss has built up more than $100 billion in positions in asset-backed securities and structured products, the Financial Times said.

The newspaper said this portfolio comprises the “complex, risky bonds at the center of the financial crisis in 2008,” but did not say whether any of the holdings are in unhedged positions.

It said the portfolio is separate from holdings in credit derivatives that led to the trading loss by JPMorgan’s chief investment office, which has sparked much criticism of the largest U.S. bank and its chief executive, Jamie Dimon.

JPMorgan spokeswoman Kristin Lemkau declined immediate comment.

The chief investment office has been the biggest buyer of European mortgage-backed bonds and other complex debt securities such as collateralized loan obligations in all markets for three years, the newspaper said, citing more than a dozen senior traders and credit experts.

That office’s “non-vanilla” portfolio has grown to more than $150 billion, the newspaper said, without citing sources or providing details of the holdings.

Earlier Thursday, JPMorgan said Dimon had agreed to testify before the Senate Banking Committee to discuss the trading loss. The testimony would follow hearings on implementing Wall Street reforms that are expected to end on June 6.

JPMorgan shares closed Thursday down $1.53, or 4.3 percent, at $33.93 on Thursday. Shares of the New York-based bank have fallen 16.7 percent in the five trading days since the loss was revealed.

Before we can understand what’s really going on with JP Morgan’s loss (which will probably end up being a lot more than $2 billion), we need a little background.

JP Morgan:

  • Essentially wrote the faux “reform” legislation for derivatives, which did nothing to decrease risk, and killed any chance of real reform
  • Has had large potential exposures to credit default swap losses for years
  • Has replaced the chief investment officer who made the risky bets with a trader who worked at Long Term Capital Management … which committed suicide by making risky bets
  • … and again in 2007  ( and was saved both times by the government at taxpayer expense)
  • Has a reputation of being the most risk-averse of the big Wall Street players

In addition, JPM’s CEO Jamie Dimon:

  • Is a Class A Director of the Federal Reserve Bank of New York, which is the chief bank regulator for Wall Street (including JPM).  Indeed, Dimon served on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and was used by the Fed as a clearing bank for the Fed’s emergency lending programs. In 2008, the Fed provided JP Morgan Chase with $29 billion in financing to acquire Bear Stearns.  At the time, Dimon persuaded the Fed to provide JP Morgan Chase with an 18-month exemption from risk-based leverage and capital requirements. He also convinced the Fed to take risky mortgage-related assets off of Bear Stearns balance sheet before JP Morgan Chase acquired this troubled investment bank
  • Has a reputation of being the “golden boy” and smartest guy on Wall Street
  • Jokes about a new financial crisis happening “every five to seven years”

Pundits and consumers alike are reacting to JP Morgan’s loss like a startled herd of sheep.

They somehow believed that the “best of the breed” bank and CEO – the biggest boy on the block – was immune from losses.  Especially since JPM has been so favored by the Feds, and Dimon was so favored that he was being groomed for Secretary of Treasury.

And the fact that the head cheerleader for letting banks police themselves has egg on his face is making a lot of people nervous.

And that the biggest of the too big to fails could conceivably fail.

The government says its launching a criminal probe into JPM’s trades.

Ratings services have downgraded JPM’s credit, and many commentators have noted that other banks may be downgraded as well.

The surprise announcement by JP Morgan that it lost $2 billion in trading derivatives was portrayed in some mainstream media outlets as no big deal.  The Associated Press reported Friday,“Bank stocks were hammered in Britain and the United States on Friday, partly because of fear that a surprise $2 billion trading loss by JPMorgan Chase would lead to tougher regulation of financial institutions. . . .”The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought,” CEO Jamie Dimon told reporters on Thursday. “There were many errors, sloppiness and bad judgment.”   (Click here to read the complete AP story.) 

I think the market thinks this $2 billion surprise loss is much more than fear of “tougher regulation,” or that it was just “sloppiness and bad judgment.”  Remember MF Global and its bankruptcy on Halloween last year?  It, too, was trading in risky derivatives, and it lost $6 billion that wiped out the firm along with $1.6 billion in segregated customer cash.  In the aftermath, we still do not know where the customer money is, but we did find out MF Global was leveraged 40 to 1.  It would be hard to believe other big banks were not leveraged in risky derivative trades the same way.  This is why traders on CNBC were hitting the panic button last week.  Joe Terranova said, “I will dump my Bank of America on this news.”  Other traders on the show were equally scared.  “I can almost guarantee it’s not just JPMorgan,’ added trader Guy Adami.  ‘JPMorgan looks like it’s going to bring down the entire space,’ said Steve Grasso.”  (Click here for the complete CNBC story.)  

The only way JP Morgan could “bring down the entire space” is if the entire space was leveraged in ways similar to JP Morgan.  Of course, no U.S. bank has more derivative exposure than JP Morgan.  According to the Comptroller of the Currency, JP Morgan has a little more than $70 trillion in total derivative exposure. (4thquarter 2011 OCC report)  The next 4 commercial banks have a combined $150 trillion (approximate) in total derivative exposure.  I am sure the banks will tell you that this is all hedged (bilaterally netted) to minimize any losses, but we all know how well that strategy worked with AIG, Lehman and MF Global.

I am not the only one worrying about JP Morgan’s $2 billion dollar surprise trading loss.  Friday, one of the big debt ratings companies downgraded the troubled bank’s debt.  CNN reported, “The closing bell brought no relief for JPMorgan Chase on Friday, as a major credit rating agency moved to downgrade its debt almost exactly 24 hours after the bank revealed a $2 billion trading loss.  Fitch Ratings downgraded both JPMorgan’s short-term and long-term debt, with the latter falling to A+ from AA-. The bank, the country’s largest by assets, was also placed on ratings watch negative.  Fitch said it views the $2 billion loss as “manageable” but added that “the magnitude of the loss and ongoing nature of these positions implies a lack of liquidity.”  (Click here for the complete story.) 

With the “ratings watch negative,” it doesn’t appear that JP Morgan’s derivative troubles are over, does it?  Renowned money manager and investor Rick Rule thinks what happened to JP Morgan could not just bring down the bank but the entire financial system in a replay of the 2008 meltdown.  In an interview Friday with King World News, Rule said, “There would seem to be a mismatch of some amount of money in the $100 billion range between credit default swaps.  They seem to have been net sellers or providers of about $100 billion in unhedged credit default swaps.  When I say seems, these are extremely complex instruments.  Investors should be aware that derivatives such as these can bring down the entire banking system. . . . It’s just an example of the potential black swans that exist in a very, very leveraged banking environment.”  (Click here to read and hear the complete KWN interview with Rick Rule.)

I am not saying that JP Morgan is going out of business anytime soon, but if the bank does get in to more trouble and there are more losses, how much will it cost to save them?   What if the other big banks are in the same spot?  Does there come a time when the big banks are no longer too big to fail but too leveraged to save?  Did JP Morgan just turn into a black swan?


thanks to rev17 for the links..

a big collection of information on JPM..they are standing in the rain with their pants down around their ankles..the hawks are circling..their exposure to CDS’s is astonishing..JPM going bust would be like 10 greece’s..its much more severe than anything greece has got going down..

a black swan event indeed..


~ by seeker401 on May 24, 2012.

4 Responses to “JPMorgan unit at centre of loss holds $100 Billion of risky bonds..the Black Swan?”

  1. […] JPMorgan unit at centre of loss holds $100 Billion of risky bonds..the Black Swan? ( […]

  2. […] JPMorgan unit at centre of loss holds $100 Billion of risky bonds..the Black Swan? « Follow The Mon…. […]

  3. Wall Street Journal
    A Mess the 45th President Will Inherit
    Thursday, May 24, 2012

    Taxpayers Now Stand Behind Derivatives Clearinghouses

    …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.

    As we noted in May 2010, the authority for this regulatory achievement was inserted into Congress’s pending financial reform bill by then-Senator Chris Dodd. Two months later, the legislation was re-named Dodd-Frank and signed into law by Mr. Obama. One part of the law forces much of the derivatives market into clearinghouses that stand behind every trade. Mr. Dodd’s pet provision creates a mechanism for bailing out these clearinghouses when they run into trouble.

    Specifically, the law authorizes the Federal Reserve to provide “discount and borrowing privileges” to clearinghouses in emergencies. Traditionally the ability to borrow from the Fed’s discount window was reserved for banks, but the new law made clear that a clearinghouse receiving assistance was not required to “be or become a bank or bank holding company.” To get help, they only needed to be deemed “systemically important” by the new Financial Stability Oversight Council chaired by the Treasury Secretary.

    Last year regulators finalized rules for how they would use this new power. On Tuesday, they began using it. The Financial Stability Oversight Council secretly voted to proceed toward inducting several derivatives clearinghouses into the too-big-to-fail club. After further review, regulators will make final designations, probably later this year, and will announce publicly the names of institutions deemed systemically important.

    We’re told that the clearinghouses of Chicago’s CME Group and Atlanta-based Intercontinental Exchange were voted systemic this week, and rumor has it that the council may even designate London-based LCH.Clearnet as critical to the U.S. financial system.

    U.S. taxpayers thinking that they couldn’t possibly be forced to stand behind overseas derivatives trading will not be comforted by remarks from Commodity Futures Trading Commission Chairman Gary Gensler. On Monday he emphasized his determination to extend Dodd-Frank derivatives regulation to overseas markets when subsidiaries of U.S. firms are involved…

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