By Greg Hunter’s USAWatchdog.com
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. (4th quarter 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 CNN.com 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?