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Friday, May 11, 2012

Deja Vu All Over Again!

Is it just me or have we been here before?  I am talking about the recently disclosed $2 billion+ loss that JP Morgan just surprised the street with yesterday.  Keep in mind that this loss comes out of a supposed hedged portfolio designed to reduce (yes reduce) risk to the bank by offsetting the risk in their mortgage portfolio.  They claim that they, meaning the CEO Jamie Dimon, did not know this kind of trading or risk-taking was occurring.  Excuse me??  We either have a CEO that is completely asleep at the wheel, or one that is lying and knows that he has traders taking enormous risks and supported it.  Either way it is unacceptable.

Keep in mind that we are talking about trades in CDSs, or credit default swaps.  Yes, you have heard this term before - these are the same derivatives contracts that put Bear Stearns and Lehman Brothers out of business, and caused the entire world financial system to collapse just a few years ago.  Now we have the only U.S. bank that seemed to avoid the majority of the poor decision-making that got us into this trouble, doing the very trading in the very same derivatives that caused the meltdown.  Have we (they) learned nothing??

By the way, they claim the loss is $2 billion, but the problem is that CDSs are private contracts and are therefore extremely illiquid.  Now that everyone knows that JP Morgan is exposed to these trades, they are going to suffer much greater losses when they try to unwind the trades, so the actual losses will very likely be much greater than the $2 billion stated.

A few weeks ago a Wall Street Journal article discussed a trader in the UK known as "The London Whale" who was placing such large trades in the CDS market - a $10 trillion market - that he was moving the market.  Now we find out that this trader was at JP Morgan.  What I think happened was that this trader or the group he works with got underwater and started panic trading to try and recoup their losses, which only exacerbated them, resulting in the current situation.  Where is the supervision?  Why are these traders allowed to place unlimited trades with no size or quantity restrictions and no oversight?  This kind of thing happens over and over again, and they never seem to learn from it.  Often these traders are young guys straight out of business school who have little or no real market or trading experience and they are given complete autonomy and no real supervision or restrictions, and this is the result.

This latest fiasco lends great support to the case for the Volcker rule, which is coming up for a vote this summer.  The Volcker rule will place restrictions on banks and other financial institutions regarding what and how they trade.  There could not be a more glaring example of why, unfortunately, we need external regulation of the financial institutions that this latest debacle from JP Morgan.  JP Morgan would be rolling over in his grave if he knew what these people were doing in his name.  I do not believe in government regulation of financial markets in general, but it is apparent that we cannot depend on the financial institutions to regulate themselves, so we are forced to accept the unattractive by necessary reality of government control over trading operations.  The financial institutions have no one to blame but themselves.

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