Friday, May 25, 2012

Taxpayer Supported Gambling

The $2 billion derivative trading loss JP Morgan announced, about two weeks ago, is growing in size. It is reportedly now more than triple the original loss. According to a CNN report, “One thing seems clear about JPMorgan Chase’s $2 billion loss. It’s no longer $2 billion. It’s likely much higher. The number being bandied about now is closer to a range of $6 billion to $7 billion, according to several people working on trading desks that specialize in the derivatives JPMorgan Chase (JPM, Fortune 500) used to make its trades and from two sources with knowledge of the bank’s positions.” (Click here for the complete report from CNN.)
The problem derivative losses seem to be growing for JP Morgan, and it’s affecting its share price in a negative way. Yesterday, The Independent (a British publication) reported, “In a further blow, chairman and chief executive Jamie Dimon has suspended plans to use the US bank’s own funds to buy back $15bn worth of shares. Buybacks are a popular way for firms to use up cash sitting on the balance sheet and prop up the share price.” (Click here for the complete Independent story.) A trading loss big enough to halt a $15 billion stock buyback sounds like trouble to me, but that’s not really the big problem.
Derivative Scandals: Taxpayer Supported GamblingThe largest banks in the U.S. were bailed out by taxpayers, and ever since the financial meltdown in 2008, all get taxpayer backing in the form of FDIC insurance. The Federal Reserve is also providing near 0% interest rates to the banks while the banks provide savers with interest rates as measured in fractions. JP Morgan may be the world’s biggest bank and holder of the most derivative exposure ($70.1 trillion), but it is far from the only big bank making risky derivative trades. Too big to fail (TBTF) banks trading in derivatives are not like taking a risk on car loans, mortgage lending, startup companies or loaning money to help companies grow and add jobs. The enormous risk the (TBTF) banks make is simply taxpayer supported gambling and nothing else. Derivatives are mostly debt bets.
The Federal Reserve seems to not only support this activity but stress tested the banks for derivative trades in a March report. (Click here for the Fed stress test for the big banks.) Look at the Fed’s “Projected Losses, Revenue and Net Income before Taxes for Q4 2011 through Q4 2013 . . . Hypothetical Supervisory Stress Scenario.” The Fed stress tested Bank of America for “$21.1 billion” in “hypothetical . . .Trading and Counterparty Losses. Citigroup Inc. was stress tested for “$20.9 billion” in “hypothetical” losses in derivative trading. Goldman Sachs was stress tested for “$27.1 billion” in “hypothetical” losses in derivative trading. Morgan Stanley was stress tested for “$12.8 billion” in “hypothetical” losses in derivative trading. Wells Fargo was stress tested for “$6.9 billion” in “hypothetical” losses in derivative trading. Finally, JP Morgan was stress tested for “$27.7 billion” in “hypothetical” losses in derivative trading.
As we have seen in recent weeks, those “hypothetical” losses can turn into real losses. But, that is the tip of the preverbal iceberg as far as taxpayer risk goes. According to the Comptroller of the Currency, in the 4th quarter of 2011, the top five commercial banks alone had “$220.9 trillion” in total derivatives. What I found frightening is how little assets some of these banks have compared to their total derivatives. For example, Goldman Sachs had “$44.1 trillion” in derivatives with only “$103 billion” in assets! That means for every $1 in assets, Goldman Sachs has $427 in risky derivative trades or, simply put, a staggering 427 to 1 leverage. What could go wrong? A 1% loss would cost Goldman Sachs four times the bank’s listed assets, and taxpayers would be on the hook for another bailout. The TBTF banks will tell you that the risk is hedged and there is very little chance of loss. JP Morgan is another in a long line that thought its derivative risk was minimal.
Investment banker James Rickards recently weighed in on derivative trading and said, “In fact, the bet is no more complicated than putting money on red at roulette. As a last resort, the executives hide behind the flag of free market capitalism when in fact they are the new welfare queens with government subsidies galore. The whole thing is a disgrace. If Jamie Dimon had an ounce of decency, he would resign now. Not because his acts were criminal, but because he presides over a corrupt institution that extracts wealth from the many and directs it to the few with no value added and not even a nod in the direction of the hard-working American victims of this scam.” (Click here for more from Rickards from
Before it’s all over, the other TBTF CEOs will be asked to resign because of future derivative scandals. The cracks in the derivative markets are going to turn into canyons.

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