JPMorgan Chase: Poisoned by Bear's 5,000 Counterparties 28 comments
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Did JPMorgan Chase (JPM) make a Faustian bargain by paying $2 per Bear Stearns share? And was the decision to buy the world’s most storied investment bank predicated in the belief that a good proportion of the $41.5 billion of Level 3 assets acquired from Bear Stearns will, with the passage of time, transition to Level 1 status?
There is little doubt that all assets levels (as per Fair Value Measurements defined under SFAS No. 157) contained in the balance sheets of the bailout targets have deteriorated since the last accounting quarter. The $115 billion market-capitalization number for JP Morgan today can be deemed a decisive overvaluation. As more data in early 2009 confirms the key underlying trends (down) governing asset valuations, JP Morgan’s share price should work its way to $15; Friday’s closing price ($30.94) represents a bargain for short sellers.
The “finger-in-the-dyke” strategy adopted by Ben Bernanke and Hank Paulson is firmly grounded in the belief that if you keep the financial and insurance sectors running (on life-support) long enough, even serious flaws within those sectors will be corrected. Therefore, the fundamental thrust of any bailout or rescue must be the avoidance, at all costs, of systemic risks. A late night (March 13, 2008) review of Bear’s books convinced the Fed Governor and the Treasury Secretary that failure (bankruptcy) was simply not an option; that Bear was “too interconnected to fail”. For instance, Bear’s credit default swap portfolio alone revealed an astounding 5,000 counterparties.
As John Cassidy (The New Yorker, December 1, 2008) explains in his insightful review of the tempestuous days of September and October, JPMorgan’s “knockdown price of two dollars a share” was the end the result of intense and “torturous” negotiations after the Fed agreed to take on Bear’s $29 billion portfolio of subprime securities, not a consequence of any comprehensive valuation of Bear’s Level 2 and Level 3 assets; while Level 2 assets are valued through observable or unobservable inputs that are corroborated by market data, Level 3 assets cannot be corroborated by market data.
Most disturbingly, based on his investigations, Mr. Cassidy suggests that many of the decision-makers involved in the Bear buyout were not entirely familiar with the dynamics of credit default swaps, collateralized debt obligations and complex structured products. So it is fair to assume that the Bear and JPMorgan merger did not adequately incorporate either the potential risk of depreciating Level 3 assets wiping out the latter’s earnings well into 2010, or the hefty loss provisions demanded by Level 2 assets in the light of rating downgrades and defaults in the US corporate matrix.
Thus far, there has been no disclosure concerning Bear’s 5,000 counterparties. For that matter, the true extent of counterparty exposure (on foreign exchange, interest rate and credit derivatives) in the financial statements of American International Group (AIG), Citigroup (C) and Goldman Sachs (GS) has also remained a closely guarded secret. But regardless of the counterparties, the post-September widening of spreads in the CDX investment-grade and high-yield indexes generally spells trouble for Level 2 and Level 3 assets and for the credibility of capital-adequacy and solvency ratios over the next few months.
As far as JPMorgan is concerned, its ability to sustain anything close to its last quarter income of $527 million ($0.11 per share) during the course of 2009 will be further impaired by the delinquency allowances required by its regular banking business, which now also includes the business of Washington Mutual.
Disclosure: Author holds short positions in C, GS, JPM
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On Dec 14 09:14 AM Herbert Hoover wrote:
> The Ponzi scheme begins to unwind. Coming next: Bernie Madoff to
> head the Federal Reserve Bank
On Dec 14 11:00 AM TomArmistead wrote:
> If Bear Stearns operations were competently run and hedged, derivative
> assets and derivative liablilities should net to zero or better given
> sufficient time. The volatility of spreads creates imbalances that
> may be temporary in nature. From where it lies, adding enough capital
> and waiting, as Paulson et al are doing, is a workable strategy.
>
>
> WaMu, when it was handed over to JPM, was adequately capitalized
> from a statutory point of view and had substantial pre-provision
> earnings, sufficient to cover losses as they occurred.
>
> I agree with ishortyou, JPM may suffer a protracted bout of indigestion
> but it is unlikely to be fatal.
On Dec 14 07:23 AM 1 world currency wrote:
> According to Treasury Department statistics, JPM has a $90,000,000,000,000
> (trillion) gross notional exposure to derivatives. One analyst said
> assuming no unusual circumstances, their net exposure is only several
> hundred billion.
>
> We are experiences unusual circumstances, and this issue can not
> be ignored. We need immediate transparency regarding all this toxic
> paper.
At least he would be able to recognize a Ponzi scheme.
On Dec 14 09:14 AM Herbert Hoover wrote:
> The Ponzi scheme begins to unwind. Coming next: Bernie Madoff to
> head the Federal Reserve Bank
Seriously, I wish you luck with your trades.
AIG seems to be the only idiot in town that has sold a bunch of CDS without any hedging whatsoever.
Berkshire Hathaway also sold a few CDS, but they number only about $8 billion in notional value and Buffett got paid roughly $4 billion upfront.
Plunge Promotion Team!
"Why Cox should have been gone a long time ago"
or
"The incalculable damage caused by Cox and Schumer"
or
"How to destroy the stock market in 8 easy years"
www.associatedcontent....
Here is an article on Zero Interest Rate Policy:
www.associatedcontent....
BTW, when you look at BAC's 10Q take a good look at what they expect to happen in 2009, 2010 and 2011 with their option arm portfolio that they "classify" as discontinued real estate. Currently over 60% of that portfolio will be defaulting.
JPM is even more screwed they took over WaMu and all of their option arms...
But the real gem of the group will be Wells Fargo...They bought Wachovia who wrote more option arm loans than any bank. However, the details of that "acquisition" has yet to hit their balance sheet.
But wait it gets even better...When these banks do workouts with troubled borrowers they simply tack the past due payments onto the end of the term of the loan and then report them as current.
They all have also changed what they call a default. A default was once when a loan was 90 days late. Now they are using 120+ days. A rather convenient method to make their portfolios look better than they actually are.
You can only not pay the piper for so long. Once they have to foreclose the property must be reported on their balance sheet as real estate owned. Wait for real estate prices to drop more. Then the banks will have to take even more losses.
Then there is the unsecured debt/consumer credit in the amount of some $17 Trillion where some 20% of the borrowers are 90+ days past due and sure to default.
Next...Commercial real estate loans....Then corporate debt...
and then the mother of them all...the derivatives and credit default swap market.
I hear JPM is on the hook for some $90 Trillion...Oddly, according to the Fed's website they only have a little over $2 Trillion in assets...
Hmmmm, I wonder what the S&P 500 will be when the government has to fully nationalize all of the banks.
I have also heard that if the S&P 500 drops to 650ish most insurance companies will be insolvent as well.
Too bad Tobin's Q Ratio is calling for a 400 S&P 500....
But hey...No need to worry the Fed has an infinite balance sheet...They'll just print more money...Is that why they stopped publishing the M3 number?
Incidently it would be nice if Rakesh would tell us when he covers his shorts in C,GS, and JPM. Don't hold your breath.
jepittman:
Yep! And it's about to blow-up in the face of the Fed, Treasury, Congress and President 1/2.
I really admire the way the Fed encorages personal finacial responsibility and saving...
Just kidding...
On Dec 16 08:37 PM curbs-in wrote:
> >Rakesh you had best cover your shorts. The economy is being drenched
> >in high octane gasoline.
>
> jepittman:
>
> Yep! And it's about to blow-up in the face of the Fed, Treasury,
> Congress and President 1/2.
>
> I really admire the way the Fed encorages personal finacial responsibility
> and saving...
>
> Just kidding...
But, I have run into a stone wall of impedimenta trying to cash out their brokerage account at JPM. Real Kafkaesque stuff like demands to reopen the entire estate, go back to court, etc.. Accompanied by a certain obtuseness about the documentation I present. Seemingly anything to slow the process. Either that, or they are dumber than nails, which creates a whole other series of problems.
Not a very big account, either. But one JPM has had pretty much free use of for the last decade or so.
Such accounts do mount up--- Artifically slowing payout of estate settlements is an effective way to keep the money as long as possible. If you tried this with primary account holders, you would soon have a bank run. But heirs might not realize what is goin on.
My general take (and I greatly appreciate Mr. Saxena's nice article), is that the problem is not only one of disclosure, but also one of the moral capacity to carry out fiduciary duty -- whether at the Fed, the Treasury, the FDIC, or the SEC.
Suspect when all is said and done we are looking at more of a systemic moral failure, rather than just a cyclical political economy problem.
On top of that, malfeasance, either in government or in the government sponsored private banks, seems to not only be endemic, but also as a general rule unpunished.
My continued reading of the core problem facing the economy today makes the US economy not dissimilar to that of the Russian Republic, or of communist China. The cycles of behavior of the wealthy and powerful appear to be more that of a corrupt plutocracy, rather than that of a republic.