JPMorgan: Counting Bailout Money as Profit

Includes: AIG, BAC, C, JPM
by: Lockstep Investing

If you are worried about where your TARP or any other bailout money is going, this press release from JPMorgan (NYSE:JPM) may provide a hint:

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The opening of the article leaves out one huge product segment of the Fixed Income Derivatives product group, Credit Default Swaps (CDS). In fact this is a huge oversight, the OCC source shows that banks have an 87 trillion OTC derivative exposure which includes fixed income derivatives and states that of the 16.1 trillion of outstanding credit derivatives, 99% are CDS. Why did Bloomberg not come out and be forthright about 20% of the derivatives market?

Moreover, over 40% of reported trading revenues derived from this segment of the derivatives market.

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With AIG posting $60 billion in losses in the last quarter, there had to be someone on the other side of those trades who would claim a commensurate gain. As of Q3 of 2008, according to the Office of the Controller of the Currency (OCC), there are only 5 major CDS brokers amongst the US banks who hold 87% of the outstanding notional credit exposure. JPMorgan is one of those five. Thus when the government provided $60 billion capital to AIG in order to meet collateral requirements for its counterparty positions, one can infer that the ultimate recipient was JPMorgan, and other major CDS dealers.

This is the fallacy of the whole market. The government is providing AIG with funds not just to keep AIG afloat but to support all of AIG’s counterparties from the systemic risk of not getting paid. But in providing this liquidity, the government is allowing JPMorgan to mark profits from bailout money originating at another firm and while they hold on to the TARP money they received from the government.

What is to be learned from this? The systemic risk of the “Shadow Banking System” is being balanced by the US taxpayer. But what is not being communicated is how many counterparties are also being saved by the single bailout of AIG and other major lenders. What's astounding is that the market makers continue to perform solid business in the very instruments that could at any moment cause their demise if the government withdrew its support for the losing counterparties. This evidence underscores how dysfunctional the whole banking system currently is and how much more needs to be done to wean the banks with the most CDS exposure from government funded settlements.