Last night, the CEO of JPMorgan Chase (JPM), Jamie Dimon, got on the phone, in an "emergency" conference call, and had a lot of explaining to do. JPM's "London Whale" had managed to lose slightly more than $2 billion on the bank's credit default swaps almost overnight. About $1 billion of the loss will be offset by the sale of bonds now in JPM's inventory, on which the bank has unrealized paper profits. Those paper profits, of course, are the result of the Federal Reserve's artificial manipulation of interest rates and bond prices.
In an article published on April 17, 2012, I provided details about the staggering risk taken on by the biggest banks in America. Taken together, the gross notional exposure of Bank of America (BAC), JP Morgan Chase, Goldman Sachs (GS), Citigroup (C), Morgan Stanley (MS) approaches $291 trillion, in American derivatives written in New York City, with the possibility of much larger hidden exposure written in the London market.
Some people who wrote comments to that article, and an article on the subject of Bank of America's exposure that preceded it, sought to downplay the dangers both to the casino-banks, themselves, and to the system as a whole. JPM's almost "overnight" loss of $2 billion, resulting from minor errors on the part of just one trader, in just one small subsection of the derivatives market, illustrates the weakness of their arguments.
This staggering loss occurred as a result of the normal fluctuation in the value of these incredibly leveraged instruments. Can anyone imagine the potential losses, in a market with a $700 trillion notional value, if a couple of real trigger events ever happen? What if Europe drops the Euro, in favor of national currencies? What if a sudden selloff of dollar assets by China forces the Federal Reserve to defend the dollar against collapse, by instituting massive interest rate hikes? What if any number of other major trigger events cause a lot of the derivatives to come due?
What is the real exposure? No one knows. Some comments to my previous articles have claimed that bank proprietary models such as "value at risk" (VAR) can be used to determine how much risk the financial system is being exposed to. Yet, Dimon admitted, during the phone call, that JPM is now going to double its VAR estimate! In doing so, he illustrated the utter worthlessness of the previous number and of the model that results in the number now replacing it. He stated:
"We are also amending a disclosure in the first quarter press release about CIO's VAR, Value-at-Risk. We'd shown average VAR at 67. It will now be 129."
He went on to say:
"Regarding what happened, the synthetic credit portfolio was a strategy to hedge the Firm's overall credit exposure, which is our largest risk overall in its trust credit environment. We're reducing that hedge. But in hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective economic hedge than we thought."
Frankly speaking, Mr. Dimon's statements prove the toxicity of the derivative holdings of all 5 big derivative banks. That the derivatives his bank and its 4 comrades in NYC have written are far riskier than anyone now imagines is obvious to even the more dull-witted of observers. No conservative investor should put money into corporations that freely enter such risks. We cannot pin our hopes on an expectation that these banks will be endlessly bailed out. The occurrence of a major derivatives triggering event will cause such large losses that not even the US government will be able to backstop them.
The casino-banking divisions of the major NYC banks are benefiting greatly by their deep connections to the Federal Reserve, and the placement of former employees into key positions of power within the entire world financial system. They collect a wide spread between the almost-free money "loaned" to them by the Fed, the bonds they buy and loans they make. Beyond that, some market commentators allege that foreknowledge is used to front-run Fed-sponsored market manipulations. This mints profits in the short run, even when less well connected institutions suffer losses. And, it has every prospect of continuing. Absent major regime change that no probable Presidential contender will bring, for example, a serious investigation of front running allegations will never be made.
In spite of these advantages, fair and/or unfair, real and/or imagined, the executives of these companies are putting shareholders and taxpayers at great risk. In fact, the hundreds of trillions of dollars worth of notional derivatives present an unprecedented level of risk, never seen before in the history of human finance. The obligations are like a Sword of Damocles, waiting to fall upon the unwary necks of innocent investors and taxpayers.
Such risk-taking is unacceptable. The big casino banks, including but not limited to JPM, are currently toxic, regardless of the profits or lack thereof, that they manage to show this quarter or this year. The casino-bank business model is fatally flawed, not perhaps for executives who collect millions in pay and bonuses when things go well, but for shareholders and taxpayers, who bear the losses.
There are still many large, conservatively run, relatively "safe", financial institutions in which one could theoretically invest, such as US Bank (USB). But, the antics of the boys in NYC and London have put the entire world financial system at risk. Even the most conservative banks are at great risk, regardless of prudent policies. This situation will continue to spur long term investment into physical gold ((GLD), (IAU) (PHYS)) and silver ((SLV) (PSLV)) and other precious metals, as investors seek safety outside the banking system.