The news of the week was that JPMorgan Chase (NYSE:JPM), held in esteem by many as the pre-eminent mega-bank, had sorely miscalculated and lost a couple of billion dollars or so on what was characterized as a "hedge." These guys were reputed to be the best and the brightest. If this was a hedge, where are the offsetting profits?
This debacle was not the work of a single rogue trader. Allegedly, the decisions were made in the Chief Investment Office.
Late in the day Friday, Fitch downgraded its ratings on the bank's long-term debt and indicated that all the bank's debt was on credit watch negative. The ratings agency indicated that the magnitude of the loss implies a lack of liquidity. Fitch also stated that the complexity of the bank's operations makes it difficult to assess risk exposure.
Onerous as a multi-billion dollar loss might be to the House of Morgan, by itself it won't threaten the bank or the banking system. Two important questions present themselves, however. 1) Is this a stand-alone sour derivative trade or--according to the cockroach theory--having seen one, can we assume that there are many still to appear? And 2) Could this be a common trade in the banking industry, which might fall apart at other giant banks as well, cumulatively causing risk to the system?
Common sense dictates we should not have to worry about such questions. No bank should be so large that it could threaten the financial system and, therefore, be too big to fail.
My April 3rd entry on this site recounted several quoted sections from the Dallas Fed's annual letter in which Dallas regional President Richard Fisher argued powerfully and convincingly against allowing any bank to be too big to fail. In light of this most recent example of giant errors from giant banks, more taxpayers must demand that we not be held liable ever again for bailing out mega-banks that are allowed to speculate to the degree that they obviously continue to do. I urge you to read my April 3rd article, "A Powerful Ally Against Too Big To Fail."
One quote from that Dallas Fed report underlines the scope of the danger that we narrowly escaped just a few years ago.
"The term 'too big to fail' disguised the fact that commercial banks holding roughly one-third of the assets in the banking system did essentially fail, surviving only with extraordinary government assistance."
That government assistance either comes out of your pockets and mine or those of our grandchildren or their grandchildren. Notwithstanding how much of that assistance has been recovered this time through the continuing largesse of essentially free money from the Fed, it must never occur again.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.