JPMorgan Mess Will Drive Stock Below $28 This Summer

May.18.12 | About: JPMorgan Chase (JPM)

In the wake of all the outcries surrounding the woes that have befallen JPMorgan Chase (NYSE:JPM) in the last couple of days, it becomes increasingly difficult to guess what the future of the company will look like.

Nonetheless, it seems a pattern is now arising from all the outcries and it seems that the easiest thing may be to classify the general responses to the bank's recent activity.

One of these categories of response deals with the irony that the trades that caused the bank to lose $2 billion (and still counting) were the deals that were supposed to protect the bank from losing that money in the first place. In simple terms, the trades, which I believe were erroneously classified as "hedging," ought to have provided a fail-safe net to JPMorgan, if they had been carried out correctly. Hedging is supposed to be the counter move that manages the risks of the bank and ensures that it does not lose money if any of its investments should fail.

In the wake of the inability for JPMorgan to properly hedge its trades, another piece of news relates to the management of the big bank's risk plays. That news relates to the successor of Ina Drew and the impact that he is expected to bring to the table. Matthew E. Zames has been chosen to take the baton from Ina Drew as the CIO of JPMorgan. Interestingly, the appointment of Zames has turned the media's attention to his career-long courtship with risk and the line he has toed throughout.

This, reportedly, started from the onset of his career when he worked as a junior trader with Long-Term Capital Management, which was a hedge fund. There, he received the necessary tutelage on the dangers associated with combining gambling with banking when the hedge fund blew billions of dollars and faced huge loss until a bailout came to the tune of $3.6 billion. That bailout was brought on by the Federal Reserve Bank of New York, and was said to be necessary to prevent a global crisis.

Zames had actually experienced quite a number of similar occurrences in his career and in no doubt has a clear understanding of the outcome of a failure to manage risks properly. Thus, his appointment may actually help to turn the situation around or at least minimize the present day risk while reducing the chances of making such mistakes in the future. However, if he has not learned his lessons, then JPMorgan had better prepare for another financial mess because it will not be long in coming.

Another category of reaction to JPMorgan's recent news is the response of the United States Government, President Obama, Congress, Senators, diplomats and Republicans alike. The essence of that shared response relates to the need for more regulation the financial sector to mitigate further such events. In the words of President Obama, in an interview taped to air on Tuesday on "The View," "This is the best, or one of the best managed banks. You could have a bank that isn't as strong, isn't as profitable making those same bets and we might have had to step in. That's exactly why Wall Street reform's so important." One other category in the news is the response of the shareholders as well as the response of the stakeholders in JPMorgan, who will be demanding an explanation soon and consistently in the coming days.

Above all, the most important news is what will happen to JPMorgan after all the responses subside and its left to really deal with its mess. There is a general consensus that the stock will fall and that the bank's management has a difficult situation to wiggle itself out of. Its stock is already in bearish territory and may continue to fall. JPMorgan had already lost about $19 billion of its market capitalization within two days of the announcement of the loss.

Nonetheless, here would be a good time to reiterate the fact that JPMorgan is big enough to withstand the losses without a bailout. Thus, even with the losses, it is may still be able to bounce back and ride the waves of coming quarters.

However, JPMorgan, being one of the biggest players in the industry, has affected its competitors by its actions. For example, itself and competitors like Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), and Morgan Stanley (NYSE:MS) now stand the risk of a downgrading in their ratings by Moody's Investors service. A lower credit rating will invariably lead to a lesser business environment for them because they will be required to provide more securities for their loans and they will be charged at a higher interest rate.

Not to mention, any regulation or regulatory standards brought on by the national government will affect these big banks as much as JPMorgan. JPMorgan may just be the rallying cry around a movement that would affect a Bank of America or Citigroup just as equally. The demands for stricter regulations of the financial sector will certainly not just be focused on one company. There are already new calls for Congress to re-enact the Glass-Steagal Act and to make a distinction between trading and securities services of traders and the deposit and lending activities of banks.

The news of potential stricter regulations is already causing prices to plummet and if a bank as big as JPMorgan Chase could fall, it gives investors little faith in its competitors who, in many cases, have already damaged their own reputations.

Yet, there is little doubt that, given time, JPMorgan will ride through the storm. However, the question is how long the storm will last and how easy the ride can be. The next few weeks are going to be bumpy for JPMorgan, to say the least. Only time will tell if there are smooth roads to ride on after all those bumps. JPMorgan has been sinking and is currently trading around $33. I expect the stock to hit a new 52-week low by June before climbing back up.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.