A bit of life is the old adage of being at the right place at the right time and capitalizing on the moment. But what does that have to do JP Morgan losing 2 billion and counting.? The attached article does a good Job of explaining what lead up to the loss suffered by JP Morgan. It explains in relative terms, but unless you’re a financial guru your eyes my start to glass over at the overly long back story of Negative Carry Trades, which is explained but honestly one of the first time I have heard the terminology used take in mind I’m not a trader more of a fundamental analyst.
If all had worked out the market and investors would be praising Diamond and his trading team, they would be calling all Wall Street whiz kids, 23 million in compensation would be peanuts to the profits brought in… But that is why the term is called speculation, and friends Vegas knows its odds to did the people at JP Morgan now theirs.
The problem as soon as I heard early on of this snafu may have been initiated by the desire to curb the expense incurred by these negative carry trades. But contrary to JP Morgan’s CEO’s belief it was the direct violation of the Volker rule which hasn’t gone into effect just yet where Financial institutions Hedge or take on risk by participating in the derivatives Market. The Volker rule states in short that financial institutions cannot use their depositor’s money to trade in exotic instruments think MF Global.
So the break down, the Bank has this portfolio of loans that it wants to protect itself from loss, it goes out and buys and insurance policy that says if borrowers default and rates go south we will pay you. So JP Morgan goes from having a known amount of liability in that Loan Portfolio and for a premium buys insurance against it in the form of a Credit Default Swap. Smart idea, as long as the premium for the insurance isn’t too high and the amount of interest brought in by the portfolio covers the premium and allows for some profit. The part I can’t fathom is the leap JP Morgan Traders made to “well we could Sell some Credit Default Swaps” which opens them to almost unlimited liability to their counter parties in order to “make money” on the premiums paid.
My issues, first you’re a bank a financial institution not an insurer, different licenses and practices all together, Banks cannot be insures point blank and selling Swaps for the most part makes them an insurer of some form to a financial instruments outcome; be it loan defaulting, interest rates falling, to commodity prices. 2nd Unlike normal insurers of say auto or home polices, even annuities most swaps have unlimited liability until they are closed out by the purchaser or run to term, it is one reason why they are so expensive to purchase. Large premium payments be damned you cannot consciously open yourself up to unlimited liability as a bank. Separate accounts or portfolios or not, the institutions ability to function depends on its ability to meet all of its obligations and setting up an unlimited one just seems like a bad idea from the word go especially if you’re in the business of holding other people’s money.
As a congressman what would I do about this mess? Well what are you “The People”, going to help me do, One guy from Fall River, MA. Calling these people morons isn’t going to do much. A women much smarter than myself named Brooksley Born who was head of the CFTC went head to head with Greenspan and his buddies in the late 90″s and was mothballed to a lonely corner of obscurity, until that is it happened again. Yes, Washington cronies have been covering up these loses since the 90″s, the losses have become a little too big to keep a lid on these days. But with your support We will institute a stead fast rule that Banks, Financial Institutions cannot Sell Derivative Contracts, only institutions that are classified as Insurers can. If they go around the rule by creating an insurance arm they will lose their FDIC as well as other Federal Insurance Guarantees, pick your poison are you a bank or an Insurer. All Sellers and Participants in the derivatives market must be registered, liquidity guidelines for all sellers and sources of funds must be disclosed. The Volker rule does some of this as well as Dodd Frank but I really think that there is too much ambiguity in those pieces of legislation and we can do better, only if more folks with common sense were elected to office. Hint Hint…