Joseph L. Shaefer | Jun 25, 2012 02:20AM ET
If I am doing right by our clients, subscribers, and online readers, it is my responsibility to advise what investment vehicles, in my opinion, should be avoided, as well as that which should be considered.
To wit: After repeated admonitions to all to avoid US money center banks and brokerages, JP Morgan (JPM) declared that, oh, whoops, we lost $2 billion + of shareholders’ money on a “risk management” issue. The biggest risk is what takes place between the ears of big bank/brokerage senior leadership’s ears and there is clearly no management of those functions whatsoever.
Morgan would have you believe this is just a one-off event that could never happen again. Like Lucy and Charlie Brown with the annual football-kicking trick, somehow they get away with it!
All analysts and reporters, it seems, and too many investors as well, fall for it. The problem isn’t that they lost money. The problem is that they are playing with fire when they haven’t any clue how to tame it. Like kids who end up burning down a beautiful dry forest, they must actually believe at the time that they are in control and they know what they are doing. The only alternative is that they know they don’t know what they are doing, but the profits are huge and they do know the US government will send the bill for restoration to the US taxpayer. But that would be way too cynical so I choose to believe they are simply stupid and not entirely venal. We all rationalize from time to time...
Maybe the better analogy than merely burning the forest down is kids digging around in the dirt and finding an unexploded land mine. It may be unarmed, the moisture and insects may have destroyed its ability to fire, or it may be a dud. I don’t want to be an alarmist and say that there must be another meltdown; merely that, as long as the arrogant and cocksure play around with the potentially-explosive, we continue to leave ourselves open to danger.
Back in 2003, when the kids were first digging in the dirt, the notional value of all derivatives outstanding, worldwide, was something like $70 trillion. Apres le deluge in 2008, when the banks received a “strong letter of disapproval” (rather than a good caning, which is what they needed,) notional values have now climbed to over $250 trillion. Boy, I guess that strong letter really slowed ‘em down.
I want to disbelieve the numbers in the chart below, from the United States Comptroller of the Currency, an independent bureau within the Treasury Department which exists to charter, regulate, and supervise all national banks and the federal branches and agencies of foreign banks in the United States. Not exactly some alarmist sky-is-falling blogger; I assume these guys know whereof they speak.
When one big firm (let’s call them Lehman Brothers) makes a bet that proves to be, shall we say, unpropitious (that would be banker talk for a #*^$*& calamity) it typically creates a chain reaction that quickly reaches into the trillions of dollars, as actually occurred 10 years earlier, when we chose not to learn this lesson, with the Long Term Capital Management fiasco, as well as in 2008.
Since we have not reined in the ability of banker/brokers to continue writing these contracts without regard to real capital structure, it is likely that similar events to Morgan’s recent $2 billion screw-up will occur, or, worse, those similar to Long Term Capital Management (an ironic name for a moronic gamble by, among others, a couple of Noble Prize winning economists — still think this is an easy business to figure out?) Or, devastatingly worse, Bear Stearns / Lehman / Step Right Up, Who’s Next?
Certainly, the rate of derivative growth continues unabated to this point. Notional values of derivatives now equal about 16 times our Gross Domestic Product and growing at more than $100 billion per day. (The GDP itself is growing by only $41 billion per day.) While the Volcker Rules held the promise of removing some risk from derivatives (Paul Volcker, a former chairman of the Fed, a non-public banking regulator, clearly knows whereof he speaks) the bank/brokerage lobby was successful in watering it down significantly and delaying its implementation until the current crop of CEOs could buy their Gulfstreams, chateaux along the Loire, and other to them indispensable baubles, and hand the business over to someone else to take the fall. (Already, the banksters have been granted a July 2014 date to comply and have negotiated the ability to request three one-year extensions. Clearly, the regulators don’t understand the issue or have all their assets in a Swiss bank.)
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