Economic Mass-Murder Primed -- first, while you dazed at the Florida
election-resolution chaos Congress totally deregulated derivatives, --
now,
two years later, JPM (JPMorganCo) has $712 in derivatives for each $1 in
US
stock -- YOU NEED TO KNOW WHAT THIS MEANS!
In 1929, the Financial and Cor****ation Oligarchs sold short (bet on a fall
in the market, buying promises (futures in stock) from others to provide
stock in the future at current prices (i.e., even if in the future the
stocks are worth at future current prices only a tiny fraction of the
agreed-upon price.) After the "shorted" the market they, Percy
Rockefeller,
Bernard Baruch, the Morgan interests and the other Anglo-American
investment
banking interests -- ordered their brokers to issue margin calls, i.e.,
to
call for immediate payment from the masses of the public who had been
buying
stock on credit -- which immediately caused runs on banks, collapse in
stock prices, contraction of money supply in the country (most of it
checkbook money based on loans) etc.
Today, selling short is a crude and too easily detected means of
mass-murder
economic crime. Today the same positioning to profit from the deliberate
collapsing of an economy is the derivatives market, not the short sell.
Derivatives are simply any "bet" that any financier wants to create on
people that anyone else is willing to buy -- futures, swaptions, any
economic event contingency, functioning like short-sells, but much richer
and varied and flexible and complex and subtle and more effective
(allowing
multiplication of the short-sell-type gains by cleaver cascading of
derivatives agreements.
The fact that an insider oligarch investment banking house like JPMorgan
(JPM) is holding over $700 dollars of derivatives (complex "bets") for
each
dollar of stock in US firms shows the magnitude of the bubble -- the US
economy is one Hindenburg Zepplin filled with derivatives hydrogen -- all
gas and no productive assets (all of our investment capital has absconded
to
China and other slave-labor countries recall) and when the explosion
comes,
thants to the derivatives (which include derivatives handling your
securitized mortgages by the way -- and remember all of your personal
debt
has been put in a second mortgage which in turn has been securitized and
sold on international markets) --
what I am saying is that everything is primed for the oligarchy to pull
the
plug on the united states, ending even the pitiful remnant of a
middle-class
that still exists -
I doubt that anyone of my readers owns stock -- most of the victims of
what
is coming are those who have been living a semblance of middle-class
existence because the Oligarchy has, until now, needed them -- but they
don't need you any more -- I look forward to welcoming you, but it will be
too bad that you join the enlightened AFTER you have been deprived of all
of
the economic means with which you could have fought the oligarchy -- you
bastards (I'm entitled to say that, I think) -- anyway, if there is
someone
listening I would recommend NOT BUYING GOLD, but rather Chinese yuan or
EUROs -- I believe the EURO was created to be sufficient monetary
leverage
base from which to flip and crash the dollar and the US market -- this
will
not be the end of the US money elite -- rather it will be them sheding at
last the remaining vestages of the United States cacoon and becoming the
global masters of their master plan. (JPM now controls 55% of all US
banks'
outstanding gold derivatives contracts), a stunning 35% drop in six short
months -- gold will not be safe -- and it is so easily taken from you
before you get to spend it in a nation like the US is now, where pirates
rule with impunity.
How to fight them -- I still say there is only one way -- only by
showing
the world the evidence that 9-11 was a mass-murder frameup can the entire
world rise up and overthrow the pirate oligachy -- it was Richard Perle,
Henry Kissinger, Paul Wolfowitz, Dick Cheney and lesser players Rumsfeld
and
Rice who masterminded 9-11 and each of them is an agent of the
Anglo-American financial and cor****ation oligarchy .
Nothing else should be your concern -- not the phony commission, not the
phony election race -- nothing but exposing the truth to the nation and
the
world.
I am talking about this proof:
http://groups.yahoo.com/group/TRUTHBAZOOKA/message/5
Don't let me see anyone continuing with the same habitual crap while
these
life-and-death issues remain unknown to 6 billion people of the earth.
Get off the dime. Don't crap out on humanity.
Dick Eastman
Yakima, Wa****ngton
Every man is responsible to every other man.
The author of the following, Adam Hamilton, may not see all of the forest
for the trees, but he deserves credit of putting together the facts --
facts im****tant to those who still have a ****tfolio and want to move to
safer positions, but more im****tant, those who wish to anticipate and
defeat
the oligarch grand plan to enslave common man once again.
--DE
===========
The sheer magnitude of derivatives positions amassed by elite Dow 30
superbank JPMorganChase is amazing. We examine the latest bank derivatives
data from the OCC. /January 4, 2002
A long time ago in a galaxy far away, or it least it seems that way, I
hammered-out an essay on derivatives powerhouse US superbank
JPMorganChase.
In my original essay, delicately titled "The JPM Derivatives Monster", I
outlined some incredible research my research group had performed
investigating the gargantuan derivatives dominance of elite Dow 30
money-center bank JPMorganChase (JPM-NYSE).
The essay was, fortunately or unfortunately depending on one's
perspective,
published the Friday before the horrific September 11 attacks. Needless to
say, the arcane and often confusing world of derivatives was all of a
sudden
infinitely less im****tant than coping with the grisly and heart-wrenching
aftermath of the notorious terrorist attacks on America.
Even rightfully relegated far beneath the long dark shadow of the tragedy,
and even though the essay tipped the scales at almost 7500 words, it drew
over a hundred-thousand hits and hundreds of comments from all over the
planet. I was personally very surprised by the popularity of the original
complex JPM Derivatives Monster essay because derivatives themselves are
so
difficult to understand and I assumed that derivatives were pretty low in
significance on most investors' radars and worldviews. Regardless, the
huge
response to the essay from almost two-dozen countries as far away as
Germany, Switzerland, Russia, China, and Singa****e has been overwhelming.
The original essay showcased data that JPM is required by law to re****t to
both the United States Office of the Comptroller of the Currency and the
United States Securities and Exchange Commission. In early September, the
most current data available on the derivatives positions of US banks was
still from the first quarter of 2001. Today, Q3 2001 official OCC
derivatives data is available and not too far into the future the Q4 2001
derivatives re****t will be posted by the OCC.
This essay is simply an update of the original "The JPM Derivatives
Monster"
essay (available at
http://www.zealllc.com/commentary/monster.htm
). If you have read and
understood that earlier work you will gain far more out of this essay. I
try
to write the vast majority of my weekly Internet essays as stand-alone and
self-contained essays, but this one is atypical. I am assuming that you
command the basic background and knowledge of derivatives articulated in
the
earlier JPM Derivatives Monster essay (henceforth called "Monster").
Certainly, if you have questions on definitions, concepts, research, data
origins, the data deployed here,
etc, the first place to go look is the September essay.
Before we begin this round, an im****tant disclaimer is in order. When I
penned the earlier Monster essay, my partners and I had absolutely zero
exposure to or stakes in JPM, either long or short. After we completed the
work and research behind the original Monster essay however, we were so
astonished that my partners and I both bet against JPM with our own
capital
and recommended JPM short positions and JPM put options to our private
consulting clients and our Zeal Intelligence private newsletter
subscribers.
We strongly believe that it is dishonorable to discuss a company without
fully disclosing long or short exposure up front so everyone understands
from where we are coming. Some folks will be uncomfortable with our JPM
short positions, which is great and not a problem, and I strongly
encourage
you to read no further if this disclosure sends up red flags in your mind.
Still other folks are more comfortable knowing that "our money is where
our
mouths are", so to speak. It is crucial that we all begin on the same
page.
On to the battle!
Our first graph is a direct update from Monster. Derivatives data used
here
is from the official Q3 2001 "OCC Bank Derivatives Re****t", "Table 1".
Since
the numbers shown below are so mind-blowing that they utterly defy belief,
I
strongly encourage you to go download the original PDF file and see the
huge
derivatives pyramid with your own eyes at
http://www.occ.treas.gov/deriv/deriv.htm
(specifically the file is at
http://www.occ.treas.gov/ftp/deriv/dq301.pdf).
Please don't just take our
word for it! ALWAYS do your own due diligence!
Amazingly, the total derivatives positions held in terms of notional
amounts
by US banks literally exploded in the six months between the Q1 and Q3
re****ts. The US banks ramped up their derivatives positions by an absolute
16.8% in a mere six months, or $7,362b (yes, that is seven thousand
BILLION,
or over seven TRILLION dollars). For comparison the US
GDP was only up an anemic 0.8% over the same six months. The exploding
broad
US M3 money supply that Greenspan is frantically pumping like there is no
tomorrow in his daring Greenspan Gambit is "only" up 5.1% over the same
period. Any way you slice it, the piling-on of over $7t of additional
derivatives exposure in six months is quite extraordinary.
JPM's share of the US banks' titanic derivatives pie crumbled slightly
over
six months from 59.8% in Q1 to 59.3% in Q3. Lest the 2,781 large
institutional investors that are holding 62.5% of JPM's outstanding shares
on behalf of their clients think that JPM's hyper-risky derivatives
positions are abating however, in absolute terms JPM's derivatives
exposure
rocketed by $4,158b, or 15.8% to $30,434b in six short months. To put a
massive $4t+ increase in notional derivatives amounts into perspective,
the
total broad US M3 money supply only crossed $4t for the first time in
United
States history in July of 1989! $4t is BIG bucks folks!
Now JPM is a big bank, indeed the flag****p US money-center bank, but the
derivatives pyramid the Dow 30 behemoth has created is even gargantuan by
its giant standards. Per JPM's Q3 earnings release, it commanded $799b in
assets and $43b in stockholders' equity on September 30, 2001. (Per the
official Q3 OCC re****t, the ****tions of JPM that deal in derivatives only
had assets of $663b, but we will grant JPM the benefit of the doubt and
use
the larger asset number that it re****ted to the public.)
In terms of total assets, JPM has implied derivatives leverage of 38 times
($30,434b notional derivatives divided by $799b in assets), a big number.
In
other words, each $1 of assets controlled by the uber-bank sup****ts
outstanding derivatives contracts with notional values of $38.
For a commercial bank like JPM however, asset size can be a misleading
measure. Most of any bank's assets, including JPM's, are offset by
matching
liabilities of the same magnitude. For instance, when you deposit money in
a
bank those funds are really yours even though you are letting the bank
tem****arily use them. A $100k deposit that you make to a bank account
becomes an asset for the bank that can be lent out but it is offset by an
equal $100k liability to you. Depending on what kind of contract you have
signed with your bank, Demand Checking versus Certificates of Deposit for
instance, you can often demand your money from the bank at any time.
Of JPM's $756b in liabilities at the end of Q3, only $47b were classified
as
long-term debt which means they are due further-out than one year into the
future. That leaves roughly $709b of short-term liabilities, amounts that
are due in the next 12 months. Of course the vast majority of these
liabilities will be rolled-over or replaced by newer liabilities, but the
huge amounts of current debt still give a general idea of the short-term
and
potentially ethereal nature of JPM's
assets.
What really matters is JPM's stockholders' equity, which contains all the
capital that JPM stockholders own free and clear, both funds that they
have
contributed and total profits earned and retained in the entire long and
distinguished cor****ate histories of JP Morgan and Chase Manhattan. After
the liabilities are subtracted from the assets, JPM shareholders only own
roughly $43b (exactly $42.735b) in equity.
Ominously, this relatively small equity capital balance is sup****ting a
cru****ng inverted derivatives pyramid weighing a colossal $30,434b!
$30,434b
of notional value derivatives controlled by JPM divided by its
shareholders'
equity of $42.735b (note this is a decimal-point in the equity number, NOT
a
comma as in the derivatives number) yields a simply unfathomable implied
leverage of derivatives to equity of 712 times! "Holy cow!" as they say in
the American Midwest.
Every single dollar of hard-won JPM equity ever contributed or retained is
sup****ting a breathtaking $712 in derivatives side-bets! 712x implied
leverage!! Old John Pierpont Morgan (1837-1913) is probably rolling-over
in
his grave, as he was a far more conservative financier, industrialist, and
deal-maker, not a pure financial speculator or hedge fund manager!
This implied derivatives leverage on equity has increased dramatically in
the six short months since the Monster essay, when it was "only" 626 to 1.
The vast JPM inverted derivatives pyramid continues to balloon ever
larger,
even through the absolutely unforeseen extreme market turbulence of
September 2001!
The inverted pyramid mental picture is a great way to visualize this
breathtaking leverage. Imagine Egypt's Great Pyramid of Giza miraculously
inverted and stood-up balanced on its apex. The relatively small point of
stone pressing into the ground would have to sup****t millions of tons of
stones above it (an estimated five or six million tons), an exceedingly
difficult task. Even if the apex of such an inverted pyramid was
constructed
from some unbelievably strong cutting-edge space-age composite that could
sup****t the cru****ng weight, an inverted balanced pyramid is still very
precarious and dangerous.
For example, what happens if a mighty sandstorm roars out of the desert?
The wind-loading forces coupled with pelting sand exerting lateral
pressure
on one or two sides of the inverted Great Pyramid would be enormous, the
whole pyramid would act like a great sail. It would be virtually
impossible
to keep the pyramid delicately balanced on its apex unless the sandstorm
was
anticipated well in advance and appropriate reinforcement countermeasures
were deployed before it hit. This is probably why you have never seen a
medium or large building engineered to look like an INVERTED pyramid, the
top-heavy design is simply far too unstable. Relatively small outside
forces
acting upon it are magnified tremendously by the leverage between the
broad
high top of the inverted pyramid and its narrow pointy base.
In the derivatives world, a calm sunny beautiful Egyptian day for the
inverted derivatives pyramid is the equivalent of normal, sedate, fairly
predictable market conditions. The sudden sandstorms that cause massive
wind-loading on only one or two sides of the inverted derivatives pyramid
are unforeseen market volatility. As any options traders will tell you,
and
options are the simplest form of derivatives, unforeseen volatility can
lead
to legendary profits or bankruptcy-magnitude losses, all in a matter of
mere
trading days or hours. In our chaotic and increasingly-weird post
September
11th world, it is hard not to imagine more unforeseen volatility
sandstorms
barreling off the desert dunes to slam unexpectedly into one side of the
greatest financial balancing act in world history.
For those dabbling in derivatives, making linear assumptions in a
non-linear
world can be lethal!
While JPM and two of its money-center superbank peers, Bank of America and
Citibank, now together control a staggering 89.6% of the total US banks'
derivatives markets, 359 commercial banks re****ted dabbling in derivatives
to the OCC in Q3 2001. In a provocative statistic, this number dropped
dramatically by 9% from the 395 commercial banks playing this same game
six
months ago in Q1. As more and more banks begin to comprehend the enormous
hazards of playing around in the unforgiving derivatives markets, more and
more are shedding their derivatives ****tfolios entirely to greatly reduce
the overall risk to their scarce and valuable capital. As fewer banks risk
their shareholders' and depositors' capital in this merciless speculator's
game, the concentration of the market in only a few mega-banks' hands will
no doubt grow more extreme.
Also provocatively, it is exceedingly interesting to note that derivatives
exposures of this magnitude have never before weathered the violent and
unpredictable financial storms of mighty secular bear markets. Derivatives
essentially began growing in significance in the 1970s and 1980s, and
every
investor knows that the greatest bull market in US history ran from
1982-2000 (see "Century of the Dow"). How will the massive inverted
derivatives pyramids fare in brutal and unforgiving bear market
environments? Only time will tell.
Our next graph is also from official OCC data and documents the banks'
total
derivatives exposure in notional terms through the 1990s to Q3 2001.
The red line below is the US banks' total notional derivatives exposure on
a
quarterly basis. The blue line is the four-quarter moving average of the
annual absolute rate of growth in the total US banks' derivatives
holdings.
For example, to get the Q4 2000 data point the Q4 1999 total notional
amount
is subtracted from Q4 2000's, and the difference is divided by Q4 1999 to
determine the absolute year-over-year growth rate for each quarter. The
four-quarter moving average of this quotient is the blue line shown below,
representing the annual growth rate in banks' derivatives exposure.
The US banks' derivatives holdings literally exploded in the 1990s, up
over
721% from Q1 1990 to Q3 2001 to the current unbelievable $51 trillion with
a
"t". Before we actually built this graph, we had assumed that derivatives
were growing at an unprecedented annual rate as the last couple quarters
witnessed the explosive 16.8% absolute growth in six short months. Very
surprisingly however, as the blue four-quarter moving average annual
growth
line shows above, periods of 20%+ annualderivatives growth were not
uncommon
in the 1990s.
The mean level of the blue line throughout the whole graph is 20.2%,
surprisingly high at least to us. From Q3 2000 to Q3 2001, the latest
available data, US banks' derivatives holdings grew by an absolute 34.3%
(not moving-averaged), which IS high. This stellar rate of growth is
obviously unsustainable! Using some quick shooting-from-the-hip math and
the
old "Rule of 72", a 34% annually compounded return doubles in a little
over
every two years. If US banks are to control a staggering
$100t of derivatives by Q4 2003, the graph above will have to shoot
parabolic, looking just like the classic NASDAQ bubble graph.
One would think that sooner or later every possible business in the world
that could possibly use an interest-rate swap, currency swap, or
any other kind of derivatives contract would have already deployed them!
Clearly current growth rates in US banks' derivatives exposures will have
to
abate significantly in the coming years.
Another interesting point to ponder in the graph above is that the two
steepest slopes in the last six years of the red derivatives line,
indicating the fastest growth, occurred during financial crises. In other
words, during episodes of severe market turbulence, US banks increased
their
rate of derivatives growth dramatically. Note the current very steep slope
ending in Q3 2001, the quarter of the diabolical September 11th attacks
and
subsequent extreme market volatility, and also the very steep ****tion in
late 1998 near the Russian Debt Crisis which caused unforeseen volatility
that obliterated elite derivatives-laden hedge-fund Long-Term Capital
Management. It appears that whenever sandstorms roar over the horizon to
buffet the inverted derivatives pyramid, that rather than prudently
reducing
exposure US banks simply pile and hang more derivatives onto the
windward side of the inverted pyramid to attempt to stay balanced. Not an
encouraging practice!
Interestingly, the current Q3 2001 year-over-year derivatives growth rate
of
34.3% is the highest witnessed since Q4 1998's 31.6% and Q3 1998's 30%,
all
near serious market crises!
As I discussed in Monster, the vast majority of US banks' derivatives
outstanding are interest-rate derivatives. This didn't change in the
latest
Q3 OCC data. In the Comptroller of the Currency's "Table 3", it claims
that
of all US banks' outstanding derivatives, a staggering 84.1% are
interest-rate derivatives. Chase Manhattan and JP Morgan, the two proud
spouses in JPMorganChase, re****t that 86.2% and 86.9% of their outstanding
derivatives contracts are interest-rate derivatives, respectively. All
together, JPM has at least $20,701b of exposure in notional value terms to
interest-rate derivatives contracts ("Table 8"). This is 484 times JPM's
total shareholders' equity, hyper-extreme interest-rate derivatives
leverage!
As interest-rate swaps and other interest-rate derivatives contracts are
the
biggest derivatives game in town for the mega-banks by far, we decided to
look at interest-rate volatility over the last 20 years or so. Everything
else being equal, higher interest-rate volatilities are the equivalent of
the sandstorm-driven wind-loads on our inverted Great Pyramid of Giza we
mentioned above. Extreme interest-rate volatility should cause great
concern
for the derivatives departments of the banks attempting to balance these
great inverted pyramids of derivatives.
The blue line in the graph below is the one-year constant maturity
Treasury-Note yield, monthly data direct from the Federal Reserve. The
yellow columns represent volatility in these interest rates. They are
calculated each month as the year-over-year absolute value of the change
in
interest rates in percentage terms. (For example, the December 2000 1-Year
T-Note yield less the December 1999 1-Year T-Note yield divided by the
December 1999 yield, absolutely valued.) The resulting quotients are then
smoothed through a 12-month moving average yielding the yellow
blobbish-columns shown below. A change of interest rates from 3% to 4%
((4-3)/3) is considered 33% volatility in this graph, as is a change from
9%
to 12% ((12-9)/9), which also equals 33%.
Interestingly, the current 12-month moving average of absolute
interest-rate
volatility in the midst of Greenspan's frantic interest-rate-sla****ng
extravaganza is currently running about 44%, the second highest spike in
two
decades. Not moving-averaged, December 2001 witnessed annual interest-rate
volatility of 66%, extraordinarily high. The average absolute
interest-rate
volatility over the last 20 years or so was only about 17.8%. The last
time
interest-rate volatility was higher was during the mid-1990s as the Fed
cranked interest rates back up after fighting the customary early-decade
US
recession.
In Q4 1995, near the last great interest-rate volatility spike, there were
558 US banks playing the derivatives game. Today there are 36% fewer banks
left in this rough-and-tumble and unforgiving arena. Back then there were
about $11,095b of interest-rate derivatives contracts outstanding in
notional terms. Today that number has skyrocketed to $33,496b ("Table 8"),
a
stunning 202% increase in not very many years. Can US banks balancing an
enormous inverted derivatives pyramid worth over $33 TRILLION weather this
current sandstorm of very high interest-rate volatility? The answer
remains
to be seen.
On another derivatives front, JPM is a defendant in Reginald Howe's
landmark
case filed in federal court alleging active official and money-center bank
suppression of the global gold price. Gold investors will be very
interested
to know that JPM's total gold derivatives exposure in notional terms has
plummeted from $57b in Q1 2001, right after the Howe case was filed (when
JPM controlled 68% of all US banks' gold derivatives contracts), to $37b
in
Q3 ("Table 9" in the OCC re****t, JPM now controls 55% of all US banks'
outstanding gold derivatives contracts), a stunning 35% drop in six short
months! There are at least a few potential interpretations that can be
advanced here, although there are no guarantees that any of the following
theories is correct.
First, gold derivatives demand may be shrinking and the market growing
less
profitable, so JPM chose to begin making an exit due to normal market
conditions. This is the simplest explanation, but it ignores a lot of
critical gold market data and assumes that there are colossal chance
coincidences. The longer I have observed and traded the markets throughout
my life, the less I believe in coincidences. Markets are giant complex and
intricate tapestries of exquisite cause and effect. A small ripple from a
stone tossed into one corner of the great global financial market pond can
quickly spread to and cause chaos in other far-off market areas that few
people would have anticipated.
Second, JPM is well aware of the mega-bullish fundamentals for gold,
including the enormous annual mined-supply and global demand deficit, the
collapsing gold-carry-trade profits, the vastly overvalued US dollar, and
the dangerous and vicious bear markets in US equities. If JPM expects the
gold markets to soon grow much more volatile as central banks run out of
both gold to lend and willing gold borrowers, it would make perfect sense
for JPM to cut its huge gold derivatives exposure and risk before the
coming
gold sandstorms strike. Remember, unforeseen
volatility is the bane of derivatives contracts' existence and can prove
lethal, and JPM STILL has gold derivatives exposure equal to 87% of every
dollar of its stockholder's equity, extraordinarily high!
Third, JPM could be stunned by Reginald Howe's amazingly well-crafted case
and can't believe that Federal Judge Lindsay hasn't thrown it out yet. JPM
may see a potential discovery phase hurtling down the pike like a
malevolent
juggernaut and it wants to exit the gold market as soon as possible in an
attempt to avoid a brewing legal firestorm and monumental scandal if the
gold-manipulation scheme breaks public for mainstream Americans. Vacating
the gold derivatives trade before it has Howe's highly-motivated and
tenacious Discovery Team pouring over JPM's private gold-trading records
wouldn't be a bad idea at all.
There are also other intriguing theories which exist on the drastic drop
in
JPM's gold derivatives exposure, many of which Bill Murphy has wonderfully
articulated in his awesome and highly-recommended members-only
contrarian-investment website www.LeMetropoleCafe.com.
The vast derivatives mysteries continue to perpetually fascinate and
titillate, defying logic and creating many more new enigmas that need
investigating.
As I wrote back in the original Monster essay, I am still just as
flabbergasted today that big institutional investors, who have a sacred
fiduciary duty to zealously protect the hard-earned capital entrusted to
them by their precious clients, would risk their clients' scarce capital
by
investing in JPM, not just a Dow 30 superbank but the biggest inverted
derivatives pyramid in world history!
A "bank" with $712 of derivatives exposure for every $1 in stockholders'
capital, in my humble opinion, is no longer a bank but a de-facto hedge
fund.
Now hedge funds are great and perform a very valuable market service to
sophisticated professional speculators with lots of capital, but a hedge
fund is NOT the place to park crucial retirement investments or college
tuition capital! Hedge funds are ultra-risky speculation vehicles for
the elite that specialize in making very large and risky bets. If JPM is
in
reality more like a hedge fund than a classic bank, both retail and
institutional investors alike carefully need to reconsider their JPM
"In financial circles 10 to 1 leverage is considered very aggressive, 100
to
1 is considered to be in the kamikaze realm, but we don't ever recall
hearing about large-scale leveraged operations exceeding 100 to 1 outside
of
the horrible example of the doomed super hedge fund Long Term Capital
Management. JPM's management may have effectively created the most
leveraged
large hedge fund in the history of the world by using $42b worth of
shareholders' equity to control derivatives representing a notional value
of
a staggering $26,276b."
Please note that the numbers in this quote are from the Q1 OCC re****t, and
are far worse now as we noted above! As I mentioned in Monster, the doomed
LTCM had an inverted derivatives pyramid of an estimated $1,250b sup****ted
by only $3b in owners' capital for an extreme implied leverage ratio of
417
to 1. JPM's implied derivatives-to-equity ratio was sitting at 712 to 1 at
the end of Q3 2001, a staggering number beyond comprehension!
The danger with hyper-extreme leverage is that even a relatively small
unexpected increase in volatility slamming into the inverted derivatives
pyramid on the wrong side, a moderate sandstorm, can cause cru****ng losses
at the apex of the pyramid, the capital base of the speculating bank
wielding the hyper-leverage. For example, a 1% fluctuation in a market
price
is not a big deal on any given day, it happens all the time. Yet, with
even
a "mere" 100 to 1 leverage, a 1% price move in the wrong direction can
totally wipe-out the underlying capital. If you have $1k in capital but
control a long bet worth $100k, even a trivial $1k price drop to $99k
obliterates you. Hyper-leverage is playing with fire!
It doesn't matter how intelligent the folks are that are managing these
gargantuan derivatives pyramids. They are probably brilliant
rocket-scientist types, the best in the world. Yet Long-Term Capital
Management also had brilliant rocket-scientists running it too, some of
the
brightest financial minds that ever lived. Even with that unparalleled
brainpower, the mighty LTCM was annihilated by a relatively small
unforeseen
market event, the Russian Debt Default, that completely blew-up its
fragile
inverted derivatives pyramid ****tfolio.
In addition, even the most brilliant market players in the world make
mistakes. JPM issued an official press release on December 19th that
claimed
it had $2.6b in loans and other exposure to financial-disaster-du-jour
Enron! Initially, JPM had "only" re****ted $0.9b of exposure to Enron.
$1.7b
more is a BIG difference. JPM also re****ted that it had at least $0.9b in
exposure to Argentina at the end of Q3. JPM might not lose all the money
it
is owed by Enron and Argentina, but if it does that is a staggering $3.5b!
For comparison, realize that JPM re****ted that it earned $5.7b last year
in
its annual re****t. If the Enron and Argentina loans alone were to go bad,
that is a potential 61% haircut in 2001 earnings with only two deals that
went sour! The point is not that JPM did anything wrong in loaning money
to
Enron and Argentina, just that even the best of the best cannot foresee
some
market events which can turn around and painfully bite them.
The more that I ponder JPM's utter dominance of the US banks' derivatives
markets, the more amazed I become that more professional institutional
investors and analysts aren't at least a little concerned that the
unprecedented Morgan House of Derivatives may be far overextended. I am
also
amazed, especially after the exceptionally ugly Enron implosion, that the
OCC and other Federal regulators are apparently not at all concerned about
a
single company somehow juggling an exceedingly tangled web of derivatives
worth over $30 trillion in notional value terms. Talk about systemic risk!
Regardless of how well JPM has balanced its enormous inverted derivatives
pyramid on top of its comparably infinitesimally-small capital base, in
these chaotic markets of today I can't help but thinking that unforeseen
sandstorms are brewing on the horizons that will place tremendous and
unexpected wind-loads on JPM's fragile derivatives positions. Hopefully
JPM's inverted derivatives pyramid will not crumble and fall to the earth,
as the consequences of such an event for the US financial system could be
dreadful.
Adam Hamilton, CPA
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