According to the Financial Times, as of last week, JPMorgan Chase sold up to 70% of its position in the CDX.NA.IG.9 index, where the Fail Whale trades originated. I assume they are working on the remaining 30%, though CEO Jamie Dimon has said that the trades would “not be an issue by the end of the year,” suggesting there are several months to go. But the bleeding will be eventually stanched from this trade, and sometime in July, when they announce their earnings, we’ll find out just how much JPMC lost on the deal – the speculation has been anywhere from $2 billion to $7 billion.
None of this should suggest that JPMorgan Chase, or any major US bank, has insulated themselves from risk around the world. In fact, that risk is gradually growing. Simon Johnson notes today at Bloomberg that US banks have no real buffer to protect themselves from a crisis in the Eurozone:
As a warm-up, consider first a simple contract. Let’s say you have lent 1 million euros to a German bank, payable three months from now. If the euro suddenly ceases to exist and all countries revert to their original currencies, then you would probably receive payment in deutsche marks. You might be fine with this — and congratulate yourself on not lending to an Italian bank, which is now paying off in lira.
But what would the exchange rate be between new deutsche marks and euros? How would this affect the purchasing power of the loan repayment? More worrisome, what if Germany has gone back on the deutsche mark but the euro still exists — issued by more inflation-inclined countries? Presumably you would be offered payment in the rapidly depreciating euro. If you contested such a repayment, the litigation could drag on for years [...]
Personally, I’m most worried about the balance sheets of the really big banks. For example, in recently released highlights from its so-called living will, JPMorgan Chase & Co. revealed that $50 billion in losses could hypothetically bring down the bank. (All big banks must provide their regulators with a living will to show how they could be shut down in an orderly fashion if near default.)
JPMorgan’s total balance sheet is valued, under U.S. accounting standards, at about $2.3 trillion. But U.S. rules allow a more generous netting of derivatives — offsetting long with short positions between the same counterparties — than European banks are allowed. The problem is that the netting effect can be overstated because derivatives contracts often don’t offset each other precisely. Worse, when traders smell trouble at a bank that has taken on too much risk, they tend to close out their derivatives positions quickly, leaving supposedly netted contracts exposed.
That’s almost exactly what happened in the Fail Whale trades, and Johnson suggested that this would occur at a much larger scale if the euro dissolves. Now, it’s true that the euro may not actually dissolve in this way. But it really may not have to – just a couple incidences of countries shifting their currencies could create this outcome. And when you have the thin margins like a JPMorgan Chase, it may only take that much to create chaos.
As Johnson explains, JPMorgan Chase and other big banks, especially the ones heavily invested in the derivatives market, stand at significant risk if several counter-parties ask for their contracts at the same time. That’s what a credit event like the dissolution of a currency could create. Under European accounting standards, JPMC has assets of $4 trillion, so a $50 billion loss, which their own living will says would bring down the bank, isn’t out of the realm of possibility. Especially when so much of it is tied up in derivatives.
If anything, the Fail Whale trades showed the potential consequences of this in miniature. JPMC may have gotten away with the Fail Whale without any major consequences, thanks to their purchase of Washington. But Washington won’t be able to help them in the event of a euro crisis. As Yves Smith writes, “a eurozone crisis is not likely to be contained, and the biggest US banks are exposed.”




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No problem. The ECB & Fed will suddenly discover they can print money to resolve the problem, as long as the rich don’t have to pay taxes to pay for anything, and can continue to loot the commons.
Glad I’m not Jamie Dimon.
What am I saying????? The bank may lose $50 billion, but Jamie will be jusssst fine.
Never mind.
Jamie and those really smart traders and hedge fund hippies will still get their bonuses no matter how much Big Ben has to spend to save their worthless aases.
It’s my understanding that the JPM trades weren’t hedges or “offsets” at all, but unrelated high risk gambling. So what if there is more of this going on under the hood?
They were “hedges” but they were “portfolio” hedges meaning the derivative(s) as a group could be expected to offset moves in the items in the portfolio being hedged.
When the correlation is not close in dollars (but this was) or in time required to get the change in value, or in liquidity (and there was not a strong correlation on the last two points) it becomes more of a gamble than a hedge. The risk manager (these are no longer actuaries on Wall Street as the street has gone to accounting rules based hedging with calculations done by new PHD’s) needed to show some business sense and say no to management – but the way he got his job, beyond family friends and his mentor, was the last person saying no and that person now no longer being there.
As to the Financial Times and Yves – well I understand she is a hedge funds consultant and listens to hedge fund folks – getting some fine analysis this way – but like many of her items this is an attempt to push the market by the hedge folks. Likewise the Financial Times seems to have chosen to not interview or analyze well.
The bottom line is that the US Banks are not going to be hurt by the end of the eurozone – or by the eurozone continuing. The only real take away from this post is how screwed up our corporation controlled accounting – the FASB – is with todays example being how derivatives risk is netted in the US being weaker than the method used overseas – despite the ongoing project to make the two accountings very similar.
You know there’ is more of this going on. These guys are high stake gamblers with other peoples money. And they are the smartest guys and gals in the room. They even use calculus in their infallible models. Er, except one in a million it doesn’t work but hey no one is perfect?
They can use all the calculus they like, but there is still chaotic behavior (with is a recent addition to math), and it states what we all know to be true.
After a chaotic event the outcome is not predictable.
Would the right accounting have fixed this.
No perfect systems. But those folks think there is.
Sorry papau ,but you could not possibly know how the global impact of euro financial collapse would eventuate .I know the market synergistics from such disequilibrium is not amenable to accounting determinism ,or math,or any formal knowledge regarding financial instruments .As Keynes postulated ,markets don’t move on reality, they move on perceived reality .The impact on currencies ,industry commodities and cross-cultural finance is an axiomatic unknowable ,even if we didn’t live in a flash trade world .I believe you already know this ,so what axe are you grinding ?