- 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 Corporation 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 corporation 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, Washington
-
- 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 important to those who still have a portfolio and
want to move to safer positions, but more important, those who wish to
anticipate and defeat the oligarch grand plan to enslave common man once
again.
-
- --DE
-
- =====
-
- By Adam Hamilton
-
- 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 important 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 Singapore has been
overwhelming.
-
- The original essay showcased data that JPM is required
by law to report 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 report 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 important 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
Report", "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>http://www.occ.treas.gov/deriv/deriv.htm
(specifically the file is at
- <http://www.occ.treas.gov/ftp/deriv/dq301.pdf>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 reports. 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 flagship 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 report, the portions 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 reported 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 supports 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 temporarily 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 corporate 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 supporting a crushing 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 supporting 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 support 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 support the crushing 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 reported
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 portfolios 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 portion
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, report 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-slashing
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 report, 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 report, 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 supported 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
crushing 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 portfolio.
-
- 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" reported $0.9b of exposure to
Enron. $1.7b more is a BIG difference. JPM also reported 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 reported that it earned
$5.7b last year in its annual report. 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.
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- 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.
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- Adam Hamilton, CPA
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