- With J.P. Morgan Chase & Co.'s rescue of Bear Stearns
Cos., a behemoth in the complex world of derivatives trading has become
even bigger, and the business is now more concentrated.
- J.P. Morgan has a derivatives portfolio that is the largest
by far among U.S. commercial banks. At the end of last year, its portfolio
hit $77 trillion in "notional value," which is the value of the
assets underlying these contracts, according to its regulatory filings.
- The company's positions were more than twice as large
as those of Citigroup Inc. and Bank of America Corp., according to data
from the Office of the Comptroller of the Currency. They run the range
from straightforward stock futures contracts to interest-rate swaps and
more complex agreements with individual trading partners.
- Analysts say J.P. Morgan's large position in the derivatives
markets meant it had an interest in seeing Bear Stearns's problems sorted
in an orderly way, because Bear is another big derivatives player. Bear's
failure might have weakened the entire market. Now the planned acquisition
of Bear means the risks that derivatives are meant to disperse may be getting
more concentrated among fewer players. J.P. Morgan's influence in the market
has risen because it is now standing behind Bear's derivatives book.
- "'Many pathways through this maze of derivatives
lead back to J.P. Morgan," said Martin Weiss, president of Weiss Research,
an investment-research firm in Jupiter, Fla. "The domino effect of
a major firm like Bear defaulting on its derivative transactions may have
hurt other counterparties in the marketplace, many of which trade with
- According to its regulatory filings, Bear had derivatives
covering notional amounts of $13.4 trillion at the end of November. Around
$1.85 trillion of these were in futures and options contracts that trade
on exchanges. Nearly $11 trillion were more complex agreements with individual
- In the fast-growing credit derivatives market, the 10
biggest players were parties to nearly 90% of the volume of contracts traded
in 2006, according to a survey last year by Fitch Ratings. J.P. Morgan
was ranked third. Bear was ranked No. 9.
- While most investors are more familiar with stock and
bond markets, the world of derivatives linked to debt, interest rates,
and currencies is far larger and more opaque.
- Some derivatives, such as popular futures and options
contracts, trade on organized markets such as the Chicago Mercantile Exchange.
The vast majority trade directly between big banks and financial institutions
in the over-the-counter market. Customers in that market, which can
range from companies looking to protect against swings in currencies to
banks betting on the direction of interest rates, deal either directly
with each other, or through intermediaries called interdealer brokers.
The market is vital to the functioning of companies and the financial
system. The total amount of interest-rate, currency, and credit derivatives
outstanding at the end of 2007 was about a notional $400 trillion, the
International Swaps and Derivatives Association says.
- Eye-popping notional amounts can be somewhat deceptive.
They represent the total value of the underlying securities affected by
a contract, although actual contract values could be a fraction of that.
J.P. Morgan, for example, said in its regulatory filings that while its
total derivative notional amounts were $77 trillion, what it is owed on
these contracts is 0.1% of that, or $77 billion.
- Kristin Lemkau, a J.P. Morgan spokeswoman, said the bank
didn't feel overly exposed to Bear before the deal. "We are comfortable
with the risks we are taking in acquiring Bear at the price we paid,"
- Policy makers are deeply worried about the threat of
a big player in these markets failing, which could cause problems for many
of its trading partners.
- Sunday night, in unveiling its acquisition of Bear, J.P.
Morgan said it would immediately guarantee the Wall Street firm's trading
obligations and its counterparty risk. "J.P Morgan Chase stands behind
Bear Stearns," the bank's chief executive, James Dimon, said in a
- J.P. Morgan's guarantees effectively provided a backstop
for Bear, whose credit ratings were cut Friday by the major rating services
to the low-investment-grade rung of triple-B from single-A because of the
firm's funding problems.
- Those downgrades could have forced Bear to fork over
significant amounts of cash or collateral to some of its swap counterparties,
demands that could have bankrupted the firm. The backing of J.P. Morgan,
with its stronger credit rating, prevented that from happening.
- "The immediate counterparty problem we tried to
avert is tabled for now," said Carlos Mendez, a senior managing director
at Institutional Credit Partners, a boutique investment firm in New York.
"However, widespread credit problems persist, and no solutions are
on the table."