Bad Karma At JP Morgan

J.P. Morgan has dropped 49% this year. Not as worse then the carnage at BOFA, Citi, or Wells, but the stunning liquidation in JP this week can't be ignored or dismissed. Sure the market stinks, and the banking system is in terminal shape, but wasn't this the bank the one that would go out and buy other "sick banks"? Wasn't this the bank that was not only deemed "too big to fail? or even better "too scary to fail'? There has been definitely bad news at JP recently, for example, they cut the dividend 87% on February 23rd. This after telling the public for months that no dividend cut was necessary. This cut will save the company $5 Billion. Also the company came out and stated that quarterly earnings would be in line, but that losses in credit cards, home loans, and home equity lines of credit would be greater then expected and that the company would have to take further write offs and build additional reserves.

But the reason the stock tanked this week was the counter party risk they currently have with General Electric Capital. There were all type of rumors this week at GE, please read my previous posts for a recap. How this effects JP is very simple, as they are very much intertwined on many levels, if GE Cap is in trouble, then nothing really is sacred. GE Cap does huge amounts of over night and daily funding at many banks, most notably JP. It reminded me a lot of the Bear Stearns saga one year ago.

We all know that VAR (Value At Risk) started at JP. They have the smartest risk managers and yes quants (yuck). They are up there with Goldman Sachs in financial engineering. They also have the best stable of traders out there, so why did the stock act so violently last week? Why did it drop nearly 30% in one week, The market already knows that JPM will have cumulative loan losses by 2010 of $174 Billion, and $193 Billion by 2011. The market has also factored in total losses of $62 Billion at WAMU by 2010.

So why?

The most simplest explanation is that investors have started to turn over stones at JP. More and more institutions have started to closely monitor the firms OTC Derivatives operations. These operations are very closely guarded and have very loose regulatory requirements. When GE was melting this week, a lot of the focus was centered at the unthinkable...what is JP Morgans true exposure to exotic derivatives? How can the firm keep making so much money? How are they doing it? What is their exposure? How come every time a firm blows up, JP Morgan is their to pick up the pieces? Sooner or later their luck has to change right?

The firm early in the week announced that their derivatives department made over $5.6 Billion in profits in 2008. Most of the money was made in the same OTC exotic derivatives that many other Wall Street Firms had blown up in, most notably Lehman Brothers, Wachovia, BOFA, UBS, Barclays, Etc. Most of these profits were made at the expense of the companies I just listed. Its a Zero Sum Game, for every winner, there is a loser. Also with many Wall Street Firms (Lehman & Bear) disappearing, large institutions and hedge funds had fewer trading partners in the private OTC derivatives market. JP Morgan dominates the OTC Derivatives trading according to many market participants. You ready for this....The bank holds an unquantifiable $87 Trillion in notional outstanding OTC derivatives contracts! So in fact the $5.6 Billion they made really is not a huge figure in the sense of their total exposure. The potential losses are unthinkable if any counter party (AIG or GE) goes belly up. This is why the government keeps bailing out AIG. And why there will be continued bailouts at any costs. Because of this $87 Trillion figure, the U.S. TaxPayer will be perpetually propping up the negligence of Wall Street for years and years to come. JP Morgan is kind of like the governments "Star Witness in a RICO Trial" The government needs this institution to stay healthy at all costs. JP is the last jewel of the US. Banking System, if they go, then everything is lost. If you thought Lehman's bankruptcy rocked and horrified the markets, then JP's downfall will finish the job permanently. There would be no banking system, credit system, and the global stock markets would be halted for trading for months trying to figure out how to match up and reconcile $87 Trillion in OTC Derivatives. I will say it again...we might as well start living in caves and learn how to draw like the caveman. No kidding here.

But how did we get to this point where one institution can have so much leverage and exposure? We all think that the NY Federal Reserve Bank that was headed by Treasury Secretary Tim Geithner at the time engineered the sale of Bear Stearns to JP right...WRONG!... It was JP Morgan that went to the NY Fed and insisted that they take over Bear Stearns. Jamie Dimon the CEO of JP knew that a bankruptcy at Beat Stearns would decimate and trigger huge debilitating losses in JP's OTC Derivatives operations. He knew that a Bear Stearns melt down would not only hammer the markets, but most importantly his own company would go down the tubes...So he made the call to Geithner and hammered out the original absurd $2 deal. He knew his company was in bigger trouble, but he played it brilliantly and grabbed Bear, and was able to offset many potential losses in not only mortgages, but the counter party risk associated with their derivatives contracts. He got Bear Stearns clearing business, Real Estate, Specialist Trading Firm, and many other pieces, but was also able to syphon $29 Billion from the government for future losses in Bears securities. He basically stole Bear, when his own company would have blown up with Bears insolvency. After the acquisition, things calmed down for a few months, JP was able to manage and actually made huge sums of money in their trading operations. But as the markets continued to sell off and the banks got sicker and sicker by the day, the government had already started to bailout the likes of Fannie, Freddie, Indy Mac, and AIG. Their best heist was yet to come.

Washington Mutual for a lack of a better word, was a total disaster of an institution. There lending practices were abysmal. In fact, they had no lending standards. There loan losses were huge but they were fairly capitalized..just barely WaMu could have gone another 2 years at their current absurd pace. What WaMu had was the following:

1-Retail Banking Network
2-Back Office Operations
3-National Foot Print
4-A recent private equity investment from TPG
5-Most importantly - Huge Deposit Base

As the markets were breaking down last fall, JP Morgans capital positions and ratio's had significantly deteriorated. The Federal Reserve as well as the Treasury knew about the $87 Trillion derivatives exposure figure....They already knew what Lehman Brothers had done to the market, they could not afford the same fate to JP. So again something had to be done. Voila! Washington Mutual was seized by regulators, after the bank had seen $16 Billion be drawn out by depositors. After WaMu was seized by the FDIC, it was sold to JP for $1.9 Billion. JP Morgan Chase didn't acquire any of Washington Mutual Bank's equity obligations. As a result of the seizure, WaMu's stockholders were nearly wiped out. In their Chapter 11 filing, WaMu listed assets of $33 Billion and Debt of $8 Billion. Currently, shareholders are fighting for what they see as the illegal seizure of Washington Mutual, claiming that the regulators acted in an arbitrary and capricious manner and seized the bank for political reasons or for the benefit of JPMorgan, which acquired a large network of branches at what they claim to be an unfairly low price.
Shareholders claim that as of the date of the takeover, the bank had enough liquidity to meet all its obligations and was in compliance with the business plan negotiated with the FDIC 2 weeks earlier. So Jamie Dimon had done it again....snatched certain defeat...and made it a victory. JP Morgan needed WaMu's assets and deposits to shore up their bleeding balance sheet, they needed to buffer potential losses in their trading book with equity deposits that they were given by the government. With WaMu's deposits and equity, JP Morgan didn't have to take write downs or marks in their trading books. They didn't need to raise new capital that would severely dilute their existing share holder base.

All of this certainly sounds like conspiracy theory but all I ask is for you to go ahead and just Google search these subjects. I am not the only one who has this opinion.

JP Morgan has dodged two bullets...Can Jamie Dimon do it again? How many more rabbits does he have? As rabbits have become quite extinct all of a sudden.

So what is JP Morgans exposure? Is it truly as scary as that $87 Trillion figure? You be the judge, why would the government keep bailout out insolvent institutions?

The answer is again very simple. They have to protect their "star witness" who keeps getting into deep trouble.