It’s All Fun and Games Until Someone Loses $2 Billion...
- Details
- Published on Friday, 18 May 2012 08:00
- Written by Sara Nunnally, Editor, Inside Investing Daily
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JPMorgan has opened the door to big losses across the banking world. There's only one way to stop this snowball.
I know there's something about a fan here... or a creek and a paddle. But I'm just happy we had a chance to warn you.
In mid-April, we published an article called "The Achilles Effect." It was published just on the heels (pardon the pun) of the JPMorgan (JPM:NYSE) earnings release that blew Wall Street estimates out of the water.
But all that good news about the strength and health of U.S. banks might be worthless now.
JPMorgan is swimming in trading losses.
New estimates are in the neighborhood of $3 billion -- 50% more than previously thought.
This is not good news for JPM. Indeed, the company's share price is down more than 10% since the loss was announced. But it's even worse news for the banking industry as a whole.
This trading loss highlights the exact problems that banking regulations are trying to fix. Check this out from The New York Times:
The Federal Reserve is examining the scope of the growing losses and the original bet, along with whether JPMorgan's chief investment office took risks that were inappropriate for a federally insured depository institution, according to several people with knowledge of the examination.
The chief investment office is supposed to be managing risk. Simply, it's a hedging arm against the bank's investments.
But five years ago, CEO Jamie Dimon charged this office with making profits. It's a 180-degree shift from keeping the banks safe to jumping into risky credit default swaps. By 2010, the office had amassed a $200 billion portfolio... big enough to move markets. Hedge funds and other investors hung on JPM's every move.
This was all fine and dandy (though probably illegal) when JPM was raking in $5 billion in profits over the past three years... folks like the Fed tend to turn a blind eye to that kind of behavior when institutions are making money.
Now that JPM has huge losses on its table with the promise of more to come, the crackdown is going to be huge. And it comes with a name:
The Volcker Rule.
The Volcker Rule tries to stop banks that are backed by the government from making bets on stocks, bonds and derivatives... This proprietary trading, the rule says, is too risky to the whole financial system.
That's because any federally backed money and cheap Federal Reserve capital shouldn't be hedge-fund money. And that's exactly what folks are saying is going on at JPM.
Mark Williams, a professor of finance at Boston University, and former Federal Reserve bank examiner, said, "JPMorgan Chase has a big hedge fund inside a commercial bank. They should be taking in deposits and making loans, not taking large speculative bets."
That's what got us into trouble the first time around, remember?
These JPM losses should serve as a canary in a coal mine for what could be headed down the pipe again. The Volcker Rule is sure to be heavily enforced now, and banks might have to unwind hundreds of billions of dollars in investments if they can't prove they are hedging risk or another position in the portfolio.
And that could send shockwaves through the markets and the financial system.
Think about it. That $2 billion (at least) in losses could be the start of an avalanche of losses. Banks will have to dump both losing and profitable positions back onto the market, and hedge funds and other investors could follow suit.
JPM alone couldn't unwind its chief investment office positions without roiling the markets. And it's not the only bank with its fingers in the pot... merely the first to announce these kinds of losses.
So what's to happen?
JPM could continue hemorrhaging, and that would make things very tricky for other big banks.
Our appetite for stupid losses has dried up. And if folks argue that banks should be allowed to compete and invest in the market, then they should do so with their own money... not funds backed by my money, or your money, or taxpayer money.
And call them what they are: hedge funds.
I'm for an even harsher rule than the Volcker Rule. It's called Glass-Steagall, and it was repealed in 1999 to allow banks back on the investment scene. (And by the way, Citi spent $100 million lobbying for this repeal.)
Go ahead and make all the risky casino bets you want, but keep them out of the commercial banking industry.
Steve Goldstein, Washington bureau chief for MarketWatch.com, says, "The simple fact is that no rule is going to be strong enough to prevent a bank from acting with hubris and stupidity, two qualities evidently on display at the New York bank... The best way to combat 'too big to fail' is to make banks small enough that failures wouldn't matter."
Bring back Glass-Steagall, and the separation of casino banks and commercial banks is clear.
Until then, short the heck out of 'em!
Chart of the Day: Bullish Gains in Boring Metals
By Adam English, Associate Editor, Inside Investing Daily
According to the word on the Street, lead is going to see a rally this year. Prices are expected to average $2,273 a ton in the fourth quarter. On a USD per pound graph, that puts the target price at $1.03.
That would be good for a 13% gain from today's prices.
Take a look at the one-year spot price for lead. On the surface it seems to pare gains as soon as they happen. So what could possibly drive up prices when stored lead hit an all-time high recently?
First off, stockpiles monitored by the LME dropped 7.6% since October. That is a good start for commodity bulls.
Secondly, demand will exceed supply by 150,000 metric tons next year. That is equal to about six months of U.S. mine production.
A single cause will drive the change. Lead-based industrial batteries now account for 33% of lead consumption. That is a 100% increase since 2005. Overall, all types of batteries account for 85% of lead consumption.
People and businesses are constantly buying larger and more powerful batteries for everything from high-end mobile phones to windmills to small electric bikes in the China.
"There has been genuine fundamental tightness in the lead market," said Nicholas Snowdon, an analyst at Barclays in New York. "With a relatively tight market balance already in place and solid improvements in the macro picture envisaged during the second half of 2012, that should be supportive for prices."
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