Dimon Loses Sparkle or “It’s not a hedge if you are the bar”

The news about Jamie Dimon’s JP Morgan losing over $2B has caused quite a debate. The point I’d like to address, is whether or not JPM was “gambling”. You see, on CNBC this week, Maria Bartiromo tried to make fun of Senator Harry Reid who intimated that JPM was gambling and should just move to Nevada. During her comments she also tried to make the point that (and I’m paraphrasing) “do we want to outlaw risk taking?” JPM’s misteps are being debated in entirely the wrong context.

To the question at hand, was JPM “gambling” or was this merely “hedging” gone awry? It helps to understand what a hedge is and why it might be used. Any business faces a variety of risks. Banks, in particular, face risks associated with the credit quality of the general economy. For an institution of JPM’s size, if the economy weakens, defaults are likely to rise or the bank is likely to need to increase reserves against potential losses. It’s obvious why a bank might attempt to hedge such risks.

European Follies

In case you were inclined to believe the rumors that Eurocrats have solved their problems, consider this quote from today’s WSJ:

After a day marked by a brawl among Italian lawmakers, debating cutbacks in the country’s pension system, Italian Prime Minister Silvia Berlusconi took time out from the Brussels summit to call into a popular television show shortly after midnight, criticizing the European Central Bank and dismissing reports he plans to call for early elections.

Should We Call It ‘Depression 2.0′?

Recently revised data show that the recovery from the 2008 Crisis is taking longer than expected. You may recall that a “recession” is the period when GDP is declining. Once GDP troughs and begins to climb, we call that phase “recovery”. Recovery gives way to “expansion” when GDP surpasses the old peak. We detailed this graphically in a prior post.

COTD: Curious Reaction to QE2

The Fed’s big announcement yesterday has been dubbed “QE2” which short for “quantitative easing part II”. QE is Fed-speak for monetizing the national debt, otherwise known as “printing money”. It is not actually equivalent to printing money, at least until the program becomes permanent. But this post is not about the implications of QE. Rather it is about the strange trading activity around the announcement.

You see, QE2 has been rumored, floated, leaked, discussed, debated and reported on since before Labor Day. That the Fed was planning some quantitative easing was confirmed and well known before the actual announcement. Thus the only thing “new” in the announcement was the exact dollar size of the program, the exact timing and the wording of the Fed’s intensions. Even here, the size of the program was pretty well known by Wall Street. So, the financial markets expected this event with stronger than usual conviction in what it would entail. In fact, “everyone” claimed that QE2 was already “baked in to” expectations with traders having positioned themselves well ahead of the actual announcement.

Instead of a yawn, we got incredible volatility in yields. Bond yields typically don’t move much in one day’s trading session, but yields moved a week’s worth in just a few minutes. Why the surprise? To make matters even more interesting, that spike in yields reversed entirely and fell even further at today’s opening. I’m puzzled as to why the violent trading reaction took place. Have a look:

Ugh. Some thoughts on today’s market crash that wasn’t

Whew, some ride! What started as a “normal” skittish day in the markets nearly turned into outright disaster. In case you didn’t see it, around 2:25 PM, the market began to inexplicably plummet. Within minutes, the market was down over 8%- a veritable crash. It was truly stunning was just how fast things turned. Usually there is a little warning- a sense of impending action, bad news on the tape or other confluence of events that ease everyone over the falls. Not so today. Rather it came like a bolt out of the blue. Naturally everyone immediately sought reasons- a hung British election, spreading of the Greek debt crisis including riots at roughly the same time, possible liquidation of a hedge fund or program trading. Early indications seem to point, in part at least, to a system malfunction or rogue trade. P&G traded from $62 to $39 while Accenture traded down from $42 to $0.10! That just doesn’t happen in functioning markets and clearly some glitch plagued the market today.

Yet “bad prints”, which is trader terminology for a mistake, happen often and don’t unglue the system. One view might be that the market was exceptionally skittish going into today. Many metrics indicated that the market had overly bullish sentiment, “overbought” conditions, expensive valuations and had largely ignored recent negative economic developments in Europe. Complacency on account of “the recovery” is rampant.

One example of how investors seem to be throwing caution to the wind lately is how they have reacted to, or failed to react to, Greek woes.  The situation in Europe has been known for months yet the markets have been complacent. Did investors just wake up for the first time today and notice how pathetically the EU is dealing with the situation? That is very plausible and if true, then caution had certainly been thrown to the wind and we could be in for a sizable correction. Just as a relatively small amount of subprime loans crippled the entire banking system, Greek debt along with Spain, Portugal, Ireland and Italy could also cripple the system.

Then again, this may have been a very random event; a mere matter of coincidence which we’ll all soon forget. At this junction, it is impossible to tell yet. While it may be comforting to hear pundits (yes you, CNBC!) definitively claim this or that, the reality is that we don’t know how this will play out.

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We’ve witnessed nearly everyone bash the US Dollar over the past few years. As I’ve often commented, the dollar is indeed a weak currency-  except for all the rest. The Euro is not a currency; rather it is a currency experiment and we’re in the lab right now. The ECB has been quiet and largely powerless, Germany and France have made promises
only to reneg, while the Greeks seem to want their cake and to eat it too. Spain, Portugal, Ireland and even Italy face huge issues. As painful financially and politically as TARP was- at least we dealt with the issues in about a month and on short notice.  The EU hasn’t done anything to address Greece after months and months of fair warning. Yet some continue to insist the Euro should be the stronger currency? I think not.

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Watching CNBC today, I heard discussion on the possible rogue trading  include comments such as “where are the regulators?” and “where are the checks to make sure these things don’t happen”? I must laugh at the hypocrisy- CNBC is a bastion of pro free-market, anti-regulation rhetoric. God forbid someone want to regulate market processes- how dare they! Let the private sector decide if program trading, high frequency trading, co-location and hedge fund algorithim flows are okay. As soon as something goes wrong however, out come the calls for adult supervision! Those pundits really ought to think about their positions a little more than superficially. Alas, they’re just talking heads I suppose. Too bad people take them seriously.

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I’ve wanted to address high frequency trading since it surfaced as a potential abuse last summer, but didn’t get to it. Perhaps now it is time. Coming soon…

When does the Chinese Credit Card Crisis Hit?

Koreans, as in Koreans who live in Korea, are not the best drivers. Korea has some of the highest car fatality rates in the developed world. The first time I set foot in Korea, it struck me how almost every car on the road had some kind of dent. Road rules seemed Darwinian. If you had the biggest vehicle, you had the right of way. Pedestrians were 10th class citizens, even on sidewalks.

Obama proposes bank taxes, reforms

A couple of thoughts on the proposals this week. Let’s start with this proposed “bank tax”. Given the outrage centered around bank bonuses, the tax is supposed to penalize the banks for requiring government help last year (in the form of TARP). The idea is that the banks benefited from TARP and TARP will probably lose money on some portion of its loans, therefore we’ll tax all banks to make up any shortfall to the return of taxpayer funds.

The Great Long Run Blog Debate #2: Keynesian Economics

Keynes has been a popular topic lately. By Keynes I mean both John Maynard and his economic theory of government intervention into the free market. To quote wiki:

The future is California – without the great weather.

California is the most heavily taxed state by most measures according to a recent L.A. Times story. According to the article, the marginal rate on taxable income over $1 million will rise to 10.55% from 10.3%.  The next-highest tax rate, which starts at $94,110 for a married couple filing jointly, will rise to 9.55% from 9.3%. Sales taxes were just increased a full point from 7.25% to 8.25% plus whatever the local municipality tacks on. Here in Santa Clara County the sales tax is 9.25%.

Stress Tests

Ever since Geithner announced they would be conducting “stress tests” on the banks a few months ago, people have been speculating on the outcome and what it will mean for the markets. Some argue that the government won’t publish negative results because that would spook the markets. Others hypothesize that good results will be viewed skeptically by the markets, owing to the fact we all “know” the banks are in bad shape.