JP Morgan was considered the poster child for how to run a bank during the crisis of 2008. It had the capital and ability to take over Bear Stearns in March 2008 when Bear got into trouble and still had enough capital to take over Washington Mutual later in the year.
It seemed to never have any serious problems and its chief executive officer, Jamie Dimon, seemed able to dodge bullets.
Investors, then, were quite surprised by the revelation on May 10 of a $2 billion trading loss from derivative positions taken by the company. To make matters worse, Dimon reported to investors that the positions are not completely closed out and that the losses could end up being higher.
Warren Buffet has described derivatives as “financial weapons of mass destruction.” Banks made a lot of money trading securities from 1999 until 2008, but many subsequently got into big trouble because of the riskiness of their bets and the amount of leverage they employed.
The Dodd-Frank Bill, which passed in 2009 but still is being implemented, is trying to limit the amount of trading that banks can do for their own accounts. The banks are arguing that eliminating this source of revenue will not only hurt their profits, but will reduce liquidity in the markets.
Regulators believe that institutions with federal deposit guarantees should not be gambling with their equity, the loss of which could force the government to make depositors whole.
We have seen how costly such guarantees can be. The markets were unnerved because if something like this could happen to JP Morgan, who else might it happen to sometime soon?
The Greek debt crisis continues with political parties in Greece still trying to decide if they will apply austerity or stimulus measures to rescue themselves from their financial woes. It is interesting that some politicians are equating austerity with economic contraction and further stimulus with economic growth.
It would seem obvious that if too much debt got you into trouble, then more stimulus and debt is probably not going to solve the problem. The fact that politicians are caving in to their constituents by not administering the harsh medicine is not being looked upon very kindly by the bond markets.
Greek yields had fallen from over 35 percent prior to the debt restructuring to about 20 percent post restructuring, but have since risen closer to 30 percent because of fears that Greek politicians don’t have the intestinal fortitude to address and remove the problems plaguing their economy. We haven’t heard the last from Greece.
The Chinese economy is showing signs of slowing, which is also unnerving the financial markets.
Purchasing Managers Indices (PMI) are slowing markedly, and news on May 16 indicated that Chinese banks have not issued any net new loans during the past two weeks. Commodities markets around the world are declining on fears that China will not require the vast amount of materials it has been importing for the past several years.
Whether this slowdown will continue is unknown, but the Chinese have usually been fairly quick to stimulate their economy in the past, so this time probably will be no different.