Category Archives: Derivatives

Rajiv Sethi: Market Overreaction – A Case Study

Yves here. While this post by Rajiv Sethi contains some important observations about valuation, I’d like to quibble with the notion that there is such a thing as a correct price for as vague a promise as a stock (by contrast, for derivatives, it is possible to determine a theoretical price in relationship to an actively traded underlying instrument, so even though the underlying may be misvalued, the derivative’s proper value given the current price and other parameters can be ascertained).

So How Much Did the Banksters Make on Libor-Related Ill-Gotten Gains?

Commentators and analysts have been starting to estimate what the costs to banks for their Libor manipulation might be. We’ve pointed to an estimate by the Economist that says the damages for municipal/transit authority swaps due to Libor suppression (during the crisis and afterwards) could be as high as $40 billion. Cut that down by 75% and you still have a pretty hefty number. Other observers (CFO Magazine) have argued that the losers were mainly other banks, and since banks are pretty much certain not to sue each other, the implication is the consternation is overdone. But these markets were so huge ($564 trillion was the 2011 trading volume in one contract, the CME Eurodollar contract, which uses dollar Libor as its reference rate) that even a little leakage to end customers still adds up to a lot of exposure.

Libor Investigation Extended to US Mortgages, but What About TALF Loans?

A good report by Shahien Nasiripour recounts that the OCC has woken up to what a hot potato the Libor scandal has become, and has identified the mortgages that might (stress might) have been hurt by the rate diddling.

To start with, the universe that might have been affected is not that large. Per the Financial Times account:

Another MF Global? Customer Accounts Frozen at Futures Broker PFGBest (Updated)

Another blow to what credibility is left in the futures brokerage business in the US may have come in the form of the failure of midsized commodities and foreign exchange broker PFGBest, which claimed to have roughly $400 million in customer assets. Although details are sketchy, the firm was may have been falsifying bank records; the founder of the firm tried but failed to kill himself.

Customer accounts were put on hold today and the firm is being liquidated. Per the Wall Street Journal (hat tip Deontos):

Yes, Virginia, the Real Action in the Libor Scandal Was in the Derivatives

As the Libor scandal has given an outlet for long-simmering anger against wanker bankers in the UK, there have been some efforts in the media to puzzle out who might have won or lost from the manipulations, as well as arguments that they were as “victimless” or helped people (as in reporting an artificially low Libor during the crisis led to lower interest rate resets on adjustable rate loans pegged to Libor; what’s not to like about that?)

What we have so far is a lot of drunk under the streetlight behavior…

Simon Johnson: JP Morgan at Risk if Euro Breaks Up

I’m surprised it has taken this long for Someone Serious to make the argument set forth in a new article by Simon Johnson at Bloomberg, which in short form says “You are dreaming if you think a European financial crisis stays in Europe.”

Johnson somewhat undercuts the urgency and importance of his article by working from the assumption that the eurozone dissolves back into its earlier configuration of one currency per nation. Economists and analysts have discussed other scenarios, such as a exit by Greece, which has the potential to precipitate contagion in Portugal, Spain, and Italy; an exit by Germany; a split into more economically homogeneous sub-groups (most likely north v. south). And Bloomberg refrains from putting the real sizzler in the headline: Johnson considers JP Morgan to be vulnerable and explains why.

Dimon Plays Humpty Dumpty to Congress

“When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master— that’s all.”

-Lewis Carroll, Alice in Wonderland

The House Financial Services Committee hearings on the losses in JP Morgan’s Chief Investment Office were an improvement over the Senate version, in that there was comparatively little fawning over Jamie Dimon and more earnest, even if not very successful, efforts to pry information from him.

Dimon Redux: Why Bank Risk-Taking = Risk Making

In case you haven’t had enough of Congresscritters lobbing softballs at Jamie Dimon, the JP Morgan CEO is appearing before the House Financial Services Committee on Tuesday. There have been a number of suitably scathing accounts of how members of the Senate Banking Committee fawned over Dimon.

As we wrote, Dimon took what is actually an indefensible position: that any bank risk taking should be permitted, so long as it will arguably do well when there is a crisis (watch for this to be broadened to merely be a bet to improve bank profits when its regular businesses are under stress). We pointed out that this logic would justify engaging in systemically destructive activities like the Magnetar trade, and that with government backstopping behind it to boot. And that is a bigger risk than it might seem at first blush.

Dimon Testimony Whopper: CIO’s Gambling on Disaster = “Portfolio Hedging”

Well, there’s nothing like seeing Jamie Dimon swinging for the fences. Dimon has taken his defense and turned it into an offense, in both senses of the word.

More on the Supposedly Out of Control JP Morgan Chief Investment Office and the “Fortress Balance Sheet”

Whocouddanode? As more and more tidbits leak out about the activities of the JP Morgan Chief Investment Office, it increasingly appears to be a unit that was inadequately supervised. While that revelation is a dent to the reputation of self-styled ubermensch and alleged control freak Jamie Dimon, if he takes a few lumps in the press and otherwise can carry on as before, what difference will it make to him and the industry? Lloyd Blankfein took at least as much heat over a longer period, and he’s still firmly in place.

The CEO “I’m in charge and I know nothing” defense is alive and well because it has proven to be so successful.

Serious Questions for Jamie Dimon in Occupy the SEC/Alternative Banking Senate Letter

As many readers may know, Jamie Dimon is on deck tomorrow before the Senate Banking Committee to explain how a soi disant hedge produced losses that are almost certain to exceed the $2 billion the bank has ‘fessed up to.

Tom Ferguson: How Wall Street Hustles America’s Cities and States Out of Billions

Yves here. While the municipal swaps fiasco may seem like old news, this piece discusses a post-crisis type of swap which is even more appalling. The old scam was to talk local and state authorities who would have been far better served with old-fashioned fixed rate financing into doing floating rate financing and entering into a series of swaps to get a fixed rate deal, with a supposed improvement in funding costs. The problem is that many of those floating rate deals were auction rate securities, and when that market failed in early 2008, the borrowers were doubly hosed. The ARS went to penalty rates. In addition, payments on the swaps often kicked up shortly thereafter (due to the slow-motion failure of monoline guarantors, which was the hidden trigger behind both events. The downgrade of the monolines de facto downgraded the municipality, which led to increased payments on the swaps).

The latest scam is more appalling. Municipal authorities would borrow fixed rate, then enter into a variable rate swap on the side. Earth to base, no responsible manager wants uncertain funding costs on a long-term capital investment. This is tantamount to the owner of a candy store borrowing money at a fixed rate from his bank to finance an expansion of his business, then betting at the racetrack to try to lower his costs. Not surprisingly, many of these swaps have proven to be costly time bombs.

By Tom Ferguson, Professor of Political Science at the University of Massachusetts, Boston. Cross posted from Alternet

Many powerful interests have jumped at the opportunity to use the crisis to eviscerate what’s left of the welfare state.

Michael Crimmins: What the Press Refuses to See in JP Morgan and MF Global Scandals

By Michael Crimmins, who has worked on risk management and Sarbanes Oxley compliance for major banks

Two former finance and political influence gods (Jon Corzine and Jamie Dimon) have tumbled back to earth. Yet, troublingly, the mythology that’s cowed the political establishment and the financial press for so long remains very much intact.

The FDIC Continues to Promote the Fantasy That It Can Resolve Megabanks

Due to being a bit under the gun before taking off for our holiday (I hope you all enjoyed the posts from Matt Stoller, Lambert, and the other guest writers), we didn’t address a May 10 speech by the acting FDIC chairman, Martin Gruenberg, on the FDIC’s current thinking on how to resolve so called systemically important financial institutions, or SIFIs. I’m turning to this despite the delay because I see some people who ought to know better, such as the normally solid John Hussmann, taking the FDIC”s claims at face value.