Saturday, May 23, 2009

Martin Weiss: JPMorgan (and 14 other banks) will fail "objective" stress test

In his usual -let's try to freak everyone out to get more news letters out- style Martin Weiss gives this fairly dry but nevertheless worthwhile talk at the National Press Club. Below is the "press release" and the video link. A few highlights:
  • Bernanke's original prediction: expect $100 billion of losses at banks
  • IMF current estimate of actual losses is $1 trillion and further losses of $3 trillion.
  • 15 of the 19 institutions would fail the "objective tests"
  • His big focus is on JPMorgan, given their massive derivatives activity
  • He also slams Citi and Wells on their loan portfolios and super-regionals on their exposure to commercial real estate.
With regard to JPM, Weiss points to their counterparty exposure to other firms via derivatives positions. He seems somewhat fixated on that issue, putting JPM at the center of his "storm". It's worth exploring this issue a bit further.

The concern would be that those derivatives trades that are profitable (winning bets) or may become profitable in the future, are effectively loans by JPM to other firms. Simply put, if you make a bet with someone and win, but the other person doesn't have to pay you right away, you effectively have a loan out to the other person. Thus the size of JPM's "loans" to other firms is massive.

However what Weiss fails to mention is JPM's ability and willingness to call for and collect margin. A counterparty failure should not be a serious issue for JPM as their trading partners would generally post margin on trades that are profitable for JPM (while JPM would post to others on trades that have lost money for them). This is similar to the way futures exchanges have been operating (Chicago Mercantile Exchange for example began in 1898) in some of the most volatile markets without major issues.

As a great example of this, JPM's losses on derivatives due to hedge fund failures have been immaterial -all due to these margin mechanics.

Well, Dr. Weiss, JPMorgan may have other problems - we don't think derivatives is one of them.

The video link

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