Thursday, January 15, 2009

J.P. Morgan's earnings

JP Morgan is the best house in the worst neighborhood, but let's take a look at a JP Morgan derivative brochure.

Third, credit derivatives, except when embedded in structured notes, are off-balance sheet instruments. As such, they offer considerable flexibility in terms of leverage. In fact, the user can define the required degree of leverage, if any, in a credit investment.

The appeal of off- as opposed to on-balance-sheet exposure will differ by institution:The more costly the balance sheet, the greater the appeal of an off-balance-sheet alternative. To illustrate, bank loans have not traditionally appealed as an asset class to hedge funds and other nonbank institutional investors for at least two reasons: first,because of the administrative burden of assigning and servicing loans; and second, because of the absence of a repo market. Without the ability to finance investments in bank loans on a secured basis via some form of repo market, the return on capital offered by bank loans has been unattractive to institutions that do not enjoy access to unsecured financing. However, by taking exposure to bank loans using a credit derivative such as a Total Return Swap (described more fully below), a hedge fund can both synthetically finance the position (receiving under the swap the net proceeds of the loan after financing) and avoid the administrative costs of direct ownership of the asset, which are borne by the swap counterparty. The degree of leverage achieved using a Total Return Swap will depend on the amount of up-front collateralization, if any, required by the total return payer from its swap counterparty

Now we know that JPM now quit selling derivatives to municipalities, since they appeared to engage in bid rigging, price fixing and anti-competitive practices, and they also appeared to screwing the municipalities with their "derivatives".

But it just wasn't municipalities, it was school boards. Remember the fees hidden in the swaps that school boards didn't know about?

The 81-year-old Roosevelt Middle School was on the verge of being condemned. The district was running out of money to buy new textbooks. And the school board had determined that the 100,000-resident community 125 miles north of Pittsburgh couldn't afford a tax increase. Then JPMorgan Chase & Co., the second-largest bank in the U.S., made Barker an offer that seemed too good to be true.

David DiCarlo, an Erie-based JPMorgan Chase banker, told Barker and the school board on Sept. 4, 2003, that all they had to do was sign papers he said would benefit them if interest rates increased in the future, and the bank would give the district $750,000, a transcript of the board meeting shows.

``You have severe building needs; you have serious academic needs,'' Barker, 58, says. ``It's very hard to ignore the fact that the bank says it will give you cash.'' So Barker and the board members agreed to the deal.

What New York-based JPMorgan Chase didn't tell them, the transcript shows, was that the bank would get more in fees than the school district would get in cash: $1 million. The complex deal, which placed taxpayer money at risk, was linked to four variables involving interest rates. Three years later, as interest rate benchmarks went the wrong way for the school district, the Erie board paid $2.9 million to JPMorgan to get out of the deal, which officials now say they didn't understand.

How about synthethetic CDO's that blew up that JPM sold to farmers in the Australian outback?

How about the Power Reverse Dual Currency Notes that JP Morgan sold to blue haired savers in Japan?

JPM talked about their "fortress balance sheet" in today's earnings. If they have a fortress balance sheet, it didn't come about from just beating up municipalities, school boards, farmers and blue haired ladies. That was just the gravy for the investment bankers.

It was from the value of their franchise, (largess from the Federal Reserve and Treasury) and their derivative book, of which JP Morgan's is the biggest on the street.

And since we can't see their derivative book, JPM's biggest asset, is the goodwill that Wall Street enamored it with.

Even though they beat up school boards, municipalities, old ladies and farmers to get the extra juice.

Maybe that's the business that Dimon was referring to yesterday in the Financial Times, when he said that it "is clear that some of those markets will never come back."

But with the collapse of Citi and Bank of America, the money has to go somewhere, even if it's the neighborhood bully with the silver tongue!

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