Sunday, May 13, 2012

JP Morgans' Stock Value Loss Far In Excess Of Trading Loss: Market Fear Of Government Response Likely Cause

The dollar amount of JP Morgan Chase's derivative hedging trading loss alone did not justify the drop in the bank's share price in the stock market. JP Morgan Chase lost 9.3 percent, $14.4 billion, of its stock market value on the announcement of a one time trading loss of $2.3 billion. The one time trading loss is about a half percent of its managed investment portfolio, 1 percent of the bank's net worth and 10 percent of last years pre-tax earnings. The bank is substantially solvent after the losses and the trading losses do not affect its future earning power and financial outlook. The other financial entity counterparties, banks, hedge funds, etc., to JP Morgan Chase's derivative trades will realize the gains equal to the bank's losses. Derivatives are a zero sum financial instrument. One investor's losses are another's gain. It is unlike the housing crisis where the decline in home values affected the mortgage collateral of all financial institutions negatively.

It is also unlikely that there are more hidden losses at the bank.

Governmental, regulatory and legislative overreach are the major risk factors affecting financial institutions these days after an unexpected trading or earnings loss. The fear of governmental dysfunctional and chaotic intrusion into the banking business of targeted financial institutions is the lasting legacy of the government's response to Bear Stearns, Lehman and AIG. It is my guess that the eagerness of the government to micromanage business when an opportunity arises, especially the financial business, is the reason behind the stock market value decline far in excess of the trading loss at JP Morgan Chase. Government intrusion into business reduces decision making responsiveness, management flexibility, increases costs and consequently reduces the profitability and value of the business.

From The Wall Street Journal, "Bank Order Led to Losing Trades: J.P. Morgan's Efforts to Shield Itself From European Market Fallout Prompted Disastrous Bets" by Dan Fitzpatrick, Robin Sidel And David Enrich:
The instructions were to find a way to reduce the bank's exposure to positions in the credit markets that had grown too large. But some of the trades they made didn't work, culminating in the company's announcement Thursday of more than $2 billion in losses.

The trading losses reverberated Friday, as J.P. Morgan shares fell 9.3%, or $3.78, to $36.96 in New York Stock Exchange composite trading at 4 p.m., erasing $14.4 billion in stock-market value.
The trading losses—$2.3 billion, according to a person close to the bank—accumulated over just 15 days in late April and early May, or an average of $153 million a day. The chief investment office managed a securities portfolio worth about $374 billion.
Several teams were assigned to review the positions, and they discovered the trading mistakes. These ranged from errors in how the bank hedged an existing hedge to how it offset the size of an existing trade that served to protect the bank, said people familiar with the situation.
One trader estimated more than a dozen hedge funds and banks profited by taking the other side of J.P. Morgan's trades.

From Brookings, "Putting JPMorgan Chase’s $2 Billion Loss in Context" by Douglas J. Elliott:
Although I am disturbed by the loss, both as a citizen and as a former employee of JPMorgan, it is also important to keep the loss in context. $2 billion is a large number, but it represents less than a tenth of last year's pre-tax earnings for the company, roughly a hundredth of the $189 billion of the firm's net worth, and about one-thousandth of its $2.3 trillion of assets.

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