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The 2 Billion Dollar Loss By JP Morgan Is Just A Preview Of The Coming Collapse Of The Derivatives Market

When news broke of a 2 billion dollar trading loss by JP Morgan, much of the financial world was absolutely stunned.  But the truth is that this is just the beginning.  This is just a very small preview of what is going to happen when we see the collapse of the worldwide derivatives market.  When most Americans think of Wall Street, they think of a bunch of stuffy bankers trading stocks and bonds.  But over the past couple of decades it has evolved into much more than that.  Today, Wall Street is the biggest casino in the entire world.  When the "too big to fail" banks make good bets, they can make a lot of money.  When they make bad bets, they can lose a lot of money, and that is exactly what just happened to JP Morgan.  Their Chief Investment Office made a series of trades which turned out horribly, and it resulted in a loss of over 2 billion dollars over the past 40 days.  But 2 billion dollars is small potatoes compared to the vast size of the global derivatives market.  It has been estimated that the the notional value of all the derivatives in the world is somewhere between 600 trillion dollars and 1.5 quadrillion dollars.  Nobody really knows the real amount, but when this derivatives bubble finally bursts there is not going to be nearly enough money on the entire planet to fix things.

Sadly, a lot of mainstream news reports are not even using the word "derivatives" when they discuss what just happened at JP Morgan.  This morning I listened carefully as one reporter described the 2 billion dollar loss as simply a "bad bet".

And perhaps that is easier for the American people to understand.  JP Morgan made a series of really bad bets and during a conference call last night CEO Jamie Dimon admitted that the strategy was "flawed, complex, poorly reviewed, poorly executed and poorly monitored".

The funny thing is that JP Morgan is considered to be much more "risk averse" than most other major Wall Street financial institutions are.

So if this kind of stuff is happening at JP Morgan, then what in the world is going on at some of these other places?

That is a really good question.

For those interested in the technical details of the 2 billion dollar loss, an article posted on CNBC described exactly how this loss happened....

The failed hedge likely involved a bet on the flattening of a credit derivative curve, part of the CDX family of investment grade credit indices, said two sources with knowledge of the industry, but not directly involved in the matter. JPMorgan was then caught by sharp moves at the long end of the bet, they said. The CDX index gives traders exposure to credit risk across a range of assets, and gets its value from a basket of individual credit derivatives.

In essence, JP Morgan made a series of bets which turned out very, very badly.  This loss was so huge that it even caused members of Congress to take note.  The following is from a statement that U.S. Senator Carl Levin issued a few hours after this news first broke....

"The enormous loss JPMorgan announced today is just the latest evidence that what banks call 'hedges' are often risky bets that so-called 'too big to fail' banks have no business making."

Unfortunately, the losses from this trade may not be over yet.  In fact, if things go very, very badly the losses could end up being much larger as a recent Zero Hedge article detailed....

Simple: because it knew with 100% certainty that if things turn out very, very badly, that the taxpayer, via the Fed, would come to its rescue. Luckily, things turned out only 80% bad. Although it is not over yet: if credit spreads soar, assuming at $200 million DV01, and a 100 bps move, JPM could suffer a $20 billion loss when all is said and done. But hey: at least "net" is not "gross" and we know, just know, that the SEC will get involved and make sure something like this never happens again.

And yes, the SEC has announced an "investigation" into this 2 billion dollar loss.  But we all know that the SEC is basically useless.  In recent years SEC employees have become known more for watching pornography in their Washington D.C. offices than for regulating Wall Street.

But what has become abundantly clear is that Wall Street is completely incapable of policing itself.  This point was underscored in a recent commentary by Henry Blodget of Business Insider....

Wall Street can't be trusted to manage—or even correctly assess—its own risks.

This is in part because, time and again, Wall Street has demonstrated that it doesn't even KNOW what risks it is taking.

In short, Wall Street bankers are just a bunch of kids playing with dynamite.

There are two reasons for this, neither of which boil down to "stupidity."

  • The first reason is that the gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as "weapons of mass destruction." And those weapons have gotten a lot more complex in the past few years.
  • The second reason is that Wall Street's incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else—the government or shareholders—covers the downside.

The second reason is particularly insidious. The worst thing that can happen to a trader who blows a huge bet and demolishes his firm—literally the worst thing—is that he will get fired. Then he will immediately go get a job at a hedge fund and make more than he was making before he blew up the firm.

We never learned one of the basic lessons that we should have learned from the financial crisis of 2008.

Wall Street bankers take huge risks because the risk/reward ratio is all messed up.

If the bankers make huge bets and they win, then they win big.

If the bankers make huge bets and they lose, then the federal government uses taxpayer money to clean up the mess.

Under those kind of conditions, why not bet the farm?

Sadly, most Americans do not even know what derivatives are.

Most Americans have no idea that we are rapidly approaching a horrific derivatives crisis that is going to make 2008 look like a Sunday picnic.

According to the Comptroller of the Currency, the "too big to fail" banks have exposure to derivatives that is absolutely mind blowing.  Just check out the following numbers from an official U.S. government report....

JPMorgan Chase - $70.1 Trillion

Citibank - $52.1 Trillion

Bank of America - $50.1 Trillion

Goldman Sachs - $44.2 Trillion

So a 2 billion dollar loss for JP Morgan is nothing compared to their total exposure of over 70 trillion dollars.

Overall, the 9 largest U.S. banks have a total of more than 200 trillion dollars of exposure to derivatives.  That is approximately 3 times the size of the entire global economy.

It is hard for the average person on the street to begin to comprehend how immense this derivatives bubble is.

So let's not make too much out of this 2 billion dollar loss by JP Morgan.

This is just chicken feed.

This is just a preview of coming attractions.

Soon enough the real problems with derivatives will begin, and when that happens it will shake the entire global financial system to the core.

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  • Johnney Rotten

    If only the general public knew that Rome is burning all around us in all the financial markets sectors we could make a plea bargain to the political powers to do something. Returning to Glass- Steggal Act is something worth considering. Some of the blogs on here adhere to the bailout method forever. This is not working but making the situation worse. We are in for a long hard ride America. Hold onto your saddle because this is going to be a rough one on the long slide down the hill to financial ruin. The point is this administration is orchestrating this. The Chinese are now going to set up shop as US Banks and the currency of the country will be recognized on world markets. What is Timothy Gietner thinking? Why is he doing this? To support the rapidly deflating value of the dollar? To make good on increasing the debt limit. I think both.

  • I am Tyler Durden’s contempt for the system

    “when the music’s over, turn out the lights.” -The Doors

    Someone didn’t turn out the lights, but the music that is fiat currency, capitalism based on it and insurmountable debts is O-V-E-R…

    Get ready to fight over meat on the streets…

    • Gary2

      sounds like you have the “Road House Blues”

  • Evie

    Realistically whete we are at now. The corporations raising prices on merchandise there is no demand for. Currency and debt swaps. Wow the citzen has no say so just pick up the bill? But whos bill? Banks think everyone owes them thousands? Um for what product or service? Corporate greed!

  • Nina
  • Neo1

    Time to starve the bastards with Lawful Money, cannot be fractionalized.
    You will pay No income tax on it. It becomes Tax Free Money.
    http://www.stormthunder.com

  • Agent P

    ‘Strong $Dollar’…? The rinse/repeat cycle can only be done so many times before the fabric of the clothes inside the washing machine disintegrate. We act as if we are our own little planet – just U.S. and our ‘strong dollar’, that Everybody is going to run to when panic ensues. Remember, we’ve been down this ‘rinse/repeat’ cycle of ‘running to U.S. $Treasuries’ a few times now since 2008. Do mistake previous inclinations as a lock on future decisions by large holders of U.S. $debt. Especially when a ‘strong dollar’ hurts our export model in a beggar-thy-neighbor world, and many of these $USD ‘buying’ countries are vigorously purchasing land, mines, gold and many other REAL assets around the world.

  • Dr. Nancy

    All the craziness
    that’s happening
    in the economy
    is predictable, as

    there are 7 stages that every
    major economy goes through.

    Those who know how it works
    profit & wealth
    is transferred to them.

    Several months ago
    I learned this information
    from a millionaire

    His free video-

    “The 1 Investment the Top 1% Are Betting On for the
    Coming Economic Collapse”

    is at:

    http://theelevationgroup.net/presentation/register.php?a_aid=160667&a_bid=e6b01db8&chan=y

    Hope this info helps you as much as it has me

    • Paul

      Thanks for the infomercial Dr. Nancy.

  • Nowhereman

    Trilions of dollars..orders of ten to the 14!! 10^14 bucks..where in the world IS that money..numbers in a computer..no wonder the world finances are in collapse. The money doesnt exist. Cant account for it in gold or silver..where is it?

  • J

    I can’t believe Obama has a “Private Client Asset Management Checking Account” with JP Morgan.

    http://news.yahoo.com/blogs/ticket/obama-financial-forms-show-big-jp-morgan-account-213119081.html

  • http://www.infinitedangers.com Gary Yantis

    It is no coincidence Jamie Dimon is also a director of the NY Federal Reserve Bank. The bank of which the directors will vote to print print print to bail bail bail keeping banks and the likes of Dimon intact, rich and out of jail no matter how much they impoverish the American people and wreck the world economy.

    Dimon until recently was an advisor to Obama – no one has said that. How about Corzine? He was scheduled to become Secretary of the Treasury! ALL world class crooks!

    “Too big to fail”. New slogan “Too Big To Arrest”.

    Look up fascism in dictionary. fascism does NOT equal Hitler. It is the marriage and monopoly of REALLY Big Business with Big Government supposedly for “the greater good” but actually to enslave the 99.9% who are not in this criminal cabal of elite thieves.

    Back to Dimon: conflict of interest? No, of course not. Have a vote to save yourself? He will vote to save the country instead. Hey, pigs do fly! Just saw one!

    BTW – have you noticed Big Business is beginning to turn toward Romney with their big campaign bucks? They see the future.

  • http://theeconomiccollapseblog.com/archives/the-2-billion-dollar-loss-by-jpmorgan-is-just-a-preview-of-the-coming-collapse-of-the-derivatives-market tom cook

    I have children and they had rules. I made them follow the rules. I was not liked at times. The people that make investments have rules and they need to be held to the rules!!!! Our government needs to step up as and hold them to the rules that are there. If they can not do the job or do not want to make them follow the rules!!!!!!!!!!

  • Luke

    I do not have a college education. Growing up I was poor and had no money for college so I got a round trip (I hoped) ticket to Vietnam. But when I returned from Vietnam I figured out that I did need to go to college to learn. So I started to read. So now here I sit with my home paid for. I am debt free. I have 25 acres which connects to Federal land, 25,000 acres. I have a tractor and I have so much gold and silver I can in no way pick it up. I have a free flowing creek 100 ft from my front door. I have four AK-47 and over two thousand round of ammo. I knew this thing was going to pop and I am going to be sitting nice. See what I found out by reading?

  • BFH

    The constant wondering if an improved housing market, lower fuel prices, etc is a joke. Here is the bottom line. NOTHING will make the economy better in the long run. You can survive with the kind of debt this nation is in. 15.87 Trillion and 16.4 in six months or so. They cannot kick the can down the road but so far. That’s when the wheels will fall off and no recovery of any segment of the economy will help even short term. The stage is set people. Stop hoping for short term recovery and start planning for long term depression.

    • BFH

      (Corrected) The constant wondering if an improved housing market, lower fuel prices, etc will help rebound the economy, is a joke. Here is the bottom line. NOTHING will make the economy better in the long run. You cannot survive with the kind of debt this nation is in. 15.87 Trillion and 16.4 in six months or so and even higher beyond that. They cannot kick the can down the road but so far. That’s when the wheels will fall off and no recovery of any segment of the economy will help even short term. The stage is set people. Stop hoping for short term recovery and start planning for long term depression.

  • Max Goldberg

    See what I found !! Gold Price Chart – Live gold spot prices http://www.sh1ny.com

  • http://goodstocktrading.com Roger heartz

    This article was published in May. Now slightly less than half a year later, JPM is 20% higher, as is the rest of the market.
    Things may be a bit bearish now, but I think your prediction was a bit premature.

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