Late last week, the financial markets were rocked with the announcement that the biggest, and heretofore assumed most stable US bank, J.P. Morgan, lost $2 billion in recent months. The $2 billion was especially of concern, since it was the outcome of what is euphemistically called ‘trading’ by the industry – a term which more accurately should be called by its true nomenclature: speculation in high risk financial securities. In other words, the kind of investing that set off the previous global financial crisis in 2007. The $2 billion losses were apparently attributed to derivatives trading, specifically ‘credit default swaps’, a particularly volatile form of derivatives.
But what is more serious than just the $2 billion in losses by J.P. Morgan is that the loss is likely just a tip of the iceberg. More news of losses is undoubtedly yet to come. And it probably won’t be limited just to J.P. Morgan. Other investment banks (Morgan Stanley, Goldman-Sachs, as well as various Euro investment bank counterparts) are also likely in a similar position. Hardly noticed last week when the J.P. Morgan news broke, for example, was the almost simultaneous announcement that one of the big three French banks, Credit Agricole, had a 75% drop in revenues.
What has also been conspicuously missing in most public commentary thus far concerning the J.P. Morgan losses is what is the source of the $2 billion derivatives-credit default swap losses? What specific speculative CDS trades lay behind the $2 billion? Was it speculation in global commodities – which have recently gone bust? Was it gold futures speculation? Oil futures insurance contracts? Or perhaps European periphery states’ (Greece, Spain, Portugal, Italy, Ireland, Latvian, etc.) sovereign debt CDSs? Or was it CDS ‘bets’ placed in US markets or Brazilian or other currencies? European securities speculation is the most likely source, given that J.P. Morgan’s big trader – sometimes called the ‘London Whale’ appears responsible for much of the $2 billion in losses.
It has been generally under-reported by the US press, but banks all across Europe are contracting their lending sharply. Is that because of Greece? Spain? Or does that story have something similar to do with the J.P. Morgan losses? Whatever, the contraction in bank lending now accelerating in Europe all but guarantees that the Euro recession now underway will be more deep and protracted than official forecasts. The Euro banks are in serious trouble. Continuing austerity policies and deepening recessions across Europe – and bona fide depressions now emerging in the southern European periphery – will result in bank problems even more severe than at present over the next twelve months.
The Euro banking problem began to emerge late last year, 2011. However, it was temporarily postponed by the European Central Bank, the ECB, pumping trillions of Euros (worth roughly $1.30 each) into the Euro banks. This has served to buy the Euro banks some time, measured in months not years, so that the major European governments, led by Germany and France, together with their bankers can come up with a more generous and longer term bank bailout program. Europe is not in a sovereign debt crisis. The real crisis lies more fundamentally in the Euro banking and monetary systems. The southern tier states—and soon others in the north—have a sovereign debt crisis only because the banks, the northern banks especially, pumped vast sums into the southern tier economies over the past decade.
The north did so not for altruistic reasons, but to make money off of booming southern real estate speculation. As the southern tier economies’ GDP surged due to a false, speculative driven real estate boom, the northern banks lent even more to governments to help build out those economies’ infrastructure to accommodate the real estate boom. Some of that secondary lending was distributed by their governments to the rest of their society in the form of social spending. So the ‘sovereign debt crisis’ created is really secondary to the real-estate driven speculative investment boom ‘gone bad’. Sound familiar to all you US folks? Real estate speculation driving banking crises and government deficits and debt?
What happened with J.P. Morgan last week—and is still yet to happen further with J.P. as well as with other US banks—also shows how deeply the US banking system is integrated with the European. J.P’s losses are Euro-centered, speculation driven, and CDS and other derivatives based.
That means what’s been happening in Europe and its banking system is not isolated from the U.S. banks. Today’s emerging European bank crisis—the second globally since the first in 2007-09 centered in the U.S.—will have a significant impact on the U.S. And it follows that if a second banking crisis emerges on both sides of the Atlantic, a second general recession will follow on both sides as well. The European side has already begun. European economies are already well down the road of that recession. And there’s no way the U.S. economy, despite all the false hype about another recovery now occurring in the U.S. (the third such since 2009), cannot avoid a further downturn as well.
The Euro bank crisis has begun to spread its contagion to the U.S. banking system, as last week’s J.P. Morgan losses—centered in Europe and in the latter’s speculative markets—now clearly shows. Watch for more bad news to come on both sides of the Atlantic.
The roots of the two banking crises are similar. In the U.S. in 2007 it was speculative excesses that brought down the ‘shadow banks’ first, in particular the investment banks and insurance ‘banks’, like AIG, Bear Stearns, Lehman Brothers. But the big commercial banks were linked by derivatives speculation with their ‘shadow’ cousins. They too were dragged down, as was the almost entire financial system in the U.S. Lending to non-banks and consumers collapsed, as then did the rest of the economy.
The solutions introduced to the 2007-09 banking crisis by the U.S. Federal Reserve, the central bank of the U.S., and the Obama administration in 2009, did not resolve the fundamental problem of US bank instability. Massive amounts of bank ‘bad assets’ still remain on U.S. banks’ balance sheets. The Obama-Fed solution in 2009 was not the outcome of the then official programs introduced by the Obama administration to bail out the banks in 2009—i.e. the PIPP, TALF, and HAMP programs. Those programs were dead on arrival within a few months. The solution in 2009 was the Federal Reserve’s pumping of $9 trillion in liquidity injections into the banks, to offset the banks’ massive balance sheet losses. But the bad assets were not removed thereby. The black hole of losses was merely temporarily filled up by the Fed’s injection of trillions. That was supposed to result in the banks’ lending to non-bank businesses once again. But they didn’t. And they still aren’t, except for only the very largest and stable companies. Small and medium enterprises are still starving for funds. Investment and hiring is still a dribble and much less than the anticipated traditional ‘trickle down’.
The real program to bail out the banks in 2009 by the Obama administration also included a series of phony ‘stress tests’ to convince the public the banks were now ok. That was designed to get the public to buy bank stocks and restore badly needed bank capitalization. Congress and the administration then further allowed the banks to falsely report their balance sheet results, by suspending ‘mark-to-market’ accounting (true market value of assets) and by letting the banks falsely report their real financial situation. Not least, the administration and the Fed then allowed the banks to turn to speculative investing once again, in particular derivatives and other risky financial instruments—all at the same time they were promoting financial “regulatory reform.”
Last week’s J.P. Morgan loss is the inevitable consequence of the phony 2009 bailout of the US banks by the Fed and the Obama administration (and the even phonier Dodd-Frank financial regulation Act that followed). J.P. Morgan clearly illustrates the consequences of the Fed’s $9 trillion injection of free money into the banks, the phony stress tests that covered up the real situation, and the giving of free rein to the banks to engage in high risk speculative investment in CDSs and other financial instruments.
Initially derided by the Europeans back in 2009-10, the same U.S. bailout approach has been followed in Europe since 2010. After having initially described the U.S. Federal Reserve’s ‘bank stress tests’ of 2009 as “a joke”, Europeans have followed suit with similar cover-ups of the true conditions of their banks in 2011. The European Central Bank, ECB, subsequently followed in the footsteps of the U.S. Fed last year and started pumping trillions in liquidity injections, free money well below market rates, into their banks in order to try to buy time until a larger collective Euro bailout plan was developed. That plan, however, is being rolled out piecemeal and is still not fully defined or implemented.
The Federal Reserve’s policy of injecting trillions of dollars of ‘free money’ into the banking system in the U.S. is called ‘quantitative easing’(QE). It has had two and a half iterations thus far, with a third on the horizon as the US economy weakens. However, the Fed’s QE policy has not resulted in a sustained recovery of the U.S. economy. All that the Fed’s QE programs have accomplished has been to provide free money to the banks (at 0.1% borrowing rates). The banks borrowed the free money, or were paid full purchase price by the Fed on their market devalued bonds. Banks then took the free money and mostly lent it to speculators like Hedge Funds, or speculated themselves directly, in credit default swaps and other derivatives, in foreign currency markets, in commodities markets, etc. In other words, the massive free money bailouts by the US central bank only resulted in even more speculation by the banks. Is anyone surprised finally by J.P. Morgan’s credit default swaps and other speculative losses now emerging?
The ECB has recently gone down the same path as the Fed with its own version of QE to keep the Euro banks from collapsing. But the result will be no different in Europe than it has been in the U.S.: the euro banks may be temporarily ‘bailed out’, but no permanent solution has been undertaken. No real banks’ bad assets have been removed, bank lending to all but speculators and well-heeled big corporations will continue to decline longer term, household consumption in Europe will continue to decline, and all the rest.
Like austerity solutions on the fiscal side, quantitative easing on the monetary side produces no basic long run results and recovery—but to the contrary only makes the economy worse.
Europe is now repeating the errors of US central bank policies since 2008, just as the US after the November elections will, this writer predicts, repeat the European fiscal errors of austerity—that is, deep deficit cutting. The two economies will in turn likely exacerbate each other’s weakening economic condition in 2013.
The real solutions to the parallel failures of fiscal and monetary policies in both the U.S. and in Europe today require basic restructuring of the banking systems in both economies. The solution to the banking crisis—whether in Europe or the U.S.—is not further free money, massive liquidity injections by central banks. The solution is to create a broad ‘utility banking system’ for consumer households and small businesses. The solution is a thorough restructuring of the mission and monetary tools of the central banks and their complete democratization. The solution is not to abolish the Federal Reserve, as simplistic conservative ideology now proposes, but to fully democratize the Fed in order to make it responsive to the needs of Main St. and not an appendage of Wall St.
On the fiscal side, massive fiscal spending is required—financed not from deficits but from a fundamental restructuring of the tax system. But unlike proposals from liberal mainstream economists, it is not sufficient simply to spend more on fiscal stimulus. It is not just a question of magnitude of spending. It is a question of the composition and timing of that spending, as well as measures to remove household debt and regenerate household real incomes once again.
Jack Rasmus, copyright May 2012
Jack is the author of “Obama’s Economy: Recovery for the Few”, released this past April 2012, published by Pluto Books, in which a more detailed critique of fiscal-monetary policies of recent years is undertaken and an ‘Alternative Program’ for recovery is described. His website is http://www.kyklosproductions.com
Should financial corporation debt be limited? That is, credit bubbles fuel unsustainable, maybe toxic growth. Debts are claims on future income, but if income is not growing relative to debt, and the balance between productivity gains and household income gains is broken, then growth in loan debt is just a recipe for disaster? This also creates the huge inequalities of income and wealth, which leads to pure speculation or gambling in the financial sector, as real productive investment disappears.— there are fewer purchasers and productive investment becomes less attractive. As you know, in 1970 the total corporate debt was 10% of GDP, and in 2007 it was116% of GDP, this from The Great Financial Crisis by Magdoff and Foster, page 121. And Epic Recession, page 220, shows that Financial Business debt was 38% of all US debt in 2008, up from 11% in 1978. I just read Andrew Sum’s Jan 2011 article in Huffington Post summarizing the 2000 to 2010 period, slowest GDP/capita growth since the 1930s, 7% for the decade, with a net loss in private sector employment even though the working age population grew by 25 million.
I’m doing my homework. I looked at the BEA figures for GDP in 1978 and 2008, I found that the ratio of total domestic debt to GDP changed — total US domestic debt was 1.58 times greater than GDP in 1978, and in 2008 total debt was 3.55 times greater. Financial debt grew from 11% of all debt to 38% of all debt. Government debt decreased from 29% of all debt to 17%; non-financial corporate debt fell from 33% of all debt to 23%; and consumer debt fell from 30% of all debt to 23% — using figures from Epic Recession, page 220, drawn from Flow of Funds Accounts, Fed Reserve. June 2009. I would like to see this as a graph. Thanks for stimulating my curiosity. A glance at A. Sum’s article, #2, http://www.huffingtonpost.com/andrew-sum/ringing-out-the-lost-econ_b_805426.html — shows median real weekly income of full-time workers grew by 2% between 2000 and 2010, productivity by 29%, corporate profits by 58%. In a nutshell, when combined with debt growth — disaster for the economy.
Two qualifiers as you do your further research: the government debt of course does not include state and local government debt. And the median weekly real income is for full time only. Total real income will be significantly less if part time workers are included, a number which rose from 2 million in 2007 to between 8-9 million in recent years. And that real income is further reduced for production and service non-supervisory workers, a subset of the total. (and even more if you count the number of workers who left the labor force and who now have ‘no income’, reducing the working age population average even further. Non of these latter adjustments are typically undertaken in the data analyses. In other words, the real numbers for real median weekly income for the non-management working population is much lower still….
Jack Rasmus
I’m confused by even the opening paragraph of this article. I simply cannot understand why after correctly identifying the losses as being due to derivatives linked to indices of credit default swaps does the article meander off to speculate on other completely unrelated markets and products as being potential sources of the loss. To me this either reflects a fundamental misunderstanding of the CDS market or is an attempt to deliberately conflate two or more unrelated events. It’s not as if very precise details of the loss-making trades are not publicly available. So have to wonder why would someone engage in ideal speculation about commodities, gold, oil, European sovereign debt etc. if not to somehow relate the specific JP Morgan loss to otherwise unrelated market events and from there draw a series of overreaching conclusions.
It is also patent nonsense that the JP Morgan losses is evidence of the European banking crisis spreading to US markets as even a basic reading of the nature of the losses and where they were located would indicate.
But what I suppose should expect from an article that boldly claims that “the Euro banking problem began to emerge late last year, 2011.”
We can agree you are confused. So let me try to clear up your confusion. First, my claim that the Euro banking problem began to emerge late last year refers to the massive liquidity intervention by the ECB of more than $1 trillion since then. That was targeted to support the EU banking system and its anticipated losses coming in 2012. I’m sure you can agree that that ‘QE-like’ liquidity injection was for the banks.
Ok, next point. JPM’s losses are largely concentrated in Europe and in speculative ‘trades’ involving derivatives. While the initial $2 billion in JPM losses reported (now, a week later, up to $5 billion and rising) were associated with CDSs, it is becoming clear as the story unwinds that JPM’s Chief Investment Office (CIO) has been buying up various kinds of derivatives and risky assets (CDOs, etc.) in the Eurozone and US for more than three years. Its CIO europe portfolio of risky assets exceeds over $150 billion. How much of that is at risk will soon be revealed in Congressional hearings. JPM has been clearly chasing speculative profits in the EU area big time. JPM’s eventual losses will likely total well over $10 billion. If you think those losses wont impact other sectors of the banking system (in US or UK where JPM’s trades acquired 45% of UK mortgage securities) you are mistaken. As comparison, recall that AIG’s 2008 losses were about $30 billion; and Deutschebank was shaken by losing only $1 billion in derivatives trading losses. We’re looking at JPM’s CIO portfolio worth $150 billion. We’ll see how much of that is at significant risk in the coming weeks.
The financial markets are betting it’s significant. Look what’s happened to the equity markets this past week. That’s primarily bad news on Eurobanks in Spain, Italy (and again in Ireland) plus the JPM news.
The connections between derivatives trading losses and other commodities trading is the chasing of speculative investing opportunities once again post-2008 crash. The markets are not unrelated. And you’re wrong when you say ‘It’s not as if loss making trades are not publicly available’. They aren’t. CDS trading is opaque and the banks and very high net worth investors want to keep it that way. Derivatives, commodities futures, currency trading are all examples of the shift to speculative investing in financial instruments that is destabilizing the global financial and economic system. It led to the crashes of 2007-08. Instead of stopping the excesses, US, UK and other governments injected massive liquidity to cover the banks’ (and shadow banks) losses, and then turned around and allowed them to ‘recapitalize’ via speculative trading once again. Dodd-Frank was supposed to stop it eventually, but it’s been picked apart and remains a legislative-regulatory joke. The governments’ decisions to allow the speculation to re-occur was to avoid having to pump even more taxpayer money into the banks. Trading (speculation) was to help banks quickly recover profits, raise their stock prices and recapitalize on their own. It partly worked, but it led once again to speculative excesses and the JPM is but the tip of that iceberg.
The commodities boomlets of the past three years were stoked by three QE events of the Federal Reserve. So too were the equity markets and the derivatives trading excesses. So there are connections, and it’s not ‘meandering’. You fail to see the broader connections between the speculation, government policies, liquidity injections by central banks, and the integration between the balance sheets risk of the US and UK-Euro bank sectors. Just as the banking institutions are integrated, so too are their markets and products. Major losses by JPM in Euro markets will (and are already) reverberating in the U.S. Further problems by EUro periphery banks (and the French big 3 banks) are part of the Euro financial crisis picture. There are connections between Euro bank and sovereign debt crises, JPM’s speculating in securities related to them, and the JPM losses that are now shaking confidence in US banks. The latter have for three years already not been lending to SMEs and will now tighten up on lending further, thus providing yet another source for the hesitant US recovery. Try to see the bigger picture and connections between institutions, policies, markets and even financial products. (You might try to read my 2010 book, EPIC RECESSION: PRELUDE TO GLOBAL DEPRESSION, that predicted the lack of recovery in the US and a second banking crisis that would emerge in Europe, leading to two or more sovereign defaults and a collapse eventually of the Euro approaching parity with the dollar.
“We can agree you are confused. So let me try to clear up your confusion. First, my claim that the Euro banking problem began to emerge late last year refers to the massive liquidity intervention by the ECB of more than $1 trillion since then. That was targeted to support the EU banking system and its anticipated losses coming in 2012. I’m sure you can agree that that ‘QE-like’ liquidity injection was for the banks.”
Smart answer but totally avoiding the issue I’m afraid. My comment about being confused was in light of your idle speculation about the source of the losses when it is abundantly clear where they actually arose – more anon.
I know exactly when the Euro banking problems emerged and it was long before late 2011. I only quoted your exact words in my comment, no more and no more less. You seem to be associating one belated policy response to the emergence of the problem. I know your focus in September 2008 (and since?) may have been on domestic US financial issues but as an Irish taxpayer I can tell you that the problems have been around for a while. If you want I can provide you some information on these problems. (As an aside, which Irish banks were you referring too when you referenced events in the equity markets last week?).
It’s nice also that your response to my comment only reinforced the accuracy of my initial speculation. In your initial piece you stated “What has also been conspicuously missing in most public commentary thus far concerning the J.P. Morgan losses is what is the source of the $2 billion derivatives-credit default swap losses?” This is simply untrue. And likewise you were incorrect to state that “And you’re wrong when you say ‘It’s not as if loss making trades are not publicly available’. They aren’t.” I would point you to:
http://ftalphaville.ft.com/blog/series/jpm-whale-watching-tour/
http://www.zerohedge.com/news/irony-101-or-how-fed-blew-jpmorgans-hedge-22-tweets
as only some of the public commentary on the precise details of the trade in question. Given that this information is available and given that the CDS losses could not be linked to commodities, gold futures, oil futures insurance (?) contracts, and that the trade had obviously nothing to do with ‘European securities speculation’, I could only conclude that you were attempting to create an artificial link between the JP Morgan losses and other issues you wanted to raise.
It is abundantly clear that the trade was based on US corporate debt (http://lcdx.wikidot.com/ig9-summary) and were in no way related to European sovereigns. Surely you can see that just because a trade was booked through London that it does not have to be connected to European markets? If the geography of where the trade takes place is important then this completely undermines your notion of it being connected to Euro banking problems as under this hypothesis such a trade would hardly take place in London! But it’s more likely that you know that and you are yet again trying to create a link between unrelated events.
In addition, while the JP Morgan losses did play a minor role in the market volatility witnessed across Europe last week much more important European events, such as on-going events in Greece, the French elections, the uncertainty around the Fiscal Treaty Referendum in Ireland, losses within the Spanish banking system and the partial nationalisation of one of the major Spanish banks, played the major part. So blaming it on JP Morgan’s speculative losses is setting yourself up to do battle with a readily defeated straw man.
Where you are correct is we simply do not know what other trades and potential losses JP Morgan, and indeed many other banks, have on their books. However, where we differ in approach is that I believe that idle speculation on these, based on little or no information, sheds more heat than light on the debate.
Finally, it was nice of you to observe that I fail to see the broader connection between events that I never even mentioned in my initial comment. What purpose that observation served is unclear apart from an obvious attempt to play the man and not the ball. But let me reassure that I am fully aware of the interconnectivity of the various financial markets, their link to the more general banking environment and government policies. The fact that someone does not share your perspective cannot, I hope, always be taken as a lack of awareness. It was also good of you to point me to your book as a resource to help me to grasp theses connections! I might give it a look but frankly, based on your own description, I question how much I’d gain from reading a book, published in 2010, that predicts a European banking crisis that had already taken place.
Apologies for some ot the typos in my last comment. My only excuse is that it’s rather late her at this stage.