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Banks Amass $211 Trillion In Derivatives, JP Morgan Loses $2 Billion And Volcker Rule Debates Continue

Problem Bank List  The goal of the Volcker Rule, which became law under the Dodd-Frank Act was to restrict speculative trading activity in risky derivatives by the Too Big To Fail Banks.  The ban on proprietary bank trading was proposed by former Federal Reserve Chairman Paul Volcker who believed that one of the primary causes of the 2008 financial meltdown was a result of speculative trading activity by banks.

Volcker argued that the use of depositor money back by FDIC deposit insurance to engage in risky speculation created systemic risk to the U.S. financial system.  In addition, Volcker said that banks holding massive positions in derivatives to allegedly control risk were, in fact, creating even greater risk to the financial system.

Under the Dodd-Frank Act, the Volcker Rule’s provisions were scheduled to be implemented by July 21, 2012.  During the two years since the Volcker Rule became law, regulators, bankers, legislators and lobbyists have been in a non stop battle over how the rule should be implemented and can’t even agree on what date the Volcker Rule regulations should become effective.

Meanwhile, the biggest banks in the country have built up massive speculative positions in derivatives.  The Too Big To Fail Banks, by engaging in activities more suited to hedge funds and casinos, have added an element of instability and risk to the financial system that was supposed to be eliminated by the Volcker Rule.

Evidence of the fact that the Too Big To Fail Banks have not taken the Volcker Rule seriously can be seen in the latest numbers published by the FDIC.  As of December 31, 2011, the 7 largest banks in the country held an astonishing $211.2 trillion in derivative contracts.  By way of comparison, the entire gross domestic product of the United States is only about $15 trillion.

Source: FDIC

The composition of the $211.2 trillion of derivatives is primarily related to bets on interest rates.

Another reminder of the huge risks that banks are taking by making risky trades with FDIC insured deposits was the announcement by JP Morgan that $2 billion dollars was lost on speculative trading bets.

JP Morgan Chief Executive Officer Jamie Dimon said the firm suffered a $2 billion trading loss after an “egregious” failure in a unit managing risks, jeopardizing Wall Street banks’ efforts to loosen a federal ban on bets with their own money.

The firm’s chief investment office, run by Ina Drew, 55, took flawed positions on synthetic credit securities that remain volatile and may cost an additional $1 billion this quarter or next, Dimon told analysts yesterday. Losses mounted as JPMorgan tried to mitigate transactions designed to hedge credit exposure.

“There were many errors, sloppiness and bad judgment,” Dimon said as the company’s stock fell in extended trading. “These were grievous mistakes, they were self-inflicted.”

The chief investment office was thrust into the debate over U.S. efforts to ban proprietary trading when Bloomberg News reported last month that the unit had taken bets so big that JPMorgan, the largest and most profitable U.S. bank, probably couldn’t unwind them without losing money or roiling financial markets. Dimon, 56, had transformed the unit in recent years to make bigger and riskier speculative trades with the bank’s money, five former employees said.

Dimon had defended the unit as a “sophisticated” guardian of the bank’s funds on an April 13 conference call, calling news coverage “a complete tempest in a teapot.” On May 2, he led fellow Wall Street CEOs in a closed-door meeting to lobby the Federal Reserve about softening proposed U.S. reforms that might crimp their profits.

‘Egg on His Face’

Yesterday, he said the timing of the trading blunders “plays right into the hands of a bunch of pundits out there” who are pushing for a strict version of the proprietary trading ban named for former Federal Reserve Chairman Paul Volcker.

“It’s a major event that confirms a lot of investors’ worst fears about bank risk,” said Frank Partnoy, a former derivatives trader who’s now a law and finance professor at the University of San Diego. Concern is “that at a large, supposedly sophisticated institution, even something called a ‘hedge’ can contain all kinds of hidden risks that the senior people don’t understand.”

It is painfully obvious that the thousands of pages of laws and regulations of the Dodd-Frank Act have done little to reduce the size, complexity or systemic risk of the Too Big To Fail Banks.

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5 Responses to Banks Amass $211 Trillion In Derivatives, JP Morgan Loses $2 Billion And Volcker Rule Debates Continue

  1. Mark Schumacher - NV says:

    Barney Frank and Frank Dodd both belong in a potato peeling facility for 20 or so years as head potato peelers. These two clowns were obviously bought and paid for, their legislation is useless as well as their tenures in office. Now what are we doing? Paying these useless morons their lifetime pensions, which amount to around 200 grand a year plus perks.

    Could somebody please tell me what these two blood suckers have actually achieved during their wasteful years in office? Frank Dodd quit office years ago and Barney Frank is right behind him. Get out while the getting out is good right morons?

  2. Mark Schumacher - NV says:

    Update to last post:

    SEC Tells JP Morgan Enforcement Action Coming over Bear’s Mortgage Backed Securities Violations

    “Fallout from JP Morgan trading losses, which led to rater Fitch downgrading their debt yesterday, aren’t the only financial worries the banking behemoth is facing. Nestled in that shocking 10-Q filed Thursday is an admission that their regulator, the Securities and Exchange Commission, thinks some of the details that lead to the explosive Ambac mortgage security fraud suit against the naughty stepchild of JPM, Bear Stearns/EMC, are worthy of an enforcement action. Yep- the SEC is giving or finally gave them a Wells Notice, which means according to their 10-Q (and their 10-K) in January 2012 the SEC’s investigation into the sins of Bear’s Mortgage team run by Tom Morano, Jeff Verschleiser, Mike Nierenberg and the subsequent cover up by JPM was worthy of a civil suit along with some penalties.

    JPM’s 10-Q states “In January 2012, the Firm was advised by SEC staff that they are considering recommending to the Commission that civil or administrative actions be pursued arising out of two separate investigations they have been conducting… In both investigations, the Firm has submitted responses to the proposed actions.”

    We see JP Morgan admit one of the Wells notices relates to the fraud actions first brought forward in the Ambac suit with this line from the 10-Q, “The second involves potential claims against Bear Stearns entities, JPMorgan Chase & Co. and J.P. Morgan Securities LLC relating to settlements of claims against originators involving loans included in a number of Bear Stearns securitizations.”

    It’s black letter law that Wells submissions to the SEC are discoverable in civil litigation. So lawyers in the monoline suits against JPM/BEAR will surely be trying to get a copy of the wells notice via discovery.

    I first reported the SEC started an investigation into these alleged securities violations (and possible criminal actions) after I saw the securities regulator approach the lawyers and whistleblowers in my Bear Stearns investigative report at The Atlantic the day after the story came out. Now a year later it appears all the ‘shitty deal’ emails, internal Bear Stearns documents, and over thirty whistleblowers who’ve come forward in the monoline suits lead by the New York office of law firm PBWT was enough to get the SEC to stand up to JPM and we think say ‘what you did violated securities laws and harmed investors’. Talk about another wave that could lead to tsunami style damage to Jamie Dimon’s ‘fortress balance sheet’.

    How many billions in damages JP Morgan will have to pay out is not yet determined but inside their Mortgage-Backed Securities and Repurchase Litigation note on the 10-Q the bank tells us “There are currently pending and tolled investor and monoline claims involving approximately $120 billion of such securities.”

    WOW that means investors think there was a heck of a lot of very bad mortgage securities that were packaged and sold and they want their money back along with some fines and are willing to spend a few million to pay expensive lawyers to sue for it. When I first reported on the Ambac case and went on RT’s The Keiser Report to explain what kind of financial trouble JPM could be in the damages in the monoline suits against Bear were only around $1.2bn. I told Max Keiser if fraud claims survived the suit that means punitive damages get lobbed on and who knows many billions JPM will have to pay out because allegedly emails showed Bear mortgage traders stole billions from their own damn clients. I threw out a number, $10bn, that JPM could be looking to pay. Now according to JPM’s latest SEC filings there are now “seven pending actions commenced by bond insurers that guaranteed payments of principal and interest on approximately $5 billion of certain classes of 21 different MBS offerings.”

    The face value amount of securities tied to the monoline suits against JPM are significant because there was a recent ruling in a Countrywide RMBS suit that ruled if plaintiffs can prove there were miss-representations in the bonds then the entire amount of the bond has to be bought back…not just the amount that defaulted or caused a loss. Reuters legal columnist Alison Frankel explains the judge’s decision and impact here. It has a lot to do with the way insurance laws are structured in New York State, which is where all the monolines suing have headquarters.

    So far we haven’t seen JPM settle any of these mortgage putback suits including the government’s housing regulator’s whopper of a suit filed this winter against a bunch of banks including JPM. The government’s outside counsel who filed the FHFA suit literally copied the fraud and breach of contract claims Ambac had laid out against JPM and since then we’ve seen a multiple of big boy institutional investors file similar suits. Thus the alarming $120bn number of possible rmbs repurchase litigation damages JPM was forced to detail in their recent 10-Q. A number which accompanies a series of motions their expensive lawyers at Sullivan & Cromwell and Greenberg Traurig have filed to slow down discovery and deny, deny, deny these aggressive fraud claims in the triple digit billions.

    And now that the SEC is about to come out and stamp a ton of merit to these civil investor lawsuits via an enforcement action that hopefully says – you guys broke the law, abused free markets, and seriously broke investor trust — then it’s looking harder and harder for JPM not to settle these investor lawsuits in the mega billions. Just think if Ambac actually got to trial and a main street jury who’s pissed very few bankers have gone to jail for the financial crisis heard some of the whistleblower testimony about senior Bear executives telling underlings to make up mortgage info for the raters. Or the third-party due diligence reports Bear got them to fudge – reports investors relied on as due diligence rubber stamping the quality of the rmbs securities. I’d image punitive damages up the yin-yang would be awarded.

    But the most telling sign JPM will have to payout big time is that HUGE jump in litigation reserves they snuck in this week. In the bank’s first quarter earnings press release, filed on April 13th, JPM told investors they were adding $2.5bn to existing litigation reserves for mortgage-related suits. And then three weeks later while all my jurno peers are focused on writing stories about what JPM’s trading screw up means to their reputation, their master public relations spin machine figures lets thrown in all the bad news we can cause we know the market will punish our stock. So they added on another $1.7bn in litigation reserves for a total hit to income of $4.2bn. That’s more than 4 times the net amount ($800 million) they claim they lost on their bad corporate bond trade.

    On top of that I’ve seen top housing analyst Mark Hanson tell hedges funds they might want look at how JPM repurchase risk will affect net income and thus the stock price. Francine McKenna, former Big 4 auditor and influential columnist for American Banker told me this is just the first phase. Accounting rules allow JPM to slowly add each quarter to litigation reserves and take smaller hits to net income than waiting for a big money suit to finalize and wipe-out a whole year’s earnings. Some financial editors like Joe Weisenthal at Business Insider allowed his team to write the $4.2bn addition to litigation reserves was due to trading loss but that’s not what the 10-Q explains. Number one these are reserve additions for events up to March 31st and JPM worrisome trading loss began in April. Number two the bank has to explain all the litigation that gets to that reserve number and there is not a word about suits from trading losses in their 10-Q litigation notes. Nope this big jump was from progress being made by rmbs plaintiffs and a looming SEC action which you see if you know how to read the litigation notes.

    McKenna, founder of says, “Banks tend to account in one lump litigation reserve number what they think they will have to payout from a suit but that’s really a disguise so that no one across the table from the litigation can see what they might be willing to settle for.”

    There is another dirty accounting trick JPM is possibly playing with here. McKenna told me in an interview this week reserves are like a cookie jar, banks can increase and decrease this balance sheet number each quarter which shows up as a loss or earning to net income. So let’s say Jamie Dimon thinks the mark-to-market loss of $800 million he just took for the trading screw up is going to be a lot more when they are done unwinding the trade. The bank they could lower their litigation reserves and boom that trading loss doesn’t look so bad on next quarter’s net income. Then going into Q3, when say maybe they settle with the SEC and the rest of the Street wakes up to how many billions they will have to pay out for the sins of Bear Stearns RMBS fraud, JPM can just re-up the litigation reserves. Now of course their Big 4 auditor has to allow them do this by signing off on the SEC financial filings but part of the Abmac suit filed last January showed PricewaterhouseCoopers tried to stand up to JPM/Bear accounting tricks before and the bank just ignored it. A detail the lawyers at PBWT discovered for us. In that case it would be up to the SEC to say ‘Hey JPM your RMBS repurchase risk is more than you are accounting for and you’d better represent a more realistic number.” This in turn hurts JPM’s income and also can lead to additional downgrades by the raters, so an accounting scolding by the SEC on top of an enforcement action might not be something they’ll man up to. But clever analyst and hedge funds will see it and the result could be free market participants take a club to the CEO, who the financial press once hailed America’s angle banker, all on their own.

    Editors Note: When my fellow financial reporters figure out I’ve reported JPM got a Wells Notice for mortgage securities no-no’s becuase of the Ambac ‘double dipping suit’ I’d like to remind them jurno standards mean you need to credit Teri Buhl for reporting this. Thanks in advance to Matt Taibbi at Rolling Stone and Max Keiser at RT who always link and mention the Bear RMBS fraud cheating their own clients news created a whopper of a problem for JPM, was a result of my original reporting at The Atlantic. Here is a shout out thanks from me to Daniel Indiviglio, my editor at The Atlantic, who understood the importantence of impact to the market in this story back in May 2010 and made sure it got published. And most important I’d like to recognize Nick Verbitsky, doc film maker of Confidence Game, a move now playing about the greed and fraud that lead to the downfall of Bear Stearns, for finding the first whistleblowers to speak out against the Bear Mortgage executives. Awareness of how these Wall Street titans cheated and stole damaging free markets was a result of investigative journalism and the PBWT attorneys not our regulators figuring it out first.”

  3. Rick says:

    There is no statute of limitations on fraud, and the whole derivatives market was a house of cards designed as a ponzy scheme to begin with. Send the whole lot of Wall Street Banksters and the lawyers and regulators who were involved to trial, and then prison for the rest of their lives, only to be carried out feet first.

  4. Albert says:

    This is a great story, and great reporting. The comments are a wake up call to the people. The only problem is that too few people will read this. No one out there wants to know that the ship is sinking. For many, it does not matter, because they really are in no position to afford a “life raft” and will be pulled down with these unscrupulous banks and governments that caused the problem in the first place.

  5. l.j.molloy says:

    The commandment says “Thou shalt not steal”.!!! These thieves have stolen all that the U,S.A. has ever stood for : the constitution, morality, .culture, especially finances and the process goes on as the people watch the “clowns” in Congress pass laws that institute legalised thievery. “Honest Abe”,(Abraham Lincoln) stated that ” the most important thing that men and woman need to do, is to overcome their ignorance on matters pertaining to money.” Today’s disaster is a direct result of such ignorance, and electing essentially financially immoral people to Government.

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