Counterparties

Back on May 10, when JPMorgan announced its massive CIO trading loss (which may or may not have been unwound courtesy of a risk offboarding to another hedge fund which may or may not be backstopped by the Fed as the massive IG9 position was not novated but merely transferred) JPM also disclosed something else which may have bigger implications for the broader, and just downgraded, banking sector. As a reminder, in the 10-Q filing, the bank reported a VaR of $170 million for the three months ending March 31, 2012. This compared to a tiny $88 million for the previous year. According to the company, “the increase in average VaR was primarily driven by an increase in CIO VaR and a decrease in diversification benefit across the Firm.” What JPM really meant is that after being exposed in the media for having a monster derivative-based prop bet on its books, it had no choice, as it was no longer possible to use manipulated and meaningless risk "models" according to which the $2 billion loss, roughly 23 sigma based on the old VaR number, was impossible (ignoring that VaR is an absolutely meaningless and irrelevant statistical contraption). Turns out it is very much possible. Which brings us to the latest quarterly Office of the Comptroller of the Currency report, and particularly the chart on page 7. More than anything it shows what happens when a big bank is caught red-handed lying about its risk exposure. We urge readers to spot the odd one out.

Goodbye European Central Bank. Hello Salvation Army Bank.

or in other words:

"THE ECB RATES THIS SPIDERMAN TOWEL-BACKED CURRENCY AAA+++

Only when the lack of visibility on forward revenue and earnings was obvious to all did Moody's act

Here we come:

• MOODY'S CUTS 4 FIRMS BY 1 NOTCH
• MOODY'S CUTS 10 FIRMS' RATINGS BY 2 NOTCHES
• MOODY'S CUTS 1 FIRM BY 3 NOTCHES
• MORGAN STANLEY L-T SR DEBT CUT TO Baa1 FROM A2 BY MOODY'S
• MOODY'S CUTS MORGAN STANLEY 2 LEVELS, HAD SEEN UP TO 3
• MORGAN STANLEY OUTLOOK NEGATIVE BY MOODY'S
• MORGAN STANLEY S-T RATING CUT TO P-2 FROM P-1 BY MOODY'S
• BANK OF AMERICA L-T SR DEBT CUT TO Baa2 BY MOODY'S;OUTLOOK NEG

So the reason for the delay were last minute negotiations, most certainly involving extensive monetary explanations, by Morgan Stanley's Gorman (potentially with Moody's investor Warren Buffett on the call) to get only a two notch downgrade. And Wall Street wins again.

There are only a few funds in the credit markets who are big enough to help manage a position the size of JPM's CIO office and, according to Bloomberg Businessweek, BlueMountain (one of the biggest) has helped JPM unwind their position by entering the market to take positions that it then sold on to the bank. This agency role is helping the bank to cover its tracks (and reducing the effectiveness and transparency of any and all DTCC data in the course of it), which argues perhaps once again for the exchange trading of these instruments (but that is another topic). While we would be sure that Blue Mountain took a wider than market bid-offer out of the middle of the brokerage move, it is nevertheless clearly a backdoor bailout of the bank's position by what is likely one of its major counterparties anyway (and why not). The activity pick-up this week makes perfect sense (as we noted yesterday) given the single-name CDS roll (and index options expiration) and as Bloomberg's Childs and Harrington note "If you were to need to move a large position, there should be greater liquidity around those days than other days, all else being equal," but as we have noted it remains unclear as to whether the original tail-risk position has been taken down at all (if so then doesn't that make JPM more risky implicitly?) or just the hedge of the hedge that got so out of hand thanks to Iksil's excess.

LCH under investigation by Holder under antitrust statutes. And just who was the ultimate counterparty to the Corzine trade?

Remember, both as my research and the past 5 yrs have made clear, counterparty induced banks runs are the most damaging and Spains banks are hit from both RE and Sovereign debt crises. Who wouldn't run from this?

As Predicted Last Year, The French and the Greeks Are In A Race For The Biggest Bank Run! Each stock showcased has led the drop as well...

Below we present two more charts for your rubbernecking pleasure. First, we observe the just released data showing Spanish bank borrowings from the ECB: at €287.8 billion, this was a €24 billion increase from April, €235 billion from a year earlier, and the highest ever. More importantly, as can be seen on the first chart below, for the first time since June of 2011, Spanish bank ECB borrowings increased to more than those of Italy, which at just €272.7 billion rose a mere €2 billion from April month (to a new record as well). In other words, both Italy and Spanish banks are now spurned by counterparties everywhere, but Spain's a little bit more than Italy's. Yet before Italy gloats, it bears reminding Italy that its own offsetting factor, and where it is weakest, its insane public debt, just hit a new record high of €1.95 trillion, pushing the country's debt to GDP ratio well into the 120%+ range.

As is well-known in the ratings world, sovereign downgrades never come alone: first the sovereign is cut, then sovereign-supported domestic banks (the sovereign is the threshold rating), then general financial companies like insurance firms and specialty fins. Such downgrades are particularly painful when they go through a major threshold such from A to B as they spring various collateral and margin calls into action. One thing we do know is that the last thing undercapitalized Spanish banks can afford now is even more margin calls, and even greater collateral haircuts. However, this is precisely what will happen for the following 3 banks tomorrow: Banco Popular Espanol, Banco Santander and BBVA, all of which are currently at the old sovereign rating of A3 and tomorrow will see their rating cut to Baa3, and we fully expect the other three Moody's rated banks: Caixa, Banco Financiero y de Ahorros and Sabadell to be cut anywhere between 1 and 3 more notches, sending them into junk territory. We can only hope that the ESM or whatever Spanish bank bailout scheme is operational tomorrow as suddenly all of the banks below will find themselves without any willing counterparties around the world.

Updated | The notion that the trades which caused the losses by JPM were put on in the last six months or so seems to have been widely accepted in the media. But is this really the case?

The man that called nearly every big bank collapse of the decade says EU nations don't stand a frozen raindrop's chance in hell of bailing out banking systems literally multiples of domiciles' GDP. So now what???

While America may be experiencing the occasional zombie apocalypse breakout, probably due to the absence of easily available edible iPads, Greek retailers are preparing for the retail version. "British electrical retailer Dixons has spent the last few weeks stockpiling security shutters to protect its nearly 100 stores across Greece in case of riot. The planning, says Dixons chief Sebastian James, may look alarmist but it's good to be prepared." Why Dixons? "Europe's No 2 electrical retailer Dixons owns Greece's market leading but loss-making Kotsovolos chain, which has a 25-percent market share selling iPads and laptops as well as washing machines, televisions and air conditioning units." There we go: Bill Dudley's edible iPads. The question is what happens when this easily digestable piece of plastic is thoroughly looted after local rioters dispense with the "shutters" supposedly protecting their wares. What will be on the menu next? Sadly not booze: "Diageo, the world's biggest spirits group and the name behind Johnnie Walker whisky and Smirnoff vodka, has reacted by slashing its marketing spend in Greece, reducing stock levels and pulling cash quickly out of the country after it saw its Greek sales halve in the last three years to less than 100 million pounds." So: no food, no booze, no cheap 99 cent iPad aps: this is the way the world's most miserable monetary experiment ends.

Bank Regulatory Capital has been in the news a lot recently - between the $1+ trillion Basel 3 shortfall, the Spanish banks with seemingly their own set of capital issues, or JPM's snafu.  There has been a lot of discussion about Too Big To Fail (“TBTF”) in the U.S. with regulators demanding more and banks fighting it.  After JPM's surprise loss this month, the debate over the proper regulatory framework and capital requirements will reach a fever pitch.  That is great, but maybe it is also time to step back and think about what capital is supposed to do, and with that as a guideline, think of rules that make sense. Specifically, regulatory capital, or capital adequacy, or just plain capital needs to address the worst of eventual loss and potential mark to market loss. Hedges are once again front and center.  The only "perfect" hedge is selling an asset. This "hedge" is also a trade.  The risk profile looks very different than having sold the loan and the capital should reflect that.

Whether it is the EU running to the G-20, nations in Asia, the IMF or Spain and Italy and their brethren calling for Eurobonds the distinction is easily made; you pay or you pay or you pay because I cannot. That is the cry in the wilderness as politely, very politely, quite politely everyone says, “No thank you.” The curtain is going down on the show and the normal pleas are being made to keep the spectacle in operation but the pocketbooks are closed and Germany and the rest are not going to bet the family farm when the final act draws nigh. The Elves in the boulders cackle and the “invisible people” move on and sigh as the ending of one more chapter is inscribed in the Book of Life.