Derivatives Could Blow Up Wall Street Again, Warn Megabanks

If the average American knew that the very same banks that blew up the U.S. economy just a decade ago were warning in their own 10K legal filings that the same thing could happen again at any moment, there would be mobs with pitchforks in the street.

By Pam Martens and cross-posted from Wall Street on Parade

The most recent 10Ks (annual reports) filed by the largest Wall Street banks covering their financial condition as of December 31, 2018, provide the strongest argument thus far for Congress to enact legislation to separate the Federally insured, deposit-taking commercial banks from the trading casinos on Wall Street. In other words, Congress needs to restore the Glass-Steagall Act, which kept the U.S. financial system safe for 66 years until its repeal in 1999.

If the average American knew that the very same banks that blew up the U.S. economy, devastated the housing market, crashed the stock market, threw millions of Americans out of work just a decade ago were warning in their own 10K legal filings with the Securities and Exchange Commission that the same thing could happen again at any moment, there would be mobs with pitchforks in the street. But because corporate media does not put this critical information on the front pages of newspapers, the public remains in the dark and Congress dawdles.

According to JPMorgan’s 10K, it has sold credit derivative protection on $177 billion of “subinvestment grade” i.e., junk credits. When you sell credit protection, you are on the hook to pay the buyer if that entity goes belly up. When you are selling credit protection on subinvestment grade entities, it is far more likely that they could go belly up. JPMorgan Chase will likely argue that they have also purchased boatloads of credit derivatives, which might be on the same entities, but there is no way for anyone to accurately predict if this mega bank has aligned these risks correctly. Even the bank admits that, writing in its 10K the following:  

“JPMorgan Chase could incur significant losses arising from concentrations of credit and market risk. JPMorgan Chase is exposed to greater credit and market risk to the extent that groupings of its clients or counterparties:

“Engage in similar or related business, or in businesses in related industries;

“do business in the same geographic region, or;

“have business profiles, models or strategies that could cause their ability to meet their obligations to be similarly affected by changes in economic conditions.

“For example, a significant deterioration in the credit quality of one of JPMorgan Chase’s borrowers or counterparties could lead to concerns about the creditworthiness of other borrowers or counterparties in similar, related or dependent industries. This type of interrelationship could exacerbate JPMorgan Chase’s credit, liquidity and market risk exposure and potentially cause it to incur losses, including fair value losses in its market-making businesses…

“JPMorgan Chase regularly monitors various segments of its credit and market risk exposures to assess the potential risks of concentration or contagion, but its efforts to diversify or hedge its exposures against those risks may not be successful.”

We know very well that JPMorgan Chase “may not be successful” in managing its derivative risks because as recently as 2012 it lost at least $6.2 billion of its bank depositors’ money gambling in derivatives in London. That episode was known as the London Whale incident and triggered a 9-month investigation by the U.S. Senate’s Permanent Subcommittee on Investigations.

According to documents released by that Subcommittee, as of the close of business on January 16, 2012, JPMorgan’s Chief Investment Office held $458 billion notional (face amount) in domestic and foreign credit default swap indices. Of that amount, $115 billion was in an index of corporations with junk bond ratings, which the bank was not allowed to own. To get around that, according to the Office of the Comptroller of the Currency, JPMorgan “transferred the market risk of these positions into a subsidiary of an Edge Act corporation, which took most of the losses.” An Edge Act corporation refers to the ability of a bank to obtain a special charter from the Federal Reserve. By establishing an Edge Act corporation, U.S. banks are able to engage in investments not available under standard banking laws.

Now fast forward to today where JPMorgan Chase has no qualms about telling one of its Federal regulators, the SEC, that it has sold protection on $177 billion of “subinvestment grade” credit derivatives.

According to the Office of the Comptroller of the Currency, JPMorgan Chase had $48.2 trillion (yes, trillion with a “t”) in notional (face amount) of derivatives as of December 31, 2018. Of that amount, 58 percent remained in over-the-counter (OTC) contracts rather than centrally cleared. Regulators have very little insight into these OTC contracts. For all we know, the Wall Street mega banks could have enormous amounts of risk concentrated with one derivatives counterparty – the very thing that brought down the giant insurance company AIG in 2008 – forcing a taxpayer bailout of the insurance company to the tune of $185 billion

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