Wednesday, March 4, 2009

JP Morgan - Counting AIG Bailout Money as a Profit

If you are worried about where your TARP or any other bailout money is going, this press article on JP Morgan may provide a hint.

The opening of the article leaves out one huge product segment of the Fixed Income Derivatives product group, Credit Default Swaps (CDS). In fact this is a huge oversight, the OCC source shows that banks have a 87T OTC derivative exposure which includes fixed income derivatives and states that of the 16.1T of outstanding credit derivatives 99% are CDS. Why did Bloomberg not come out and be forthright about 20% of the derivatives market?

Moreover, over 40% of reported trading revenues derived from this segment of the derivatives market.

The bailout money for AIG CDS positions no sooner hit AIG's account before it was transferred to AIG's counterparties to settle collateral requirements for it's positions. With AIG posting $60B losses from CDS in the last quarter, there had to be someone on the other side of those trades who would claim a commeasurate gain.

As of Q3 of 2008, according to the Office of the Controller of the Currency (OCC), there are only 5 major CDS brokers amongst the US banks who hold 87% of the outstanding notional credit exposure. JP Morgan is largest one of those five.

Thus when the government provided $60B capital to AIG in order to meet collateral requirements for it’s counterparty positions, one can infer that the ultimate recipient was JP Morgan, and other major CDS dealers. This is the fallacy of the whole market. The government is providing AIG with funds not just to keep AIG afloat, but to support all of AIG’s counterparties from the systemic risk of not getting paid. But in providing this liquidity, the government is allowing JP Morgan to mark profits from bailout money originating at another firm while they hold on to the TARP money they received from the government.

What is to be learned from this? The systemic risk of the “Shadow Banking System” is being balanced by the US taxpayer. But it is not being communicated how many counterparties are also being saved by the single bailout of AIG and other major lenders. What astounds is that the market makers continue to perform solid business in the very instruments that could at any moment cause their demise if the government withdrew it’s support of the losing counterparties. This evidence underscores how dysfunctional the whole banking system is currently and how much more needs to be done to wean the banks with most CDS exposure from government funded settlements.

The author is long puts in JP Morgan.


Lockstep said...

In the AIG disclosure they showed that $400M of the bailout funds were sent to JP Morgan as collateral or settlement for CDS contracts.

Lockstep said...

The author sold JPM puts in June 2009 for a 70% loss