No Lessons Learned

http://www.moneyandmarkets.com/issues.aspx?Closer-to-a-Financial-Meltdown-1558

Excerpt: " Now, at long last, looking back at the truths ~ and deceptions ~ revealed in recent months, you'd think someone might have learned a lesson from this experience.

Instead, here we ago again in a typical 1-2-3 pattern ...

1. Like June of last year, Bear Stearns is the first to reveal a disaster.
   
   
2. Like last year, the authorities have been huddling through the weekend, poring over Bear Stearns' books. And ...
   
   
3. Like always, they are trying to come up with a story to spin the facts.

But this is not June of 2007, when it was still easy to fool most investors most of the time. Too much has changed too quickly, and the crisis has already progressed to a more advanced phase. Now ...

• Revelations of big losses are being replaced by fears of big bankruptcies.
  
  
• The collapse of subprime mortgages has been replaced by the collapse of nearly all major credit markets.
  
  
• And most worrisome of all, these fears and collapses are threatening to freeze up the greatest grand casino of all: Derivatives.

The Truth and Consequences
Of $172 Trillion in Derivatives

Derivatives are essentially bets ... and ... debts.

As an illustration, if you and I were players, I could bet you that a particular firm will go bankrupt between now and year-end ... and you could bet me that it won't.

Or I could bet you that interest rates on junk bonds will rise more than interest rates on Treasury bonds ... and you could bet they will rise less, or not rise at all.

We could bet on virtually any market that moves, or even bet that it won't move.

For each wager, we'd likely borrow huge amounts of other people's money. And in each case, we'd have a contractual obligation (or right) to consummate the deal: To pay up if we lose (or collect if we win).

That's the essence of each transaction in the frenzied, hectic world of derivatives.

But what was once a small sideshow in the traditional world of stocks, bonds and loans has become the towering center ring in the big-top: The derivatives market has now ballooned into a monster of unimaginable dimensions.

At U.S. commercial banks alone, the total national value of the derivatives is $172.2 trillion, according to the latest report by the U.S. Comptroller of the Currency (OCC). Plus, the OCC reports that:

• In over 90% of these derivatives, there is no established exchange that helps protect either party from default.
  
  
• Just FIVE major U.S. banks control 97% of all the bank-held derivatives in the United States, a concentration of power and risk unsurpassed in the history of finance.
  
  
• All five of these major players would likely be severely crippled, or even bankrupted, by the default of just a few major counterparties like Bear Stearns.
  
  
• Four have more credit exposure to counterparty defaults than they have capital.
  
  
• Two have over four times more credit exposure than capital. (More details in a moment.)

The Potential Damage of Bear Stearns' Demise
Today Is Far Bigger Than the Feared Impact of
Long Term Capital Management's Fall in 1998.

So in the days ahead, don't be surprised by new announcements of "big, bold steps" being taken by Washington and Wall Street. Also don't be surprised by a bigger-than-expected rate cut by the Fed today.

But throughout it all, don't let them fool you when they again put out the word that "Bear Stearns is alone" or that "the crisis is contained."

Not true.

Why JPMorgan Chase Is
Among the Most Vulnerable

Logic alone dictates that containing the crisis is highly unlikely. Let me walk you through the facts, and you'll see what I mean ...

• All major Wall Street firms engage in the same kind of trading strategies that entrapped Bear Stearns.
  
  
• All use the same kind of high-powered leverage that sunk Bear Stearns.
  
  
• And perhaps most important, all are joined at the hip to each other as counterparties (trading partners) in derivatives, including Bear Stearns.

Indeed, even as you read these words, derivatives are emerging as the new core of the crisis. And derivatives are definitely not limited to Bear Stearns.

Among investment banks that do not report to the Fed, the biggest players are Lehman Brothers, Goldman Sachs, Morgan Stanley and Merrill Lynch.

And among those who do report to the Fed, the five dominant players in derivatives that I mentioned a moment ago are Citibank, Bank of America, Wachovia, HSBC and the biggest of them all: JPMorgan Chase.

We believe all are vulnerable, in varying degrees, to the kind of crisis that struck Bear Stearns last week.

We believe JPMorgan Chase could ultimately be the most vulnerable.

And we believe this may help explain why JPMorgan Chase was the Wall Street firm that emerged as a participant in the Bear Stearns rescue on Friday. "

Allen L Roland  http://blogs.salon.com/0002255/2008/03/18.html