I spoke to Paul Waldie and Brian Milner of the Globe & Mail on BNN’s headline on Monday. The big story was JPMorgan Chase and the London Whale trades. JPMorgan Chase’s CEO Jamie Dimon, as the leading lobbyists for the hands-off regulatory approach for US banks, has become a lightning rod for criticism of too big to fail banks in the US. The huge trading error made by JPM has already cost the firm $2 billion and the misstep continues to dominate US headlines. Even so, I think it’s unlikely that Dimon will be forced out of his position. Instead the London whale fiasco marks a dénouement for US banks as JPMorgan Chase is the last big US bank to have escaped the credit crisis without its reputation shredded by losses, bailouts or misconduct. Over time the regulatory noose will tighten.
The big news here then is that big banks will face margin pressure from all sides, which can only be thwarted by taking on risk. That’s negative for shares.
Take a look
I should point out Yves Smith’s view of the JPM situation because I think it’s the correct one: She quotes Amir Bhide saying “What Scares Me Isn’t $2 Billion Loss JP Morgan Made, What Scares Me is the Record $19 Billion in Profits”. Clearly if the only big bank with a reputation for risk management is blowing up and still making tens of billions, you know they have to be taking on a lot of risk. Remember, JPM is not just the creator of CDS but also has the largest derivatives book on the planet. It has been a major seller of CDS over the four years since the market was vacated by AIG. And the London Whale trades seem to be a hiccup in that strategy.
Look, I told you two years ago that JPM was getting paid to borrow on $271 billion worth of repos. They had huge carry! We’re talking zero-rate induced net interest margins well over 3%. Here’s the thing though; I also told you later in 2010 how quantitative easing and permanent zero are toxic to bank net interest margins. See, a lot of people are trying to brainwash you into thinking interest rates are going to spike because of US federal government fiscal profligacy. They invoke the phantom bond vigilantes to spin this tale. That’s not what’s happening at all though. As the long end of the yield curve comes in due to either QE or what I have been calling permanent zero (PZ), as zero rates become a permanent state of affairs, interest margins have compressed. Why? The yield curve is not about confidence fairies. It’s about inflation and interest rate expectations. Future expected overnight rates reflect only market-determined median expectations of future Fed Funds target rates as set by the Federal Reserve (plus a risk premium). Long-term interest rates are a series of future short-term rates. End of story.
Bottom line: Since short rates are at the zero bound, the longer rates stay at zero percent, the flatter the US yield curve is going to get. Good bye net interest margin.
So, thinking about JPM and it’s monster accounting gains, there are only two ways to rack up accounting gains of this size in this poor lending environment. One is benefitting from a flight to quality. The other is taking on risk. That’s why JPM’s record accounting gains are scary. This is the big missing story on JPMorgan Chase.
Anyway, that’s my piece on JPM.
On Monday, we also talked about Yahoo and the oversubscribed Facebook IPO, which seems to be a major pump and dump, that I believe could add to downside market sentiment if a second half slowdown takes hold. For me, Facebook is interesting because despite all the hoopla surrounding the company and the huge market cap, Facebook is still a company in its infancy. It was just started in 2004 and is therefore only 8 years old.
If you compare Facebook to Yahoo, the other company we discussed at length, that would be 2003 on Yahoo’s corporate timeline. At that time, Yahoo was just in the beginning of an enormous surge that took the stock from under $5 a share to over $40. I worked at Yahoo at exactly that time. And while the ride was good for employees cashing in stock options, I can tell you my first hand experience at Yahoo was that the surge was mostly cyclical; it was a technical bounce precipitated by the extreme lows in 2002 and the housing bubble the Fed was busy creating. Underneath Yahoo’s Internet media strategy was falling apart as Google ate its lunch in search.
I am pretty sceptical on Facebook. They are going to have to execute really, really well to justify the IPO valuation. And while they have done well so far, the problems at Yahoo show you what can happen when an Internet company is not ready as it moves into the big time.