JP Morgan and MF Global Caught Chasing Yield

Jeff  Carter
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Posted: May 17, 2012 12:01 AM

Anyone find it ironic that JP Morgan ($JPM) sustained a big loss in Euro debt, and that Jon Corzine brought down his company chasing yield on Euro debt? To add to the irony, isn’t it interesting that JPM was the counter party to MF in a lot of cases!

They were trying to get greater returns with free money provided by the Federal Reserve window.

Of course, the big government fanatics are out in the media pounding their chests that we need more regulation. I thought we had great new regs with Dodd-Frank, and prior to that we made CEO’s and CFO’s responsible with Sarbanes-Oxley.

Maybe what we need is less regulation and flatter, transparent and more horizontal markets.

So what, JPM made a bad trade. Happens in the trading business. At least they have the money to stay in business, unlike Bear, Lehman, MF, Merrill….. The answer to all of these situations isn’t more regulations. It’s not a crime to lose money. The answer is to ask yourself how did one trader amass a huge position?

This isn’t the first time in history a big institution, or a powerful institution lost money. LCTM lost a bunch in 1998, and destabilized the world market for a short time. Barings went broke when a trader went big. China lost a boatload in London trading copper a couple of years ago. But because of our response to the financial crisis in 2008, we have created institutions that are too big to fail. Because of their size, they have a hard time staying on top of risk. That’s one of the core reasons we should have let them go broke in 2008. Going broke makes traders take responsibility for the risk they take. It’s a necessary outcome. Bandaging it over with Federal Reserve paper takes risk out of the marketplace.

There are many reasons our markets are broken today. A primary one is the regulatory environment hasn’t kept pace with the sweeping changes that have been made to them. Because institutions, and people react the same to economic incentives, when markets changed, the entities with the wherewithal to protect themselves did so. They went to government and created favorable regulations. They bought up competitors and created dark pools where they could dominate. They put up structural and regulatory barriers to entry to keep the game behind closed doors. Instead of inviting lots of people, institutions and entities to the market bazaar, the rules of the game today lock them out or charge them juice to play.

Ironically, some of the most messed up industries in the US also happen to be the most heavily regulated. Education, Health Care, Energy, Housing, and Finance. The common theme among them is government bureaucrats try to set the rules of the game. That leads to severe imbalances that manifest themselves as dead weight loss in the economy, and harms shareholders of companies in the long run.

The lesson we ought to be focusing on with regards to the losses at JPM and MF isn’t that we don’t have enough regulation. We have plenty, too much actually. We should instead focus the laser on the structure of the marketplace and think about how one trader was able to amass such a position. But, most of the bureaucrats regulating the market place are loathe to pull back that curtain-or just don’t understand enough about it to open up the ticket booth.

UPDATE

I have no hard evidence, but as Jack B commented on my FB page, I wonder if JPM didn’t buy the MF debt portfolio at a deep discount and had The Whale hedge it. When the European market began to unravel again, the trade went underwater.

It’s not as if traders don’t purchase large scale positions from other traders. It happens all the time. Lehman was able to unload their portfolio in 2008 at a discount to other traders.

Why do they do this? In most cases, the opportunity cost of their exposure is greater than the cash that they will receive to dump the portfolio. So, in bankruptcy dumping it is cost efficient.