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Don't Look Now -- Banks Are Still Ruining America: 6 Harsh Lessons from the JP Morgan Fiasco

JP Morgan Chase is part of an entwined system of too-big-to-fail institutions that are ripping us off.

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A large part of JP Morgan Chase's betting strategy involving playing the A.I.G. game using those nefarious credit default swaps we’ve been hearing so much about, and that JP Morgan Chase invented two decades ago. That game goes like this:

Make believe you’re an insurance company and you are writing insurance on corporate bonds that you don’t own. You guarantee that if the bonds fail, you will make the person you insure whole. In exchange you get premiums, just like a real insurance company. But you don’t call any of this insurance because:

  • Insurance is heavily regulated – you have to have ample reserves to pay off losses. But if you call it a credit default swap you aren’t regulated as an insurance company.

  • Also in the insurance industry you can’t take out a policy on your neighbor’s house unless you own it. That’s because about 800 years ago someone figured out that if you did, your neighbor’s house might mysteriously burn down. But in the credit default insurance game, you can insure anything and everything. You don’t need to own what you insure. And you are free to burn down others' assets if you can. 

This is supposed to allow you to hedge your risk. But since you can bet on bonds you don’t own, it quickly turns into a game of fantasy finance, much like fantasy baseball. It’s pure gambling and no one has yet to show that it has any redeeming economic or social value. (In fact, as an avid fantasy baseball gambler, I believe strongly that fantasy baseball is far more socially useful and far less dangerous that fantasy finance.)

Well, JP Morgan Chase’s gambling house – called the Chief Investment Office – decided to follow in the footsteps of A.I.G. and insure others who were betting on corporate bond derivatives. The bank figured out, just like A.I.G, that the more derivatives it insured, the more revenues it would receive in the form of premiums. It was like printing money (and then getting fat bonuses based on those hefty premiums). As long the corporate bond market didn’t go bad, they could just pocket those premiums and not worry about paying out on their insurance bets. Like A.I.G., they thought the risk of having to pay up was minimal.

Of course, they had incredibly complex ways to cover their bets. There derivatives piled onto derivatives like planes stacked up at JFK. But those strategies collapsed when the corporate bond market started to deteriorate over the past several months.

JP Morgan Chase became so big in this obscure casino market that they were able to manipulate it. At first the manipulation helped them milk the market for more than $3 billion in profits over the past several years. It was a rigged game while the relatively good times lasted. But the game turned sour when the corporate bond market deteriorated. That’s when being a big fish in a small market meant trouble. It means you can’t sell your gigantic positions to cover your bets because there are no buyers. Instead, hedge funds saw the bank as a beached whale and bet against it. To date, something like $13 billion has evaporated in the form of former profits and current losses, with more sure to come.

So, what are the lessons learned?

1. The big banks are still gambling. Shocking, isn’t it? Obviously, it’s a way of life. It’s built into the fabric of who they are. They always have at the ready a cover story about how they’re just hedging their assets, making markets for their customers and protecting their downside. Baloney. Their real motive is ever so simple --- money. Financial gambling is the quickest way to big bucks. When the big banks and hedge funds see the opportunity, they jump at it. It’s in the DNA of the banking system. It's what the financial elite are trained to do – all of them. And it will never change as long as we allow them to play with all that money. Why invest long-term in goods producing industries when you can milk your casino?

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