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Saturday, 12 May 2012

US Fed breeding bigger, more dangerous whales

JP Morgan's derivatives loss amplifies deep concerns about the financial safety of the big banks.  Financial backstops designed to protect those banks privileged to be "too big to fail", along with very low interest rates and now declining profits, create incentives for those big banks to further increase their gigantic financial risks.

Government guarantees distort proper market incentives for banks to avoid risk.  The threat of failure is no longer real.

See's interview with Heidi M. Moore from around the 7:00 minute mark in "JP Morgan's "unicorn hedge" fairy tale harpoons the London whale".  A unicorn hedge is a hedge which nobody has ever seen before.

JP Morgan's unicorn "hedge" involved shorting a short position to create a long position over corporate debt, by selling (shorting) credit default swaps (CDSs).  It appears not to be a hedge to cover, insure or protect any JP Morgan position, rather, it appears to be a net long position, taking a directional "bet" on prices moving up.  It is suggested that the complexity of the position may have been designed to hide risk and increased leverage to avoid impending financial regulation.  Moore suggests that after building the position, JP Morgan didn't know how to get out of it.

Moore also claims that the JP Morgan disclosure reveals that there is no risk management culture on Wall Street.  JP Morgan was the one bank which should not have failed to manage their risk, with ostensibly better risk management than others.

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