Tag Archives: Eurozone

Clearing The Bull: JP Morgan And Derivatives Derangement Syndrome (DDS) Part III

Some of the attacks on JP Morgan are indicative of the extent to which governments, regulators and the media understand neither risk nor banking. This is the third in a series of articles on the JP Morgan derivatives loss—here are the links for Parts I and Part II.

What is Derivative Derangement Syndrome (DDS)?

It is when the fear of derivatives becomes so irrational that it renders the victim either unwilling or unable (sometimes both) to see derivatives for what they are, or to come to terms with potentially greater threats to the financial system and the economy. It is a dangerous malady.

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Clearing The Bull: JP Morgan And Derivatives Derangement Syndrome (DDS)

The headline writers are at it again as just about every publication that can spell the word derivatives is bemoaning JP Morgan’s $2 billion credit derivatives loss. Meanwhile, on planet Earth, the EU continues to sink under hundreds of billions of dollars of debt.

JP Morgan’s $2 billion credit derivatives loss is, in reality and the greater scheme of things, a non-story.  It’s a 1% loss on a $200 billion investment portfolio. It is a 0.1% impairment of a $2 trillion balance sheet. This is minor when compared to the hundreds of billions of dollars in junk and distressed Eurozone sovereign debt.

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The Disastrous History of Financial and Market Dogma

Like alchemists on an eternal quest for a method for turning base metals into gold, the financial markets have proved susceptible to one dogma after another—with disastrous consequences.

One of the primary causes of the massive growth in the subprime market was the idea that if you took a well-diversified portfolio of sub-investment grade loans you could convert them into AAA securities. Some market professionals were even of the opinion that the level of risk reduction that could be achieved through diversification could effectively, with the aid of a few credit derivatives, immunize banks from any significant losses whatsoever.

While acknowledging that was the prevailing view, Alan Greenspan the former Fed Chairman had another perspective. In a column in the Financial Times of March 26, 2009 Greenspan stated:

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