November 11, 2002 10:00 AM
JPM Denies -- Harvey Cries
Since the Fed cut rates last Wednesday the U.S. dollar has declined, bonds have gained, stocks have dropped, and no other major central bank has followed the Fed’s lead and cut rates (both the BOE and ECB held rates firm last Thursday). Suffice it to say, and speculations that a falling dollar is wonderful news for the U.S. aside, the 50 basis point cut by the Fed has not turned out to be a welcomed surprise.
As suggested last Monday, bank stocks were one of the most important groups to watch following the FOMC meeting. As it turned out, no one was willing to make any bets that a new bull market was in the works following the FOMC meeting – no one was willing to buy bank stocks. The BKX index topped out at 797 last Monday, it began to drop leading into the Fed meeting, and the average has slid lower ever since (thanks in part to rumors of JPM default).
Derivatives Giant Says Rumors Just That
If JPM or any other OTC player wants to assure shareholders that their multi-trillion dollar OTC positions are not at risk of collapsing there are two ways to do this: open up the books or stop using OTC derivatives. Quite frankly, that JPM continually has to deny that they are not at risk of a massive OTC default adds validity to the idea that a default is at least possible…
Supposedly derivatives can help companies manage risks in currency prices, energy prices, gold, interest rates, etc. Think about this for a second:
- Companies that previously used derivatives to hedge against fluctuations in the price of gold lost money when gold rallied so they don’t hedge anymore.
- Companies that previously traded energy derivatives (often times to artificially boost revenues), have yet to recover after merchant energy king-pin Enron collapsed, so they don’t trade derivatives anymore.
What happened with many gold and merchant energy companies is not an isolated phenomenon. To be sure, derivatives are not solely used for the purposes of ‘hedging’ exposure to unexpectedly freakish developments (i.e. a plunge in a foreign currency which could impact financial results). Rather, derivatives are used by companies to make money. Quite frankly, when a trading instrument is used to make money this creates risks – the exact opposite of what OTC derivatives are supposedly used for.
“The rumors circulating today are false and irresponsible” JP Morgan
What is ‘irresponsible’ is for any shareholder to believe that a company can have $25 Trillion in leveraged financial instruments and not be at any risk of losing money. Yes, I understand the concept of ‘hedging’ – I even understand that unless the unbelievable happens -- unless gold goes to the moon, the U.S. dollar collapses, interest rates collapse, etc – that the larger OTC players are not at threat of default.
However, what I also understand is that the derivatives in general can be used to strangle markets: gold hedgers helped beat gold down to $252 an ounce by selling their production forward and using secretive put/call schemes, and energy traders sent California Energy prices spiraling higher simply for the fun (profit) of it. This is what unmitigated financial leverage can sometimes do: it massages market prices to extreme levels, thus making further ‘hedging’ activities increasingly more dangerous. Put simple, and as was (is) the case in gold and energy prices, the unregulated influence of the OTC derivatives market becomes a fundamental. Such is why people fear that a party is about to be crushed by a gold rally: the supply/demand fundamentals argue that gold should be trading at a higher levels while the OTC derivatives fundamentals are what is holding the price down.
Some investors worry about expensing stock options, deteriorating pension plans, and off balance sheet financing. We regard these investors as smart, skeptical, and logical people. By contrast, when someone says JPM is rigging the price of gold through use of OTC derivatives most people regard these commentators as crackpots.
As it stands now, Greenspan will bail out the next institution whose computers didn’t think a financial instrument could possibly sway beyond a certain price level. Given that LTCM was brushed off as a one time fluke, it remains to be seen whether the next default will generate enough public outcry for the regulation of the OTC derivatives. That said, some investor’s voted against non-regulated multi-trillion dollar financial exchanges last week: some investor’s sold JPM…
Fed Still Has Some Magic
Before last weeks FOMC rate cut it was reported that consumer confidence was at a 9 year low – the markets rallied. As well, the ISM manufacturing index slumped below expectations – the markets rallied. Furthermore, Oct payrolls decreased by 5,000, auto sales crashed, demand for mortgages weakened, retail sales dropped, and 3Q02 GDP came in lower than expected – yet the markets still rallied.
Point being, if maniacal traders, speculators, and investors had not been salivating over an anticipated Fed cut two weeks ago the markets would not be as high as they are today.
That said, with the markets using the FOMC meeting as a reason to sell it is worth remembering that the Fed is almost out of rabbits, and one of these rabbits is reserved for the next LTCM.
This Week
The two main reports due out this week are October Retail sales and October Industrial Production (capacity utilization). Also on tap is the first glimpse at November consumer confidence (Mich). The confidence numbers could be higher given the October stock market rally and last week’s stable retail sales reports.
“The Fed's pre-emptive move to cut the federal funds target to 1.25 percent should head off any negative market reaction to the economic data in the next few weeks.” Rex Nutting, CBS MarketWatch
How Mr. Nutting can make such a bold claim is unknown. For certain, if this weeks numbers are exceptionally bad the markets will not care about last weeks Fed cut. In fact, and someone should inform Mr. Nutting of this, financial markets around the world have actually dropped because of the Fed’s rate cut – there has been no post Fed upshot! Mr. Nutting also predicted that the Fed would not cut interest rates before last weeks FOMC meeting.
Thankfully, The Pitt Saga is Almost Over
Brief Chronology:
-- The Public Oversight Board voted to terminate its existence because Pitt met with accountants and CEOs and not them.
-- POB backer Lynn Turner was ousted by Pitt. Mr. Pitt replaced Turner with his accounting buddy Herdman.
-- Pitt met with accountants and CEOs under investigation without telling anyone at the SEC. He apologized after the first questionable meeting but was too ashamed to say anything after the second incident.
-- Pitt lied (forgot?) about the extent of his involvement with AOL.
-- Pitt neglected to inform SEC voters that new oversight board candidate Wesbster’s past might come under investigation. This new board is supposed to replace the POB.
-- Pitt resigns after Webster debacle is exposed.
-- Herdman resigns after Pitt is exposed.
Following this chain of events you would think that Mr. Pitt would be endlessly apologizing for failing miserably as SEC Chairman. Instead, Mr. Pitt had the audacity last week to state that political reasons were behind him having to resign. Pitt received a standing ovation from an almost tearful crowd as he lashed out, “I hope my successor isn't greeted with the same climate of attack and partisanship. It's easy to find fault and it's easy to criticize.” Does Mr. Pitt not realize that investors and fellow SEC members also want him out?
If remembered at all, Mr. Pitt will go down in history as one of the worst SEC bosses ever. Good intentions and promises for tangible changes aside, Mr. Pitt spent his entire tenure on the defensive because he never once challenged corporate America and Wall Street on important issues. Incidentally, the only reason why the crowd cheered and sobbed during Pitt’s farewell speech was because the audience was mainly from Wall Street. Of course Wall Street loves Mr. Pitt – after lying, cheating, and stealing Wall Streeter’s thought they were headed for prison. Instead, Pitt took them out to lunch.
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