Theater of the Absurd: A View From the Inside
by Rob Kirby, Kirby Analytics. May 18, 2009
I read an article that was published by The Institutional Risk Analyst [IRA] titled, Kabuki on the Potomac: Reforming Credit Default Swaps and OTC Derivatives. According to the Kabuki article,
"Kabuki is classical ancient Japanese folk theater performed broadly and loudly for the general public. I became familiar with it when I lived in Tokyo years ago. Kabuki on the Potomac this week fit Kabuki's theatrical definition with lawmakers wailing loudly, uttering angry threats, and rhythmically pounding podiums in a performance of mangled metaphors and fantasy."
An article about derivatives whose title is drawn from Japanese folk theater, law makers wailing loudly, angry threats, mangled metaphors and fantasy sounded like it might contain a few kernels of truth, piqued my interest, so I read it. I took issue with the thrust of the article and contacted the folks at Institutional Risk Analysis and told them I thought their article was “missing it” – to me, characterizing the ongoing derivatives debacle as a big mistake.
To their credit, one of the principals at IRA responded, asking me what “it” was that they were missing.
This is how I replied:
Your article mistakenly cites CDSs as the epicenter of the derivatives mess. The rest of the derivatives are only referred to as “other OTC derivatives”.
“Despite bringing the world economy to its knees and costing taxpayers hundreds of billions of dollars in bailouts for events such as Bear Stearns, Lehman Brothers and American International Group (NYSE:AIG), the Masters of the Universe who run the largest Wall Street firms of have learned not a thing when it comes to credit default swaps ("CDS") and other types of high-risk financial engineering. Indeed, not only are the largest derivative dealers fighting efforts to reform the CDS and other derivative instruments that caused the AIG fiasco, but regulators like the Federal Reserve Board and US Treasury are working with the banks to ensure that a small group of dealers increase their monopoly over the business of over-the-counter ("OTC") derivatives.
Why such a desperate battle for the OTC derivatives markets? For the world's largest banks, the OTC derivatives markets are the last remaining source of supra-normal profits - and also perhaps the single largest source of systemic risk in the global financial markets. Without OTC derivatives, Bear Stearns, Lehman Brothers and AIG would never have failed, but without the excessive rents earned by JPMorgan Chase (NYSE:JPM) and the remaining legacy OTC dealers, the largest banks cannot survive. No matter how good an operator JPM CEO Jamie Dimon may be, his bank is DOA without its near-monopoly in OTC derivatives -- yet that same business may eventually destroy JPM.”
Your article asks about or suggests that there was a desperate “battle” in the OTC derivatives market, but then speaks in terms of it being about J.P. Morgan wanting or needing to earn excessive rents to survive.
This completely misses the mark. You have not identified “the major” contributor of this excess AT ALL.
Look at the concentration of derivatives as reported by the OCC:
66+ of 91 Trillion notional at J.P. M. is interest rate exposure. 22+ of 34 Trillion at Citi the same. 16+ Trillion of 32 at B of A. And all your article mentions is CDS???
Much of these interest rate derivatives are interest rate swaps [IRS]. IRS > 3yrs. duration typically have U.S. government bond trades embedded in them. Total outstanding U.S. debt is 11 or so Trillion. So, ask yourself why all this trading when there is DEMONSTRABLY NO end user demand for this stuff:
If you follow John Williams’ work – shadowstats.com you know that official inflation reporting is “jacked beyond belief”. The interest rate FRAUD goes hand-in-hand.
The creation of this interest rate DEBACLE is tantamount to the GROSS mis-pricing of capital which all other economic excess [including the tech boom, real-estate boom and CDS extravaganza] stemmed from.
Additionally, given the size of J.P. Morgan’s derivatives book and the fact that the contents thereof have crippled or killed other institutions with fractions of their exposure, other BIGGER questions should be asked. When you read the following – given what is already known - it should make one wonder if accounting even happens at J.P. Morgan:
First reported by Dawn Kopecki back in 2006 when she reported in BusinessWeek Online in a piece titled, Intelligence Czar Can Waive SEC Rules,
"President George W. Bush has bestowed on his [then] intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye."
What this means folks, if institutions like J.P. Morgan are deemed to be integral to U.S. National Security – they could be "legally" excused from reporting their true financial condition.
The entry in the Federal Register is described as follows:
The memo Bush signed on May 5, which was published seven days later in the Federal Register, had the unrevealing title "Assignment of Function Relating to Granting of Authority for Issuance of Certain Directives: Memorandum for the Director of National Intelligence." In the document, Bush addressed Negroponte, saying: "I hereby assign to you the function of the President under section 13(b)(3)(A) of the Securities Exchange Act of 1934, as amended."
A trip to the statute books showed that the amended version of the 1934 act states that "with respect to matters concerning the national security of the United States," the President or the head of an Executive Branch agency may exempt companies from certain critical legal obligations. These obligations include keeping accurate "books, records, and accounts" and maintaining "a system of internal accounting controls sufficient" to ensure the propriety of financial transactions and the preparation of financial statements in compliance with "generally accepted accounting principles."
The CDS Fraud that your article identifies is a “side show” which deflects attention away from the more heinous crime committed with “neutering usury” thereby allowing the U.S. Treasury and Private Federal Reserve to “scapegoat” mostly non-bank entities like AIG, Bear, Lehman and YOUR grandmother as soon as they figure out a way to blame her too!
And here’s how they responded back to me:
“Good piece. Our view is from inside. Yours is a market view. Somewhere among several perspectives lies the truth – at the moment.”
The truth really is out there, somewhere, isn’t it?
Overseas equity markets began the week on a sour note with Japan’s Nikkei Index falling 226 points to 9,038. North American markets brushed that aside and reacted positively with the DOW advancing 235.40 to 8,504.10, the NASDAQ gaining 52.22 to 1,732.36 and the S & P ahead by 26.80 points to 909.70. NYMEX crude oil futures gained 2.92 to close at 59.28 per barrel.
In the interest rate complex the benchmark 5 yr. government bond finished the day at 2.08% while the 10 yr. bond ended the day at 3.22%.
On foreign exchange markets the U.S. Dollar Index gave up .43 to 82.68.
Precious metals were battered with COMEX gold futures falling 12.40 to 919.50 per ounce while COMEX silver futures dropped .17 to 13.82 per ounce. The XAU Index fell .38 to 136.41 and the HUI Index was off by 3.50 to 338.42.
On tap for tomorrow, at 8:30 a.m. Building Permits data is due – expected 530k vs. previous 516k and also at 8:30 a.m. April Housing Starts data is due – expected 525k vs. prior 510k.
Wishing you all good health and a pleasant evening!
© 2009 Rob Kirby