Tyndall Monthly Commentary

Last Friday we took the red-eye back from New York following some meetings with quite senior staff at some of the "Masters of the Universe" institutions and on landing we found that we had been volunteered by our domestic management to man a stall at the school fair.... To pass the time and keep awake we found ourselves flicking through a tatty copy of Tom Wolfe's Bonfire Of The Vanities, which, following our trip and the situation that we had uncovered following the JP Morgan (JPM) trading debacle, seemed oddly appropriate, if not a little concerning.

Without going into the details of JPM's travails, we believe that following what started as a rational, well-advised and probably notionally very profitable hedge on corporate risk in the Euro crisis became rather too large and as a seemly exit from the position became impossible, an offsetting hedge (that is, selling insurance on US corporate default risk) was concocted but, partly as a result of the mathematics of the derivatives, this too became an overly large position that now also cannot easily be reduced.  Unfortunately for JPM, the markets now all know the sizes and compositions and hence are proving adept at trading against the company and thereby creating if not the prospect of an open-ended loss, at least the prospect of a very large one.

It is not, however, the reaction of the press to the JPM incident that is significant here. Instead, it is the attitude of the Federal Reserve's regulators to the event.  As we understand it, from the official side it is not just the SEC that has become involved in investigating the incident but also the Federal Deposit Insurance Corporation and, most of all, the supervisory departments of the Federal Reserve, who are now moving through JPM's and the other banks' systems with a fine-toothed comb.  Moreover, when we have asked industry insiders as to whether this type of reaction by the authorities matters to JPM or to others in the industry, we have found that the response has been rapid and at times even bordering on emotional: the JPM trading losses and most of all the authorities' natural reaction to them have already unleashed a process that is likely to curtail not only JPM's activities in the securities markets but also those of others for a significant period of time.