just in in-tray
November 10, 2011
The Canary in the Coalmine,
and Why JPMorgan’s Hands Are Filthy
by Shah Gilani
Dear Reader,
What a fun day that was yesterday.
No, I'm not talking about Jefferson County, Alabama, filing for bankruptcy... that's not fun or funny, as you'll come to learn shortly.
I'm talking about global stock markets and bond markets.
Wow, what fun! Can you imagine being short stocks and having one heck of a day yesterday? I can.
Can you have imagined that Italy's interest rates would have soared the way they did? I can. And you could too, if you read what I wrote on Monday about how the CDS market was broken and what that would do to Italian bond rates.
Look, I'm not the kind of guy to say I told you so, but if I was, I'd sure be saying it now.
Italy is the canary in the coalmine - not Greece. (FYI, they used to keep a canary in every coalmine, because if it died, that meant poisonous gases that humans couldn't smell were present.)
If Italy implodes, either by its bond yields exploding, its economy sinking, or its fiscal house burning, all of Europe is going down. And America will surely follow.
While you were sleeping this morning, Italy had to offer 6.087% interest on the one-year bills it floated. That compares to the 3.57% it paid just last October 11. What smells is that Greece just floated some bills at 4.90%.
In other words, the canary (Italy, in case I lost you) is starting to teeter on its perch.
It has another €28 billion to roll over by the end of 2011, and how much it will have to offer investors to buy its paper is anybody's guess.
There's only one guessing game that matters in Europe right now. That is whether or not the ECB will step up and promise - à la the U.S. Federal Reserve Bank - to be lender of first and last (and in-between) resort.
The ECB has to do something bold. And it probably will.
If it does, the next guess will be, where will its backing and credibility to backstop all of Europe come from?
Will it come from the same teetering nations that's its going to have to support? Good luck with that. Or will it come from the backing of the IMF, with a ton more commitments from the U.S. and other G20 countries? Good luck with that.
We're going to get a relief pop this morning in the stock market. Good luck with that, too.
Until Europe is figured out - and it won't be any time soon - stay short with tight stops, just in case there is a Santa Claus coming to a chimney near you.
Oh, and by the way, if Italy starts singing again, watch Spain, then France, they are the next canaries we'll have to watch in the coal pit we call the European Union.
Now for the "indictment" poke today...Jefferson County filed for bankruptcy protection yesterday. It just happens to be the largest municipal bankruptcy in U.S. history.
Is it the canary in the coalmine for municipal finance? I'm not sure yet. I don't think so. But if the U.S. economy double-dips, like everyone is now saying it won't, then, yes, there will be more municipal bankruptcy filings... count on it.
But that's not the story.
The story is how filthy dirty JPMorgan Chase's hands are in the whole Jefferson County saga - specifically, their JPMorgan Securities arm.
This isn't "new" news. I've written about it before - a lot of people have. You may have missed it, because the spin was so effective that the story got fairly quickly buried.
It's really a long story, and someone should write a book - really, it's that great a story. But I don't have the space and you don't have the time, so, here's the short version.
Jefferson County is full of characters, a few of them who made it into local government, as on the county commission, turned out to be good old boy crooks.
Jefferson County, home to Birmingham, had an aging and stinky sewer system. The EPA demanded that it do something about it as far back as 1996. And, they did.
It was decided that a brand-new sewer system needed to be built, at an expected cost of around $1.5 billion. So the county commission had to decide who would run the financing operations, craft a plan to manage the debt, and float bonds to pay for it.
Here's where I'm cutting out all the starch and getting to the meat of the story...
Local politicians, who were in cahoots with local broker-dealers (securities firms), wanted a piece of all that money that was going to be sloshing around. They ended up demanding (and getting) hefty bribes from big securities firms to let them become the chosen ones to run this lucrative muni finance deal.
I'm not going to get into how Goldman Sachs got involved in 2002 and ended up being paid some $3 million (some of which it passed along to "consultants") to get into this deal... which it ended up doing nothing on, other than participating in the back-door swap arrangement with JPMorgan Securities.
Nor am I going to get into Bear Stearns' dealings, or the small securities dealers who acted as conduits for money being exchanged between JPMorgan (who I am getting into) and all of them. Everybody has dirty hands.
But JPMorgan ended up constructing the finance arrangements and doing most of bond deals that served to finance the building of the new sewer system, and its hands got filthy as a result.
JPMorgan not only overcharged the County by some $100 million in fees (according to an advisor subsequently hired by the County) and, jointly with its co-conspirators, paid out some $8.2 million in bribes; JPMorgan actually imbedded the cost of the bribes it paid into the finance deal it constructed.
In other words, taxpayers and bond holders paid the bribes JPMorgan conveyed to get to run the County's financing of the sewer system.
Oh but it gets better.
Before JPMorgan came to run things, some 95% of Jefferson County's debt was fixed-rate obligations. JPMorgan turned that around to the point that the County ended up with some 93% of its outstanding debt being variable and floating rate debt, subject to interest rate hikes.
But not to worry. JPMorgan created a neat little swap deal so the County was "protected." It didn't work out that way, and interest costs on the County's debts rose to as high as 10%.
In the end, JPMorgan admitted no wrongdoing but amazingly, considering it did nothing wrong, settled an S.E.C. fraud complaint and paid Jefferson County $50 million, paid the SEC. $25 million in penalties and agreed to not demand a $648 million "termination fee" it was due when the County backed out of its swap deal, which helped bankrupt it.
No one at JPMorgan went to jail. Although others were convicted of conspiracy and fraud and folks went to jail for 48 months, 52, months, and 15 years.
But not JPMorgan.
Everything is broken. Good luck with that.
Shah |
