I could have been a contender!

Bummer, they cut me, I’m off the team.  It was a blast while it lasted though.  Imagine, on the same 4x100 free relay with Michael Phelps, Ryan Lochte and Nathan Adrian!  I thought it was a long shot, a good joke really, but no, I got to be part of the team and practice with these guys in Colorado Springs for almost a week before I got the word, you’re out.

It all started on a whim; I sent to the powers that be a photo of a CTS scoreboard with my name on it and my time for the 100, 48”60.  I guess they were real impressed because they sent me an email, backed by a written invitation via Fedex, to come up.  Sure, I looked older - actually I could have been the grandfather of any of my team mates - and as muscular as Popeye before he gulps down his spinach, but hey, 48”60!

I did explain that I needed to use flippers for kicking sets because it helped build up lactic acid faster and therefore was more challenging;  I also avoided racing sets because of a tender rotator cuff.  I got some strange looks, but in the end, they let me do my stuff.  The food was great, I really liked my Ralph Lauren USA sweatsuit, and being with the guys was a blast.

I guess the fun could have gone on for a while longer had we not been dragged to a charity event to race a strong local team of Boys 10 and Under, and lost.  Michael stormed out of the pool, Ryan had a good laugh and Adrian’s eyes rolled back into their sockets.  The coaches were not amused and got real unpleasant: 

-          “What the heck were you doing out there, looking for clams!  And what’s your name again?”

-          “Euh, well …. I can explain but no need to blow a fuse …”

So I did explain; the CTS photo was real enough, except that I had photoshopped it a bit; you see, the actual time was 1’08”46, and no, it wasn’t a long course meter time but a short course yard one.  Anyway, there were pissed and I thought it was unfair because they were all of a sudden nitpicking everything when they had welcome me as one of the boys, as a real contender.

That’s why I do feel great sympathy for the Greeks, I mean, they photoshopped some stats and reports and the like, but it was all in good fun and the Europeans should have realized it from the start, and now the poor Greeks are the butt of unseemly sarcasm and threats of expulsion.  Christine Lagarde of the IMF is even demanding that they pay their taxes!

But you know, there is life after the Eurozone just like there is after Colorado Springs.  Greece is no more competitive within the EU than I was in the pool.  When you “restructure” your privately held sovereign debt and your creditors take an 81%[1] loss, and you still can’t carry your remaining debt, you don’t really belong in the same club as the AA and AAA rated members.  More importantly, you need a break, a devaluation, to adjust your costs, otherwise, you starve yourself to death and/or you have a revolution on your hands.  During the Asian crisis, the Russian ruble devalued 333%, from 6 to 26 to the dollar, making exports of goods very competitive, and while inflation shot up in the fourth quarter of 1998 and the first quarter of 1999, it then slowed down considerably.

While Greece should exit the Eurozone, it doesn’t need to leave the European Union.  Some may argue that Greece should stay within the Eurozone and carry out the reforms needed to regain competitiveness.  The problem is that these reforms, politically and socially, would take years to be implemented (more time than financial markets would allow), and success would not be assured.  Even then, given its demography, economic structure and size, Greece can’t rely solely on cost cuts to be competitive with the likes of Germany, Holland and France; so it still needs a one-time large devaluation to close the gap, and perhaps a continuing one to stay within range.  Either way, it would be a hard slog, and it may be that Greece chooses to follow a different path, of less stress and slower growth.

A good relay must be made up of swimmers of comparable caliber who also get along well together.  The same goes for a political and economic federation of countries.  People point out to the example of the USA at the end of the 18^th century as a possible model for the Eurozone.  I would say that the (voting) Americans of that time had more much more in common than the EU today:  they were Anglo-Saxon, spoke English and had left Europe to found a new country common values.  The Europeans of today are far more diverse, don’t speak the same language and don’t (yet) want to be governed by bureaucrats from Brussels.

Perhaps a smaller eurozone will survive, with the necessary fiscal and political integration. This may not be the best outcome, as it may not respond to popular aspirations and would codify a two or three-speed EU.  A better solution may be a Europe of Nations, as envisaged by de Gaulle back in the 1960s, but one accepting enough fiscal and monetary coordination so as to facilitate a system of floating currencies whose exchange rates will be confined to a wide band that will accommodate some differences in policies and economic cycles; an improved “snake in the tunnel” of the 1970s if you wish (it is interesting to note that, in the end, only Germany, the Benelux and Denmark stayed in the tunnel).

Step up …get set …

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[1]  It was estimated at 75% initially, but since then, Greek yields have skyrocketed.

A few thoughts on JP Morgan’s hedging loss

JP Morgan announced yesterday that its Chief Investment Office had incurred a loss of $2 billion on derivative trading undertaken for the purpose of hedging its loan portfolio.  This loss in turn had been partially offset by $1 billion of realized gains in regular trading.  JPM’s Jamie Dimon further warned that the CIO loss could rise or fall substantially until the derivative positions were undone.

As a shareholder, I was surprised by the announcement and I am not happy.  In the charged regulatory and political climate of Washington, we can expect all kinds of theater; Congress has already announced hearings on the matter; the SEC and the New York State Attorney have announced inquiries.  While the stock has fallen 9% already, it could fall further.

There some troubling aspects to this loss:  (1) how could these derivative positions lose so much money in so little time? (2) market rumors of excessive position building seem to have preceded JPM’s top management awareness of the magnitude of the problem, (3) how could anyone believe that building a position, big enough so as to be illiquid, be a good way to hedge a portfolio? (4) if indeed the short hedges lost money, there should have been a commensurate gain on the asset side JPM balance sheet.

Beyond the above questions, there are some more fundamental issues: (1) is this incident evidence that JPM has become too big to manage, even for as detailed-oriented a manager as Mr. Dimon, or is this proof that even the best falter sometimes? (2) there have been reports, unconfirmed so far, that those responsible for hedging at CIO had recently been expected to show a profit as well; (3) old-time bankers like me remember when the kind of derivatives JPM used didn’t exist, yet banks tried to protect against portfolio losses by having ample capital and  building general loan loss reserves in good times; shouldn’t regulators and banks take another look at these remedies?

I will close with two observations:  having pulled through the crisis unscathed, JPM has not been bashful about its prowess.  Its CEO can come across as arrogant at times, and I can see how many officers at the bank, by assimilation, could consider themselves as the new masters of the banking universe; hubris can be as dangerous, in its own way, as lack of competence.  Although it is purely a personal speculation of mine, I believe that the huge cost of litigation and regulation is pushing banks to make up for lost profits in every nook and cranny, in the case of JPM in what used to be a hedging activity.  Ironically, Congress and state attorney generals have some paternity in the JPM loss.

Clearly, JPM has built huge derivatives positions that it can’t easily close.  Market participants will quickly figure out which these are, if they don’t know already, and bid against JPM.  This is why Mr. Dimon warned about volatility and his determination to use his balance sheet not to be forced into untimely liquidation.  Consequently, it is prudent, in the absence of detailed information which is unlikely to be aired publicly, to assume that JPM could incur a bigger loss than the above gross $2 billion.

Even if the gross loss number were doubled to $4 billion, or about $1.05/share , pre-tax, the tangible book value at the end of the year is likely to be close to $36 [1] per share.  I would think that buying below that level would represent an interesting opportunity.  After all, the bank is well diversified, has plenty of capital and, despite this embarrassing loss, well managed.

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[1] $34.5 tangible book at 3/31 + $4.7 of earning - $2.1 of net loss - $1.2 of dividends.  Book value would rise to $49.1.  I have assumed no net share buyback for the rest of the year.

Presidential aftermath

François Hollande won the 2012 presidential elections, which was not a surprise.  As I anticipated in my previous blog, the score was much tighter than expected, 51.6% to 48.4%.  Also, people who had voted for the Front National in the first round largely voted for Mr. Sarkozy in the second.

I thought that, with a good debate performance, Mr. Sarkozy could squeak by.  Unfortunately for him, while he assumed the role of the underdog, he was too often on the defensive and his overly aggressive style grated on many.  Mr. Hollande held his own, looked more composed, and in my view won.

Indeed, Mr. Sarkozy may have lost his reelection on style rather than substance.  Many would acknowledge that he did his best to undo some of the anti-competitive measures that prevented France from keeping up with the likes of Germany – the infamous 35 hour week, retirement at 60, an ever growing public sector – and he tackled some other issues – such as wearing the burka in public – that risked poisoning social relations.  But his often rough tone, cavalier treatment of his cabinet, apparent fascination with billionaires and hyperactivity gained him many detractors and won him few allies.  When he needed the votes, supporters didn’t materialize and opponents felt energized.

Obviously, other factors were at play.  First, many felt that after 17 years of center right government, there was a need for change.  Second, the incumbent was penalized for the economic crisis which happened on his watch.

What next?  As Mr. Sarkozy steps out of politics (at least for now), the political debate will focus on issues.  It will be interesting to see what Mr. Hollande proposes, but as I pointed out in the past, the actor to watch is Italy: in my view the dual leadership of France and Germany is fading, to be replaced by a troika of France, Germany and Italy.  And while Italy is sympathetic to greater emphasis on growth, it is doing the heavy lifting in the area of reforms and will not support mere deficit spending, if it were proposed.  Besides, Italy doesn’t have the financial resources to fund such an EU-wide program.

Yes, difficult times lie ahead, but failure is far from being a foregone conclusion; on the contrary, there are elements in place to produce a sounder, better balanced EU.  Markets, for the time being, sense this and are giving European politicians the benefit of the doubt.