The House of Morgan

"Day after day, J.P. Morgan’s name keeps turning up in the wrong places."

Eric Fry

From south of the Rio Plata comes more evidence that Central Bankers – like other bankers – will only give you money when you don’t really need it.

"Every day, about 1,000 Argentines like Gauto stand in line to sell anything from cameras to violins to ivory chess sets at Banco de la Ciudad de Buenos Aires, the only government-owned pawn shop in the capital," reports a Bloomberg article. "With a devaluation that has cut the peso’s value in half the past month eating into wages, and most savings still locked up in banks, Argentines have resorted to selling their most valued items to pay for food and rent.

"The recession has brought new business to Banco Ciudad, owned by the City of Buenos Aires, where the number of pawned items has almost doubled since December, when Argentina first limited withdrawals. On Tuesday, Argentines pawned 900 pieces of jewelry valued at 233,000 pesos, 102 items of audiovisual equipment worth 14,000 pesos and five works of art appraised at $3,000. In the 12 months through January, sales of goods brought in for direct sale rose 30 percent to $320,000."

Argentines desperately need money. And if any central bankers know how to "crank up the presses," surely it is the Argentines. As recently as the late ’80s, the printing presses of the pampas cranked out so much currency that a peso printed at the beginning of the year had lost 90% of its value by Christmas.

But, of course, that was when Argentina had no use for additional currency. In the ’80s, Argentines needed less money, not more.

Who would have imagined what would happen scarcely a decade later? Argentina, as you may recall, beat its inflation problem by turning off the presses and pegging its peso to the U.S. dollar. The dollar, though, has been remarkably high, which put Argentina’s exporters at a comparative disadvantage. Within a few years, the economy was in a slump. This year, in fact, marks the 4th year of recession.

Argentina, of course, borrowed billions from accommodating lenders such as J.P. Morgan…which, as Eric points out above, never met a bad loan it didn’t want to make.

Finally, Argentina had to break the currency peg and stiff its creditors. Naturally, people in Argentina worried that the peso would fall in value and rushed to banks to try to get their money. The government moved to protect the banks by limiting the amount of money a person could withdraw. Even if you have a million pesos in the bank, you’re only able to take out about $800 per month to live on.

We reported the strange case of a man who showed up at a bank with a hand grenade – threatening to blow the place up if he didn’t get his money. The man was arrested. Which just goes to show how upside-down things really are in the southern hemisphere. It should have been the bankers and politicians who were arrested – for stealing the poor man’s money. But that is not the way of the world south of the equator…or north of it.

Central bankers can create "money," dear reader, but only when you don’t really need it. The argentine peso has lost 50% of its value in the last month. Still, in real terms, prices are falling – as desperate people unload family heirlooms in order to get enough cash to pay their rent. The pawnshop lines begin forming at 4 a.m., reports Bloomberg. And prices for unreclaimed goods are plummeting. Unemployment is soaring to Great Depression levels. If central bankers really could create "money," what better time to show off their skills?

But that is the problem. Alan Greenspan is only a maestro at creating "money" in a boom. In a real bust – which we haven’t had yet in America – he will be a total flop. In a bust…that is, when money is most needed… the demand for cash goes up, but the supply goes down. Central bankers can do nothing about it.

American Banker magazine reports that the largest 25 U.S. banks have $16.6 billion of exposure to just two risks – Argentina and Enron. And the bank with the largest exposure – to these as well as other hazards – is J.P. Morgan. Today’s news tells us that the House of Morgan was also the most aggressive lender to Tyco… from which it now faces a loss of up to $1 billion. As long as the economy was in boom mode, lenders were happy to throw their customers’ money around. But when times begin to get tough, it becomes tough to get new credit. Lenders become wary. Even as the central bank lowers short term rates, borrowers find they have to pay more for their money.

As Eric notes above, Qwest had to draw on more expensive bank financing after it was unable to sell its commercial paper. Other borrowers are facing the same problem. Regardless of what Greenspan may want, the credit markets have interest rate policies of their own. A credit downgrade is equivalent to an interest rate hike.

J.P. Morgan was named "Bank of the Year", "Derivatives House of the Year", and "Loan House of the Year" by International Financing Review. But when one’s star has risen so high that one’s mug appears on a magazine cover – like Jeff Bezos on the cover of TIME – it is usually a prelude to disaster.

In the investment world, few indicators are as reliable as the big banks. Find out where the big banks are lending a lot of money – and it is almost always a black hole. Each decade seems to produce at least one major cosmic implosion in the banking world. In the ’70s, banks lent to oil producers…and Texas real estate. In the ’80s, it was emerging markets. In the ’90s, telecoms provided the garbage pail for bankers’ money.

And some banks seem to be able to get in on every losing opportunity that comes along. So far, no major losses have been announced in the press without J.P. Morgan’s name mentioned. Enron, Qwest, Argentina, Tyco…how many of these disasters can the bank sustain ?

We don’t know. But the problem goes far beyond J.P. Morgan.

"Maybe I’m naive," writes Stephen Roach, "but I must confess to being amazed at how little we in the macro community know about the possibility of more Enrons. The same is true of the markets…there can be no mistaking the broader excesses of corporate leverage in the system; corporate debt currently stands at a record 65% of US GDP. While that doesn’t guarantee that there will be more Enrons to come, it does speak of a business culture replete with risk – one that is ill-prepared to handle a broader contagion that would raise borrowing costs and/or result in a significant restatement of the underlying earnings stream that is required to service such obligations.

"The same can be said of household sector leverage in the United States," Roach continues. "Total consumer indebtedness currently stands at a record 73% of GDP. This, in my view, is an unmistakable legacy of the asset bubble. First stocks, now homes, American households have been unusually aggressive in borrowing to support lifestyles. In doing so, of course, they have depleted traditional saving balances and relied increasingly on readily available credit to extract newfound income from inflated asset values. The overhang of excess debt, however, remains a troubling aspect of the post-bubble hangover. Should income continue to weaken, or interest rates suddenly increase, it would be exceedingly difficult for the household sector at large to keep servicing this debt. The problem, of course, would be even more acute if the U.S. were ever to experience a whiff of deflation. The debt-deflation trap is one of the most intractable dilemmas for any economy. Just ask Japan."

We don’t know what will happen to J.P. Morgan. (We’d like to know where the big banks are going to lend next, so we can sell short).

But we’re willing to bet that even J.P. Morgan is beginning to ask questions of its borrowers, and may ask for a point or two of extra interest to try to offset its losses in other parts of the business. And, we’ll hazard another guess – that the recovery in the U.S. economy will be as strange as the recession that preceded it. "Money" will get tighter, not looser. The more people really need it, the less money will be available to them.

Telling it like it ought to be,

Bill Bonner
February 15, 2002  — Baltimore, Maryland

Not much excitement in the markets yesterday. The Dow closed above 10,000. Gold closed above $300.

The recession is over. Stocks are nearly as high as they’ve ever been. Why? Because investors lack imagination. They believe the next 20 years will be like the last 20.

If the next 20 years are like the last 20, in 2022 gold will again close at $300…and the Dow will close at 100,000.

People generally find it pretty easy to extrapolate out current trends. Why shouldn’t the Dow continue to go up, they ask. Why shouldn’t gold stay where it has been?

And maybe that is exactly what will happen…

But Mr. Market, we observe, likes to surprise people. Stocks could go nowhere for the next 20 years…just as they did following the peak of ’29 and the peak of ’66. Gold, on the other hand, could be at $3,000 an ounce by 2020. Sounds incredibly high. But it’s less than 4 times gold’s previous peak – set more than 20 years ago!



Eric Fry on Wall Street:

– Forget about the heart-shaped box of chocolates. Put away the pink lingerie. Valentine’s Day on Wall Street featured no passion whatsoever. The stock market’s trading action was like a kiss from grandma. Some stocks fell; some stocks rose; some did nothing at all.

– The Dow Jones Industrial Average managed to close a hair above 10,000 by gaining 12.32 points. However, the Nasdaq Composite slipped 15.78 points to 1,843.38.

– It should be clear by now that we here at the Daily Reckoning are lovers…not fighters. And we are particularly infatuated with poking fun at Wall Street’s absurdities…like the CEO who can’t remember anything about the company he ran last year, or the analyst who makes a couple million dollars per year no matter how rarely he is correct, or the highly regarded bank that never met a bad loan it didn’t like.

– JP Morgan Chase made more of the wrong kind of headlines yesterday. Day after day J.P. Morgan’s name keeps turning up in the wrong places. Yesterday, its name turned up in connection with the financially destitute Qwest Communications.

– Qwest’s stock and bonds tanked yesterday, Bloomberg News reports, "after the fourth-biggest local phone company borrowed $1.1 billion from banks because it couldn’t get money from money-market investors. Qwest tapped a credit line arranged by J.P. Morgan Chase & Co. and Bank of America Corp. for day-to-day financing because the company couldn’t sell commercial paper."

– "Tyco International Ltd. tapped bank lines last week," Bloomberg reminds us, "and Enron corporate did so before filing for bankruptcy."

– Morgan is a prominent lender in all three cases.

– One thing I’m dying to know: Has J.P. Morgan Chase made any GOOD loans?

– I’m also very curious to know why the esteemed Wall Street strategist, Douglas Cliggott, abruptly announced that he will resign his post at J.P. Morgan.

– On the one hand, the move seems fairly predictable. The habitually bearish Cliggott always seemed like a misfit within the oh-so-New-Economy House of Morgan.

– On the other hand, it is quite curious that Cliggott would depart from JP Morgan, the investment bank nonpareil, to join the virtually unknown Brummer & Partners, an asset management firm in Stockholm, Sweden.

– Maybe Cliggott caught wind of some kind of upsetting news one day by the water cooler. Or maybe he just likes herring and Abba.

– J.P. Morgan’s serial lending disasters illustrate that there may be a lot more that we don’t know about this banking giant than we do know.

– It’s enough to make an investor paranoid.

– But if the folks running American corporations are as deceptive, greedy and/or inept as recent events suggest, paranoia is not a psychosis, but a rational response.

– In the current environment it’s easy to feel like a woman who suddenly discovers that her husband of 25 years has a second family in Thailand and a third family in Newark. Every minute detail of those 25 years suddenly falls under a dark cloud of suspicion.

– Meanwhile, the woman’s friends, somewhat nervously, begin to wonder where their husbands’ second and third families might reside.

– "The issue isn’t so much whether many companies are committing fraud," the Wall Street Journal explains, "it’s more a question of how many companies tweak their earnings numbers here and there just to make the crucial number, earnings per share, look better."

– It’s true that "tweaking the numbers" has become as politically incorrect as smoking cigarettes, and that investors want "honest numbers"…or so they say. Unfortunately, the dishonest numbers we’ve grown to love look a heck of a lot better.

– "The attention being paid to quality of earnings is likely to increase rather than fade away," says Bridgewater associates, "and the surprises are more likely to be bearish then bullish."


Back in Baltimore…

*** Lost money in the stock market? Don’t spend a minute worrying about it.

*** My son Jules was out late at night with his 14-year- old friends. One of the group stepped out into the street and was struck by a speeding van.

*** The boy was rushed to shock trauma. At first, the family was hopeful that he would be all right. But it is now 2 weeks later, and today brings sad news. The boy is still in a coma…and seems to have suffered severe brain damage. He may never wake up, say the doctors.

*** "I can’t imagine how bad Edouard’s parents must feel," said Elizabeth when she told me the news by phone. "I don’t even want to try."

*** When you are crossing the road in Paris…or any city…please be careful.

The Daily Reckoning