Auntie Fannie and Uncle J.P.
A flat yield curve makes it difficult for these behemoths to make money.
MV Special Announcement: Be sure to participate in the Minyanville/Ruby Peck Foundation gold coin auction to invest in a piece of history and a child's future.
Editor's Note: Minyanville is a community of people who share an interest in fiscal literacy. As perspective is an important aspect of our daily routine, we share this exchange with hopes that it adds balance to your process.
Prof. Succo -
Thanks for keeping our friends at Fannie Mae (FNM) front-and-center. I've got a question related to the contagion theme. You've cited several times that J.P. Morgan (JPM) is the largest counterparty to Fannie in their derivatives portfolios. Today, as Fannie tanks, JPM yawns. So what's awful for Fannie isn't necessarily awful for JPM (or maybe the Minx just doesn't care, yet).
Could you tell the Minyanship a bit more about the counterparty relationship (i.e., who owes what stream of cash flows to whom and under what conditions), and explore the possibility that what's really bad for Fannie might (1) not matter much to JPM or (2) might actually be good for JPM? Thank you.
(disclosure: short FNM)
JPM is a completely different animal with completely different risks.
They are the largest counter-party to FNM, taking a fair portion of the company's interest rate (volatility) risk: FNM buys a derivative from JPM that hedges their interest rate volatility risk, thereby transferring it to JPM. So JPM will lose money if the bond market gets more volatile (they get paid a good premium to take this risk). Of course, if FNM were to "default" on their derivatives, JPM could lose billions of dollars, but this won't happen. The government (taxpayers) would almost certainly step in and guarantee performance on those contracts. Otherwise, FNM could cause a financial melt-down.
The risk that JPM entered into finite insurance arrangements (these arrangements really only "smooth" earnings, acting as a pool of funds a company can draw upon from time to time) similar to FNM is not higher than any other company just because JPM did business with FNM.
That being said, I have other reasons to be negative on JPM and other central banks like Citigroup (C) and Banc of America (BAC): a flat yield curve makes it difficult for these behemoths to make money, these are the largest credit card dealers in the world and that business in my mind is likely to hit a rough patch, the risk controls are not conservative enough, and they have large derivative exposure (an understatement especially for JPM) that I believe is not marked to reality.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter