Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
USDT is 9-11 for Central Banks the Bitcoin Black Swan - Tether Un-Stable Coin Ponzi Schemes! - 30th Jul 21
Behavior of Inflation and US Treasury Bond Yields Seems… Contradictory - 30th Jul 21
Gold and Silver Precious Metals Technical Analysis - 30th Jul 21
The Inadvertent Debt/Inflation Trap – Is It Time for the Stock Market To Face The Music? - 30th Jul 21
Fed Stocks Nothingburger, Dollar Lower, Focus on GDP, PCE - 30th Jul 21
Reverse REPO Market Brewing Financial Crisis Black Swan Danger - 29th Jul 21
Next Time You See "4 Times as Many Stock Market Bulls as There Are Bears," Remember This - 29th Jul 21
USDX: More Sideways Trading Ahead? - 29th Jul 21
WEALTH INEQUALITY WASN'T BY HAPPENSTANCE! - 29th Jul 21
Waiting On Silver - 29th Jul 21
Showdown: Paper vs. Physical Markets - 29th Jul 21
New set of Priorities needed for Unstoppable Global Warming - 29th Jul 21
The US Dollar is the Driver of the Gold & Silver Sectors - 28th Jul 21
Fed: Murderer of Markets and the Middle Class - 28th Jul 21
Gold And Silver – Which Will Have An Explosive Price Rally And Which Will Have A Sustained One? - 28th Jul 21
I Guess The Stock Market Does Not Fear Covid - So Should You? - 28th Jul 21
Eight Do’s and Don’ts For Options Traders - 28th Jul 21
Chasing Value in Unloved by Markets Small Cap Biotech Stocks for the Long-run - 27th Jul 21
Inflation Pressures Persist Despite Biden Propaganda - 27th Jul 21
Gold Investors Wavering - 27th Jul 21
Bogdance - How Binance Scams Futures Traders With Fake Bitcoin Prices to Run Limits and Margin Calls - 27th Jul 21
SPX Going for the Major Stock Market Top? - 27th Jul 21
What Is HND and How It Will Help Your Career Growth? - 27th Jul 21
5 Mobile Apps Day Traders Should Know About - 27th Jul 21
Global Stock Market Investing: Here's the Message of Consumer "Overconfidence" - 25th Jul 21
Gold’s Behavior in Various Parallel Inflation Universes - 25th Jul 21
Indian Delta Variant INFECTED! How infectious, Deadly, Do Vaccines Work? Avoid the PCR Test? - 25th Jul 21
Bitcoin Stock to Flow Model to Infinity and Beyond Price Forecasts - 25th Jul 21
Bitcoin Black Swan - GOOGLE! - 24th Jul 21
Stock Market Stalling Signs? Taking a Look Under the Hood of US Equities - 24th Jul 21
Biden’s Dangerous Inflation Denials - 24th Jul 21
How does CFD trading work - 24th Jul 21
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Derivatives Disaster: Deriving The Truth

Companies / Corporate Earnings May 19, 2007 - 11:10 AM GMT

By: Rob_Kirby

Companies

In an article I penned two weeks ago, I discussed the misfortunes of the Bank of Montreal [BMO] and their costly foray into Natural Gas derivatives trading. In that piece I wrote what are now some rather prophetic words in my assessment of BMO and their 450 million “charge” against 2 nd quarter earnings, when I opined;

“This means that the BMO's ‘long natural gas position' was almost certainly a MUCH BIGGER LOSS – at one point in time – than they are admitting to us now.

BMO's year end is Oct. 31. I'm left wondering why they did not report a bigger loss last quarter.”


Then, this week, BMO announced they REALLY lost 680 million and they are now going to “restate” 1 st quarter earnings.

Amazing, eh?

But I suspect something is still not quite right.

You see folks, what has befallen BMO is not dissimilar to that which befell Amaranth. They made a rather large bet on the direction in price of a vital commodity – no doubt based on their fundamental views of its value – and lost.

The BMO was Amaranth's prime Canadian broker. Could they have been trading on the coat tails of Amaranth? Who knows?

But what we do know is that ‘the other side' of Amaranth's ‘losing long natural gas derivatives bets' was none other than J.P. Morgan Chase. In fact, it was J.P. Morgan Chase – and their ‘short position' that ultimately ‘ absorbed ' Amaranth's long position in the wake of their demise.

Getting back to the BMO, in an April 30 Bloomberg article dealing with this fiasco, it was revealed that,

“Bank of Montreal managed its trades according to a value- at-risk, or VaR, a model that gauged how much the bank could lose in a day if markets moved against it. The company increased its commodities VaR to C$5.9 million in 2006 from C$1.3 million in 2004, according to Dominion Bond Rating Service.”

So, it now appears that BMO, SOMEHOW, managed to lose 680 million bucks with a VaR of C$5.9. 

Now, let's stop to consider that the other side of those trades, namely, J.P. Morgan Chase has a derivatives book in the neighborhood of 68 TRILLION in notional and VaR of U.S.$88:

Read about VaR here . [pg. 5 of pdf. doc.]

So, now ask yourself this question: Using an ‘apples to apples' comparison - if the BMO lost 680 million with a VaR of 5.9 $CAD – what kind of loss could we expect to see from good ole J.P. Morgan if they ever “got-it-wrong” with a VaR of U.S.$88? Doing some quick ‘back of the envelope' math [not even accounting for exchange, which increases the number]:

88 / 5.9 = 14.92 x 680 million = 10.1 BILLION

Isn't math fun?

Amaranth's well publicized failure – resulting from a ‘long natural gas position' – became public knowledge in the Sept. 06 time frame. Sept. 06 falls within decline “B” on the chart above. Conventional mainstream financial media accounts at the time were rife with claims that Amaranth's difficulties were “one off” in nature – and the steep declines in natural gas prices would/should not meaningfully affect ‘ANYONE' other than this rouge trading entity.

September 23, 2006
Amaranth : Lessons on Hedge Fund Failures

“The difficulty of Amaranth has three notable features. First, there was no market panic. It caused barely a ripple. Those who believe a hedge fund failure could take down our financial system are... well... silly.”

The Pundits Were At Least Partially Wrong – Maybe Very Wrong

For anyone who adheres to logic or reason - the chart above clearly shows that to incur losses trading Nat. Gas from the ‘long side' of the magnitude that BMO is now reporting [680 million at last count] – one would NECESSARILY have been “LONG NATURAL GAS” through one or both of the circled steep price declines depicted on the chart above [A and/or B].

What this means is that the BMO incurred their losses BEFORE their year end. So now, shouldn't we really be asking the question, Why weren't these losses reported in Q4 when they were incurred – and in all likelihood – were still much greater than they are being admitted to now?

Because derivatives are classified as “off-balance sheet items”, institutions like the BMO, Amaranth, Enron et al have the ability to play “shell games” with their unrealized profits/losses and effectively prolong [or time, perhaps?] the exact time when they assimilate/admit [mark-to-market] their impact back into the balance sheet.

The fundamental difference between a banking institution and a non banking institution being that latter is usually more levered - unless of course we're talking about J.P. Morgan Chase - than the former and therefore ‘more beholding' to the banking entity.

In the case of J.P. Morgan Chase, one can only wonder if this applies and is perhaps the real reason we've never heard of a J.P. Morgan “oops”,

“President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye.”

Perhaps some people never catch colds.

The notion that trading losses inflicted on “hedge funds” could not bring down the financial system is beyond silly – it fact, it's MORONIC. The BMO [a publicly traded bank] has CATEGORICALLY incurred substantial losses trading Natural Gas derivatives and they've kept this all a private matter – seemingly – for AT LEAST two quarters!

Yeah be they who create the money out of thin air!

Why BMO Waited to Acknowledge Losses

This is a question that only BMO management can truthfully answer. It would appear that – under the circumstances – likely contributing factors might have been:

  • not wanting to report such sudden “steep losses” so close to YEAR END – in an ‘otherwise' profitable year and negatively impacting generous year end bonuses.

  • not wanting to acknowledge “steep losses” in Natural Gas trading at the same time as Amaranth was collapsing to avoid being ‘painted with the same brush' and possibly having their share price beaten up in equity markets.

  • BMO's new chairman, Bill Downe, was “announced” to succeed former chairman, Tony Comper, on November 29, 2006 – effective March 1, 2007. Down is the former head of Capital Markets – the same division of the bank where the now 680 million losses have occurred. Would admission of these or steeper losses back in November 06 have interfered with planned succession of the chairmanship?

The really BIG and most important question – in my mind - is how and why did regulators ever allow J.P. Morgan Chase to inflict such damage on these players?

By Rob Kirby
http://www.kirbyanalytics.com/

Rob Kirby is the editor of the Kirby Analytics Bi-weekly Online Newsletter, which provides proprietry Macroeconomic Research.

Many of Rob's published articles are archived at http://www.financialsense.com/fsu/editorials/kirby/archive.html , and edited by Mary Puplava of http://www.financialsense.com


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in