good afternoon welcome to capital account i'm lauren lyster here in washington d.c. these are headlines from may fifteenth two thousand and twelve j.p. morgan shareholders meeting was today as all eyes remained fixed on that two billion dollars trading loss on a position that could grow much larger in the coming days weeks or even months as j.p. morgan attempts to exit its position does this massive blunder demonstrate the financial shenanigans that can go into evaluating and possibly hiding risks when bankers have a multimillion dollar paydays on the line that's a question we'll ask and all the reaction to the trading loss is reigniting regulation talk what the volcker rule what reinstating glass steagall even go far

enough to curb systemic bank risk or is about something bigger karl denninger denninger joins us he'll explain his one dollar of capital solution and in the eurozone greece cannot form a government the country is headed back to elections the one where public though is capturing headlines meanwhile lightning is striking in the core literally olanda is sworn in as french president and jets off to meet with merkel and germany for the first time today but his plane is struck by lightning reportedly in route sending him back to paris to try again when asked if there is a greater risk than ever before of this. thirty second to climb out. because there's nothing we could do but. we're talking about a core meltdown in germany and france we'll explain let's get to today's capital account.

so j.p. morgan shareholder meeting went on today in the midst of whale gate and the wall street journal reported the d.o.j. and f.b.i. have begun a criminal probe surrounding the two billion dollars trading loss to be sure we know that the lid has been blown off of diamonds tempest in a teapot narrative remember that that's what he said this was these were the words he used to originally dismiss concerns that the bank's whale positions were too large but though the tempest is out there are still plenty willing to downplay its significance and the issue is even though two billion dollars isn't going to derail j.p. morgan the question is what if it is twenty billion dollars or what if there are

more trades like this there are also plenty of people willing to parrot the conventional wisdom that jamie diamond and the largest bank by assets in the u.s. that he has up represent the best of wall street this includes the u.s. president take a listen. j.p. morgan is one of the best managed banks there is jamie diamond the head of that is one of the smartest bankers we are and they still lost two billion dollars in cali . precisely because they were making bets. in this biz derivative markets we don't know all the details yet it's going to be investigated but this is why we passed wall street reform. this is why you passed wall street reform what reforms exactly because dodd frank didn't stop this from happening and the volcker rule in its current incomplete incarnation would have arguably allowed for it to because of loopholes we'll get back to that later the hold that thought let's get back to

jamie dimon because there seems to be a more fitting description of him then the best guy on wall street how about this jamie diamond the clown now we can't take full credit for this image it's inspired by one of our guests janet have a koli who writes in her latest piece that j.p. morgan's chief is the world's funniest finance a year and as so often happens when we're talking about too big to fail banks it appears the joke is on us ok this savers subsidizing the banks speculation while j.p. morgan is considered the best risk manager there is a question about changes to the way that chief investment office this is where the london whale worked evaluated risk at the same time it was growing its trading positions and complexity to have a coolie who mind you wrote the book on credit derivatives and synthetic structures writes this the thing about credit derivatives is that the models are very vulnerable to the assumptions one uses in that model so you wouldn't want to say push your people to make more money for j.p.

morgan and then let the people whose multimillion dollar bonuses depend on the outcome influence the assumptions but that's only if you don't have diamonds flair for comedy because under diamond that's what appears to have happened in the cia though there are still a lot of details i will say that we don't know so let's get into what we do and what we can surmise from all of this with karl denninger the traitor and author of leverage how cheap money will. destroy the world because this is about a lot more than a two billion dollar loss which although it sounds huge really isn't for j.p. morgan but this could signify so much more so carl first the big question is how much bigger could this loss really be because j.p. morgan says two million dollars maybe three billion total but we know that they have to unwind this huge position there are a lot ahead funds maybe that of smell blood in or out to get him it's not going to be easy and everybody knows about it now that's the problem warren is that nobody

knows exactly how big this problem really is an interview on wanting to trade you're not going to get an honest answer so it could be two billion which is what they claim it is at this point it could be three billion there may be other trades similar to this that have to be on while there may be other positions and then you have outside traders who now smell blood in the water and just like sharks they're going to see how many points they can get before they're you know or they're shutdown is it conceivable could be twenty billion you know it is and then we have the other problem which is we don't know whether or not the other banks on wall street positions similar to this one that are outstanding and are some rules exposed and that's a really good point and you know you have jamie dimon out saying this didn't affect individual investors or clients or or anybody like that but could this potentially have an impact on other investors on average investors. well and if you lost two billion dollars somebody made two billion dollars so the obvious question that

arises who's on the other side of the traits of that's just how derivatives work there's there's no such thing as a free lunch he didn't lose the money to go into some black hole somebody's property and by the same amount so you know there are there probably are people that are laughing right now at the facts they took advantage of and if it gets bigger and snowballs though could there be a larger impact on average investors because because it does affect them right oh absolutely oh this could potentially get into capital issues and things like that although a two billion dollars it won't budge you can see it's already had a major impact if you happen to be a j.p. morgan stock holder fortunately i was not but so their stock has got its just absolutely tone to the last couple of days right and the question that you brought up that we were talking about earlier is not necessarily ok what is the impact of this two billion dollar loss on j.p. morgan because j.p. morgan is a very big bank it's the largest bank by assets the question is what if it's twenty billion dollars and what if there are four or five more trades like this that are so big that need to be unwound what if there is an other exoticness risk like

a crisis in europe or something that compounds the issue so in this situation does j.p. morgan have capital buffers that are appropriate. well they claim yes supposedly the regulators claim yes the question that arises out of the regulators allow this kind of thing to go on in the first place and how do they get into this box i think the answer the real answer is nobody knows jamie diamond may not know that's the scary part is that i'm not convinced that he actually knows what he's got within his own bank imagine that the best banker in the whole world doesn't know what's and all the little black boxes that you say may be lurking i guess the question bigger picture is what this says to you about regulation the need for regulation or more importantly car all the problems associated with easy money policies and compliance central banks that have created oceans of liquidity for

a london whale to inhabit in the first place. the real issue comes back to being able to create credit money without anything behind it that's the fundamental problem that we have at the core of this is what caused the internet bubble which will cause the housing bubble and if we don't cut this out it's going to lead to another collapse like we did in two thousand and eight but this one will be worse of the you know as an individual trader i don't get to play those games i have to actually post assets real cash whenever my positions go underwater big banks don't necessarily have to do that and when it's in the over the counter credit derivative market it's even worse because there's very little supervision and all you have is computer models and is janet explain those ships that go into their make a huge difference in the outcomes of what your computer tells you yeah i want to get more into those assumptions and the rest models the j.p. morgan was using and change which sounds a little fishy but i do want to ask about about continuing on this notion of the cash that you have to post because we hear calls in the wake of this for the book

or roll but there are a lot of loopholes to the volcker rule that arguably could have passed as hedging when for you or i but you never know with these regulators there's calls to reinstate glass steagall the separation of commercial banking from investment banking but none of these may go far enough in your view you're proposing one dollar of capital which is what you say in quotes is your solution what is the solution why would this be the real deal. well one dollar tip will simply says that for every dollar of unsecured lending that you're doing when you're into a credit derivative trade like this any part of that position is underwater isn't on secured loan you have to have a dollar of your own money and so there is no war game playing was saying well posed this asset over here it has you know it belongs to somebody else it's a deposit or whatever have you it has to be actual capital and you have to get data from shareholders you have to sell bonds or you have to have retained earnings this comes off the game immediately because now there can be no systemic risk is the

depositors and the other people other than the bondholders are stockholders and willingly took the risk their capital is nothing beyond that can ever be lost and so that's the solution and yet that's that's what glass steagall trying to impose away from deposit banks and it was circumvented in the knesset convention starting with alan greenspan with the a city solomon merger and so on and sort of what you're calling for do you think any of these regulations won't stop this kind of fifth democrat from continuing at a bank like j.p. morgan. well glass steagall would go on awfully long way to do it it would be certainly better than what we have no the banking system since two years it wasn't until people started gaming it that we ran into problems a little the talk about kind of the risks that are that's going on here because while jamie dimon says that hey this is just one bad trade this is just a lot of big mistakes made and this one specific london whale trade there's this

whole question about the risk and the cia office because there's this kind of sketchy thing we don't know a lot of details but what we do know is that they changed the way that they evaluated risk in two thousand and twelve at the same time that they were presumably taking more risk and taking more complicated risks and then jamie dimon comes out and he announces this two billion dollar loss and says and we're going back to the old way of evaluating risk and a lot of holes so we don't know exactly why but girl come on we're kind of questions is this raise. the obvious ones the the all these the so-called valuation at risk group are models are simply computer simulations that say that the market will not move more than x. amount in a given direction on a given day in this area and that's how you get your numbers it's just math the problem of course is that it's a statistical model and statistics work right up until they don't and you have something bad that happens like europe blows up or

a lehman brothers files bankruptcy or you know any one of a number other things and then all of those statistical models go out the window and we've seen it everything anshul any throughout history that these models are not valid to show you what the odds are when something really outside the normal range of experience occurs it's happened repeatedly happened in one thousand nine hundred seven it happened in two thousand and eight and we're probably about to have it happen again and will and the changes to these models it doesn't raise questions about the vested interest of traders that have multimillion dollar payday of on the line were deciding on the the functions and they have a vested interest in making them look rosier than they really are. you know and it's even worse on their lauren because what can happen news is that because of the way these models work if your model allows you one hundred million dollars or risk a day for example that's the amount that you're allowed to have on a line you may actually be swinging around a hundred billion dollars worth of assets or liabilities in order to get that

hundred million dollars number or so the multiplier is extremely high in as a result if you make small changes in you assumptions you can make millions of dollars worth of difference in your compensation and that's a huge issue that's what janet was talking about and it's something that is very difficult to deal with because the compensation of the officers at the top of these organizations is tied to performance yeah that brings up a lot of questions when we get back i want to answer them more of an because it sounded like you were alluding to. some kind of crisis i want to delve into that and speaking of crisis i want to talk about the depression scenario you laid out for me earlier when we're talking about europe and hey guys it does not end with grace that is for sure we'll have more with karl denninger author and trader after the break also still ahead we missed out on a last week so we'll catch up with some of your feedback today i'll share my responses to your comments i'm still reading them i'm still responding and first your closing market numbers.

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all right we're talking about the london whale j.p. morgan and what this means about the broader risk in the banking system and what it would do if there was an exhaustion is risk like what's going on in europe if that really blows up which it could first i want to play a little bit of president obama today on the view talking about reacting to this j.p. morgan news take a listen to this this is the best or one of the best managed breaks where you could have a bank that is in a strong isn't as profitable making those same bets and we might have had to step them and that's exactly why wall street reform so important. ok so his idea is that j.p. morgan is so big that you know this doesn't matter in this case but if it was a smaller bank we'd have to step in but there is this whole broader issue of more widespread risk that could be bigger for j.p.

morgan that could be bigger for other too big to fail banks and the question is not if they're too big to fail well that is the question but also if they're too big to manage so i want to bring back karl denninger he's trader and author of this book the leverage how cheap money will destroy the world and i want to ask him that question i do want to stick to j.p. morgan for just one more moment because it is such a compelling story that i think symbolizes a lot more one of the things you hear the mainstream media asking is how did such a great risk manager jamie dimon get caught in this situation with this bad trade now you and i are both kind of already talked about that you do think that this is brings up questions about more broadly risk in the banking system but is the question that comes of that not if these firms are too big to fail but if when they're doing is kinds of traits they're too big to manage. that's a very clear question that needs to be asked you know the obvious question that arises was jamie diamond fully aware of the scope and exactly what instruments were

being put on in the how they were trading and exactly what did they represent i don't think that's been established and if the c.e.o.'s office was doing this and got into this mode where they were just chasing more and more money which it does appear at some point did it happen then you have a situation where one arm of the organization literally sitting next to cheney the next level down in the company from him was doing things he didn't know about and that's a very troubling problem because this is not some random trader sitting on the floor that went over his authorized position limits this is the c.e.o.'s office it doesn't really get any further up the chain than that right and along those lines i want to delve a little bit more into this trade because people it are interested in it and we don't know everything about it that's for sure you mentioned it could have been about hedging the bank's exposure to credit extended during the mortgage boom and exposure to other forms of debt within collateralized debt obligations explain and also could this loss be some kind of act though of the mistakes made during the

credit boom of the two thousand that we're still paying for. we don't know and that's the biggest problem with what's happened here we do however know that washington mutual was absorbed by j.p. morgan during the crisis and throughout this entire thing when i first ran my back of the envelope calculations on the losses in the housing market i estimated that they were going to run about three trillion dollars but we've seen about a trillion dollars worth of that lost recognized various institutions in funds and sub prime mortgages and everything else but there's still true trillion dollars worth of loss out there i can't find it nobody else seems to be able to find it so the obvious question is where is it and was part of this an attempt to joff sobel what is now literally rotting fish because housing is not come back and you know it is states right now and you mentioned it when we're talking about reckon and the the broad prevalence of it and i'm asking about you started to hint at a crisis is that where you think we're headed for. i do and i don't think it's

going to come out of the united states i think it's going to be triggered out of europe the the rot that we have going on over in greece and what let's face it there don. there are people who have been pushed and pushed and pushed they got all these bailout funds to the i.m.f. and everything else but none of it went to the people that all went to the banks to keep them solvent and prevent them from collapsing so the common man on the street has seen no benefit whatsoever from all of this money and yet he's being told that he's going to have to give up his benefits and see a salary collapse and everything else yeah well and he's turned around said no more right and so now the question is what you can do about this in answer is that there are assets so well to european banking system that are impaired as a consequence of these bailouts and of the underlying positions if those become exposed there are going to be real cross winds within the banking system in europe and there they will be centered in france and germany and let's talk about that

because all of the headlines are focused on greece and that's understandable because they can't form a government and it's political uncertainty to put it mildly we're talking about greece now as though it's a foregone conclusion it's either going to exit the euro or as you said to me earlier they are going to put their obligations through a paper shredder and sentiment to angela merkel once and for all and you're saying that the way this comes to roost is in the banking system in the core we see a higher risk of a core meltdown in the banking system and germany and in france you call this a great depression scenario that you laid out how does that play out what does that look like. well there's potentially a couple hundred billion euro as worth the real risk that is currently sitting at both the e.c.b. and him places like bonus bank in the way the allocation mechanism works in the european union there would be a ratable capital call on all of the nations in the euro if this was to happen so what happens when you make the capital call the body has any capital well what

people would try to say is well the e.c.b. just has to print more money to cover this the germans are not going to tolerate that and one of two things occur as either you can't meet the capital call in which you have a bunch of banks that are insolvent in that you know it blows up or the alternative uses the e.c.b. says nuts to bundle spank goes in and starts even erodes in germany says notes to then goes back to the door which mark and inter european union collapses will that have quite good impressions an aerial you got a point there i appreciate you laying it out we'll have to see how this unfolds i your analysis is great that with karl denninger author and trader thanks so much karl thank you very much.

all right let's wind down with some viewer feedback i didn't get the chance to get to it on friday when we usually do it because there was so much news so many guests so let's get to it now first we want to bring attention to a post from mike shad logs blog we all know him as mish his a frequent and very popular guest on this show also a really good friend of the show so we want to make sure that you do not miss one of his latest pieces here it is it is a more personal piece about his efforts to raise money for a ls research you can see he's got money from twenty two countries and counting he's looking for more this is obviously a debilitating disease known as lou gehrig's it's one that's affected his family personally so he's raising money for charity including a raffle he's got a big goal he's trying to meet we know a lot of our viewers are his readers so you can check out his blog to find out more you know it's global economic analysis we want to make sure you don't miss that and

much much much lighter your feedback let's get to my very favorite viewer comment that maybe we've ever received show me the money says capital account is by far the most new wants financial and economic show on television i'm constantly amazed at their ability to produce such smart show hosts without talking down to their audience i have learned so much from watching this show every day since december of last year bravo and thank you and show me the money i think you know that is the nicest comment it made my day this is a lot of what we hope to achieve the things that you. touched on is very nice to know that it's resonating with a dedicated viewer like yourself we want to be sophisticated we don't want to talk down to you we want to give you the things that we see as most important that are not being covered well by the mainstream media and it sounds like that's resonating with you meanwhile i don't know if it's resonating with you tube user twenty one

air drop because this is what he said about our guy jules feraud interview that we did last week he said lauren let their authors talk your questions are far too long winded simply get out of going to let your guests tague. all right well you know what can i say you only get a few minutes of fair agin european parliament you get a whole show of america reason flat on a serious note that's our job that we're doing we try we do the best we can we try to get as much as we can out of the guests get you as much of their analysis we appreciate the feedback i will heed that i will tighten it up meanwhile yesterday jim rickards wrote a piece on the j.p. morgan fiasco and wrote that jamie dimon should resign it was his op-ed we covered it on the show with our guest and aaron task host host of yahoo's daily ticker tweeted me and jim records and said i'd be shocked if diamond resigns but simon johnson said the same thing on daily ticker on friday so simon johnson is also

a very well known commentator mit professor former chief economist at the i.m.f. so we're seeing a few calls for resignation meanwhile today what do we just see we just saw jamie dimon twenty three million dollars compensation to say shame package approved by the board and a vote to strip diamond of his chairman title fell short so we're going to see a resignation we're guard less it is interesting and important to talk about and we will get to tomorrow with jim rickards because you are going to be on the show he's in studio you will not want to miss it and with that that's all we have time for that is it for our show today thank you so much for watching also we will be back tomorrow and meantime you can follow me on twitter lauren lyster and give us feedback on the show at youtube dot com slash capital account there is more that you'll want to catch this week not only will we have jim rickards in studio we will also have chris whalen in studio he has a different take on j.p. morgan and the unintended consequences of regulations like the volcker rule it will

be great to get his take also on some of the bankruptcy issues surrounding the frauds we've seen with m.f. global and others but for now from everyone here thanks for watching and have a great night. there hasn't been a thing get on t.v. . it is to get the maximum political impact. before source material is what helps keep journalism honest we. we want to present. something else. wealthy british style. that's not on my list.

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