CMRE''s fall dinner in New York examines topics important to GATA

New Monsters Inc. on Wall Street:
Credit risk, derivatives in J.P. Morgan horror tale

By Thom Calandra, Editor
CBS.MarketWatch.com
Wednesday, Sept. 18, 2002

It's fitting the nation's second biggest bank chose the DVD
debut for the film quot;Monsters Inc.quot; to unveil its own monster
mash.

J.P. Morgan Chase gets other monikers, half a day after it
pointed to poor prospects for its cartoonish portfolio of loans,
some $12 billion worth to cable and telecom companies.

One of them is the quot;Sinking of the U.S.S. Titanic.quot; Bill Murphy,
editor of www.LeMetropoleCafe.com, for months has been
pointing to the bank's vast position in derivatives as a
sinking ship for investors.

quot;Not pretty,quot; Murphy tells me from his Texas office. The New
York bank has, by some estimates, more than $20 trillion of
customized and other derivatives on its books. The Office
of the Comptroller of the Currency lists J.P. Morgan Chase
as the largest holder of gold derivatives, such as
deferred-sale contracts and other hedged instruments,
swaps, and futures-linked devices that gold companies
and central banks used to generate extra income during
gold's descent in the decade of the '90s.

The faltering bank is regarded as one of the largest
dealers in the lending of gold, a practice that generated
steady profits when gold prices were (until this year) falling
and interest rates were higher than they are now.

In the world of derivatives, about 2 percent of a bank's total
exposure is seen as at risk in the normal course of business.
In the case of J.P. Morgan Chase (stock market capitalization:
$37 billion), 2 percent of $20 trillion comes to about $400
billion.

quot;It might help to keep in mind that it was the tanking of the
share price of Enron that set in motion their serious problems
with counterparties,quot; Murphy says. quot;That is what bankrupted
Enron. They could not hold on any longer. Ironically, I think it
was the breaking of the $20 price level that did Enron in.quot;

J.P. Morgan, its shares below $20 Wednesday, saw its
counterparty credit ratings lowered to single-A-plus/A-1
from double-A-minus/A-1-plus at Standard amp; Poor's. A
long-term counterparty credit rating was also lowered.
Fitch, another agency, also lowered ratings. Generally,
central banks and governments require AA ratings from
their big-bank counterparties in the swapping of loans,
paper, and in other transactions.

quot;Let's see how Morgan's announcements affect the
entire financial section,quot; says Murphy, a former
commodities trader who is lauded by the pro-gold
followers to his subscription service yet dismissed as
a fanatic on Wall Street.

quot;A panic shouldn't be too far away,quot; says Murphy, who
has been joined in his concern about gold derivatives
and manipulated gold markets by a growing number of
precious-metal fund managers. quot;It will also be interesting
to see how the yellow metal reacts. Hold tight, and batten
down the hatches.quot;

On Wednesday morning, James Moore of gold news
service www.TheBullionDesk.com reported traffic on its
Web site was 25 percent above normal. quot;This is sometimes
an upside indicator,quot; Moore says.

Gold on Wednesday morning rose as high as $321 an ounce
in the spot market -- up from about $317 before J.P. Morgan's
bombshell. Gold since Jan. 2 is up 18 percent from the $270
level.

J.P. Morgan shares Wednesday morning were down 12
percent to $19. Bernie Schaeffer of Schaffer's Investment
Research tells me there is the equivalent of almost 2 million
shares of the Sept. $20 put contracts in open interest. The
contracts, which rise as J.P. Morgan shares sink, expire
Friday.

quot;Normally, there is a very vigorous defense of these strike
levels, with big put open interest by the put sellers to save
themselves from big losses,quot; says Schaeffer. quot;In other
words, stock is bought to help keep the shares above
the strike.quot;

Schaeffer says a $20 J.P Morgan stock price already has
significant psychological meaning for investors. quot;There's
nothing nice about one of the lower probability scenarios,
which cannot be dismissed: a plain old meltdown,
especially if the July 24 low at $18.22 gets taken out. And
this is a nightmare whether it happens this week or down
the road,quot; Schaeffer says from his Cincinnati office.

J.P. Morgan is a member of the Dow Jones Industrial
Average, a price-weighted index destined for steep falls
in coming months.