There’s absolutely no doubt that when it came to the financial sector, JP Morgan was considered the head of the class. They knew how to manage risk and didn’t make all the same mistakes the other large financials did before the last crisis. Even Warren Buffett sang the praises of Jamie Dimon saying that is shareholder letters were must reads.
Boom!
Everything was chugging along fine and then: Boom, along comes JP Morgan with the announcement of what is being described as a poorly managed hedge had lost the company at least two billion dollars and could be more.
When there are still risks in the financial and economic system and the company who is believed to be above the fray comes along and can be surprised with a loss of this magnitude it makes you step back and really think about what is considered safe anymore.
Can It Happen Again?
The financial meltdown in 2008 brought us to the brink of collapse. However most feel that safeguards and changes have been put in place so this doesn’t happen again. Just to be safe you invest in the best in breed like JP Morgan and Wells Fargo. But what happens when the best in breed falter or succumb to an unexpected event?
If JP Morgan can lose two to five billion on a hedging strategy, what does that mean for the weaker players? We’ve seen MF Global collapse on a bad bet on European bonds and now the JP Morgan loss. What’s the next shoe to drop?
There are MANY factors out there that can give us cause for concern:
1. European Debt Crisis
2. Burgeoning US Deficit
3. Possible Chinese Slowdown
4. Shaky US Economy
Throw these things into the mix along with a financial system that is highly leveraged and you have the recipe for a problem. The derivatives exposure to banks is unknown. JP Morgan apparently didn’t even know about a two billion dollar problem less than a month before they announced it.
What to Do?
The best course of action is to stay nimble and don’t let a bad trade turn into an even worse investment. You couldn’t get me to invest in the financial sector. There are just too many unknowns within the highly leveraged system. If I could give someone one piece of advice it would be to avoid financial stocks like the plague.