Headline: JP Morgan Chase announces that the bank will quit their physical commodities trading. What we have is the remaking of history. To understand what is going on, we must go back into our financial past during the Great Depression. The crash of 1929 was largely blamed on the bankers for their unscrupulous trading activities. The aftermath saw a plethora of investigations and cries for reform. The Glass Steagall Act of 1932 followed by the Banking Act of 1933 sought to curb some of the excesses in the financial system. Foremost among them was a mandate to separate Commercial Banking from Investment Banking. It prohibited deposit institutions from dealing in securities for customers, investing in securities transfers, underwriting or distributing securities or to be affiliated with those companies and any sharing of employees in similar activities.
For the next 30 years bankers pretty much followed the letter of the law. In the 60s and 70s, banks started chipping away by sneaking in their own brand of interpretation. They started setting up subsidiaries and affiliates and keeping these entities “off the books.” This “off the books” procedure is still in effect now. The next step was to allow banks to become “market makers’ in various securities. By 1999, the game was on in force, so much so that Congress passed the Gramm-Leach-Biley Act (GLBA) Citibank took the lead and formed ties with Salmon Brothers and Smith Barney.
Now it was off to the races. Banks started a practice of parallel banks or shadow banks by setting up hedge funds and all manner of derivatives.
At the same time Fannie Mae and Freddie Mac relaxed their mortgage requirements that set the stage for the housing bubble that was to follow.
Key derivatives included Credit Default Swaps that were like insurance against a possible default by a company or individual. The banks then invented Collateral Debt Obligations or CDOs. Under this scheme they packaged mortgages together and resold the package to pension funds and municipalities. By 2006 the seams started bursting. The leverage got so huge and kept “off the books” that regulators didn’t know what was going on. Here are some of the mind- boggling numbers. Freddie and Fannie plus the five largest banks had a whopping $9 TRILLION in derivatives outstanding. AIG was the key player for insuring Credit Default Swaps. Their obligations were staggering to the point where the US Federal Reserve had to bail them out to the tune of $180 Billion. In 2008, “over the counter” derivatives totaled $683 TRILLION. We know that the Federal Reserve bought a big chunk of this junk with its QE1, 2 and infinity. We still don’t know how much of this amount is still being held “off the books” by the big banks.
The echo of the 1932 and 1933 cries were being sounded in 2010 with the passage of the Dodd Frank Wall Street and Reform Protection Act. The Act. It included the Volker Rule that forbids mixing of normal banking activities with non- banking proprietary trading. Some of the large banks have already ended their proprietary trading.
Congressional hearings currently underway are digging deeper into non- commercial bank holdings and have discovered that banks control power plants, warehouses, oil refineries, African crude oil and Chilean copper mines. These hearings are continuing as this is being written.
JP Morgan Chase has already taken a $6.2 billion loss from the “London Whale” trading debacle. A London trader working for JPM was caught on the wrong side of his trades and ended up causing the loss. So far, none of the big five banks have been criminally prosecuted. They have had fines levied by regulators but this is a drop in the bucket compared to their assets.