Over the three years since I have been publishing BoomBustBlog, I have amassed what many consider a remarkable track record, having called nearly every major market crash and large financial/real estate/bank collapse over said time period.  Believe it or not, many have even went so far as to call me "intelligent". While I would love to bask in the light of potential admiration, let me assure you, although I am in no way lacking in confidence or ability, I am also quite average in the intelligence arena. While not being any more intelligent than the average man, I do have an uncanny knack for seeking out that rarest of rare concepts these days - the TRUTH! This increasingly uncommon ability (to both speak and seek the truth) has served me quite well in both my investing pursuits as well as in the personal aspects of life. Let's delve into how I translate this personal talent into a product that I distribute from my BoomBustBlog, and then into the facts in regards to the current state of concentrated risk in today's US banking system - to wit, the systemic risk of derivatives concentration.

The full 3rd quarter forensic analysis and valuation update for JP Morgan is now available for all subscribers: JPM 3Q 2010 Forensic Update. The download is a much more detailed version of the (not so) quick overview I posted the day after earnings that reveals some very interesting points. All in all, the JPM quarter was quite bad, considerably worse than the media appears to be making it out to be. I have taken the liberty to include some of the highlights of interest in this blog post. While the hardcore actionable stuff is reserved for clients, I feel there are a few topics of discussion that demand public attention. I would like anybody who reads this to go to their local broker (or prime broker) and get a copy of their JP Morgan quarterly research opinion and update - regardless of the source(s). If the four issues that I have discussed in this blog post are NOT PRESENT in your (prime) broker's report(s), I respectfully request that you do yourself a favor - subscribe to BoomBustBlog.com and download the report linked above, which includes valuation as well. I will be offering an extra download for professional and institutional subscribers interested in granular, detailed loan, charge-off and derivative holdings in the near future.

FACT ONE: First and Foremost, JP Morgan has been DESTROYING Shareholder Value for TWO Years Running, and I Don't See It Getting Much Better Any Time Soon! That Two Years Is Exclusive Of The Devastating 2008 Market Crash!

Getting back to the issue of Wall Street's sell side analysis, the biggest problem I have with them (outside of rampant conflicts of interest, which is probably not the fault of the individual analysts) is the abject reliance on accounting figures to measure and value an economic entity such as a business as an ongoing concern. Let' be frank here, accountants, albeit probably quite smart, don't necessarily make the world's best investors. As a matter of fact, practically every accountant I know comes to me for my investment opinion and I make a horrible accountant. Try and try as I might, I can only think of one accountant that has ever excelled at investing over time (not to disparage accountants, of course, with all respect due). Granted, this man is probably a damn genius, and he knows how to identify quality when he sees it - having created Canada's largest independent brokerage and independently its premier asset management firm with ~$6 billion under management - including the innovative physical gold trust. He has said, and I quote from Crain’s New York:

“His work is so detailed, so accurate, it’s among the best in the world,” says Eric Sprott, CEO of Sprott Asset Management, a Toronto firm that manages about $5 billion and subscribes to Mr. Middleton’s research.

Yeah, I know that was cheesy, but I couldn't help myself :-) . Back to the matter at hand, accountants have not been - and currently are not, trained in the economic realities of corporate valuation. They are trained to tabulate business operations data. There is a marked and distinct difference. That difference is as stark as night and day for investors, yet despite this stark difference, Wall Street still reports corporate performance metrics strictly in accounting terms, and the media (both mainstream and the more specialized financial media) simply follow suit.

Here's a little cross pollination to attract bears from all over.  Karl Deninger, the editor of the Market Ticker, invited me over for a half hour chat on his Blog Talk Radio show to discuss things such as foreclosure fraud, banks, derivative risk and the markets. You can access the original airing podcast on Karl's site. I have taken the liberty to append some graphics to the background to add some information to the discussion (see below). Enjoy!

Part One (the impatient may want to skip ahead about 1:32 to get the actual start of the discussion. I highly recommend you choose the 720p HD setting and expand to full screen in order to read the graphics in full fidelity.

Part one

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Part two

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Summary: Without an economic incentive to foreclose, it would not be in the bank shareholders best interests to pursue foreclosure even though borrowers clearly defaulted & owe money to the lender. The economics of distressed assets in mortgage and commercial banking are quickly changing. I am quite open to discussing this in the mainstream media if any are interested in hearing the "Truth go Viral!" I want all to keep this in mind when pondering the release of reserves by the banks. My JPM quarterly review is still on its way, and I will share a substantial amount with the public.

About a week or so ago, I posed a controversial question, Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two! In that missive I warned that the recovery rate on many of the repossessed properties was not only at a historic low, but actually approaching zero, save a few blips from .gov bubble blowing and shenanigans by banks in the form of kicking cans down the road. I also said that the time may very well come when there may be no economic incentive for banks to foreclose on certain properties, and that pool of properties may grow larger than many could imagine. I know it is difficult for many to come to grips with this, but the math really ain't that hard.

Even Tyler Durden, whose controversial ZeroHedge site I read and contribute to with a passion, is being too optimistic. Yeah, that's right! You know things are bad when ZeroHedge is too optimistic! In his post "Quantifying The Full Impact Of Foreclosure Gate: Hundreds Of Billions To Start^", he assumes there WILL be something to foreclose upon. I assert that in increasingly more common instances, there will be no economic interest to foreclose upon. It is starting at the fringes and the margin, but it is moving closer to the center faster than many think. And the longer, and deeper "Fraudclosure" investigations continue, the closer and faster to the center it will get. This is, of course, not even considering the fact that all of this investigating and shining the light in dark corners will reveal the true elephant in the room (and it is not hastily signed affidavits that can be quickly fixed) which is that many, if not most, high LTV mortgage originations were fraudulent to begin with. That means that not only would it not be cost effective to foreclose, but everybody and their momma will be scrambling to put the fraudulent loans back to the originating banks - see The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008! for my realistic take on the situation and the expenses that it entails. Yes, the elusive recovery rate is going to be pushed that much lower. Long story short, bank expenses will skyrocket, along with efficiency ratios, which were already increasing to begin with at the same time housing sales economic activity and prices will drop and credit losses will spike. Oh, what fun we have in store.

Here is and excerpt from Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two to refresh your collective memories and then I will run through an example that clearly shows a high LTV property in Nevada that the lender literally has no economic incentive to foreclose upon if there is litigation to be had.

As those that follow me know, I have been bearish on US banks since 2007. That bearish outlook resulted in massive returns ensuing years, just to have nearly half of it returned due to rampant shenanigans and outright fraud. Needless to say, it pissed me off - but it did much more than that. It created a re-bubble before the bubble that was bursting had a chance to fully deflate. As a result, what we have now is one big mess that is getting messier by the minute.

On Friday, July 16th, 2010 I posted "After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????”. The impetus of such was that this bank that all seem to be in awe of was taking a big risk in order to pad accounting earnings for a quarter or two. Below is an excerpt of my thoughts:

Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!

The delinquency and NPA levels drifted down a bit, but they are still at very high levels. Charge-offs came down but the reduction in provisions has been quite disproportionate bringing down the allowance for loan losses. In 2Q10, the gross charge- offs declined 26.6% (q-o-q) to $6.2 billion (annualized charge off rate – 3.55%) from $8.4 billion in 1Q10 (annualized charge off rate – 4.74%). But the provisions for loan losses were slashed down 51.7% (q-o-q) to $3.4 billion (annualized rate – 1.9%) against $7.0 billion (annualized rate – 3.9%) in 1Q10. Consequently, the allowance for loan losses declined 6.2% (q-o-q) from $35.8 billion from $38.2 billion in 1Q10. Non performing loans and NPAs declined 5.1% (q-o-q) and 4.5% (q-o-q) respectively. Thus, the NPLs and NPAs as % of allowance for loan losses expanded to 45.1% and 50.7%, respectively from 44.6% and 49.8% in 1Q10. Delinquency rates, although moderated a bit, are still at high levels. Credit card – 30+ day delinquency rate was 4.96% and the real estate – 30+ day delinquency rate was 6.88%. The 30+ days delinquency rate for WaMu’s credit impaired portfolio was 27.91%.

While the lower provisioning was able to beef up the bottom line in this quarter, the same is not sustainable in the future as JPM cannot afford to reduce its allowance for loan losses substantially. This is a one shot, blow your wad and go to sleep deal!  There is no margin for error in the future, and one can only assume that the reason this was done was to pad accounting earnings and to take advantage of the extremely short term, and obviously naïve, memory of the financial media and retail/institutional investor. Given the high charge-off rates and delinquency levels, the provisioning will probably need to be bolstered again in the not too distant future.