THE HOUSE OF MORGAN

"Day after day, J.P. Morgan's name keeps turning up in

the wrong places."

Eric Fry

From south of the Rio Plata comes more evidence that Central Bankers - like other bankers - will only give you money when you don't really need it.

"Every day, about 1,000 Argentines like Gauto stand in line to sell anything from cameras to violins to ivory chess sets at Banco de la Ciudad de Buenos Aires, the only government-owned pawn shop in the capital," reports a Bloomberg article. "With a devaluation that has cut the peso's value in half the past month eating into wages, and most savings still locked up in banks, Argentines have resorted to selling their most valued items to pay for food and rent.  

"The recession has brought new business to Banco Ciudad, owned by the City of Buenos Aires, where the number of pawned items has almost doubled since December, when Argentina first limited withdrawals. On Tuesday, Argentines pawned 900 pieces of jewelry valued at 233,000 pesos, 102 items of audiovisual equipment worth 14,000 pesos and five works of art appraised at $3,000.

In the 12 months through January, sales of goods brought in for direct sale rose 30 percent to $320,000." 

Argentines desperately need money. And if any central bankers know how to "crank up the presses," surely it is the Argentines. As recently as the late '80s, the printing presses of the pampas cranked out so much currency that a peso printed at the beginning of the year had lost 90% of its value by Christmas.

But, of course, that was when Argentina had no use for additional currency. In the '80s, Argentines needed less money, not more.

Who would have imagined what would happen scarcely a decade later? Argentina, as you may recall, beat its inflation problem by turning off the presses and pegging its peso to the U.S. dollar. The dollar, though, has been remarkably high, which put Argentina's exporters at a comparative disadvantage. Within a few years, the economy was in a slump. This year, in fact, marks the 4th year of recession.

Argentina, of course, borrowed billions from accommodating lenders such as J.P. Morgan...which, as Eric points out above, never met a bad loan it didn't want to make.

Finally, Argentina had to break the currency peg and stiff its creditors. Naturally, people in Argentina worried that the peso would fall in value and rushed to banks to try to get their money. The government moved to protect the banks by limiting the amount of money a person could withdraw. Even if you have a million pesos in the bank, you're only able to take out about $800 per month to live on.

We reported the strange case of a man who showed up at a bank with a hand grenade - threatening to blow the place up if he didn't get his money. The man was arrested. (see the complete note)

Which just goes to show how upside-down things really are in the southern hemisphere. It should have been the bankers and politicians who were arrested - for stealing the poor man's money. But that is not the way of the world south of the equator...or north of it.

Central bankers can create "money," dear reader, but only when you don't really need it. The argentine peso has lost 50% of its value in the last month. Still, in real terms, prices are falling - as desperate people unload family heirlooms in order to get enough cash to pay their rent. The pawnshop lines begin forming at 4 a.m., reports Bloomberg. And prices for unreclaimed goods are plummeting. Unemployment is soaring to Great Depression levels. If central bankers really could create "money," what better time to show off their skills?

But that is the problem. Alan Greenspan is only a maestro at creating "money" in a boom. In a real bust -which we haven't had yet in America - he will be a total flop. In a bust...that is, when money is most needed... the demand for cash goes up, but the supply goes down.

Central bankers can do nothing about it.

American Banker magazine reports that the largest 25 U.S. banks have $16.6 billion of exposure to just two risks - Argentina and Enron. And the bank with the  largest exposure - to these as well as other hazards - is J.P. Morgan. Today's news tells us that the House of Morgan was also the most aggressive lender to Tyco... from which it now faces a loss of up to $1 billion.

As long as the economy was in boom mode, lenders were happy to throw their customers' money around. But when times begin to get tough, it becomes tough to get new credit. Lenders become wary. Even as the central bank lowers short term rates, borrowers find they have to pay more for their money.

As Eric notes above, Qwest had to draw on more expensive bank financing after it was unable to sell its commercial paper. Other borrowers are facing the same problem. Regardless of what Greenspan may want, the credit markets have interest rate policies of their own.

A credit downgrade is equivalent to an interest rate hike.

J.P. Morgan was named "Bank of the Year", "Derivatives House of the Year", and "Loan House of the Year" by International Financing Review. But when one's star has risen so high that one's mug appears on a magazine cover - like Jeff Bezos on the cover of TIME - it is usually a prelude to disaster.

In the investment world, few indicators are as reliable as the big banks. Find out where the big banks are lending a lot of money - and it is almost always a black  hole. Each decade seems to produce at least one major cosmic implosion in the banking world. In the '70s, banks lent to oil producers...and Texas real estate. In the '80s, it was emerging markets. In the '90s, telecoms provided the garbage pail for bankers' money.

And some banks seem to be able to get in on every losing opportunity that comes along. So far, no major losses have been announced in the press without J.P. Morgan's name mentioned. Enron, Qwest, Argentina, Tyco...how many of these disasters can the bank sustain?

We don't know. But the problem goes far beyond J.P. Morgan.

"Maybe I'm naive," writes Stephen Roach, "but I must confess to being amazed at how little we in the macro community know about the possibility of more Enrons. The same is true of the markets...there can be no mistaking the broader excesses of corporate leverage in the system; corporate debt currently stands at a record 65% of US GDP. While that doesn't guarantee that there will be more Enrons to come, it does speak of a business culture replete with risk - one that is ill-prepared to handle a broader contagion that would raise borrowing costs and/or result in a significant restatement of the underlying earnings stream that is required to service such obligations."

"The same can be said of household sector leverage in the United States," Roach continues. "Total consumer indebtedness currently stands at a record 73% of GDP.

This, in my view, is an unmistakable legacy of the asset bubble. First stocks, now homes, American households have been unusually aggressive in borrowing to support lifestyles. In doing so, of course, they have depleted traditional saving balances and relied increasingly on readily available credit to extract newfound income from inflated asset values. The overhang of excess debt, however, remains a troubling aspect of the post-bubble hangover. Should income continue to weaken, or interest rates suddenly increase, it would be exceedingly difficult for the household sector at large to keep servicing this debt. The problem, of course, would be even more acute if the U.S. were ever to experience a whiff of deflation. The debt-deflation trap is one of the most intractable dilemmas for any economy. Just ask Japan."

We don't know what will happen to J.P. Morgan. (We'd like to know where the big banks are going to lend next, so we can sell short).

But we're willing to bet that even J.P. Morgan is beginning to ask questions of its borrowers, and may ask for a point or two of extra interest to try to offset its losses in other parts of the business. And, we'll hazard another guess - that the recovery in the U.S. economy will be as strange as the recession that preceded it. "Money" will get tighter, not looser. The more people really need it, the less money will be available to them.

Telling it like it ought to be,

Bill Bonner