Perhaps the most revealing aspect of the $2.3 billion loss disclosed by Jamie Dimon last week after the U.S. equity market closed is that it may have been incurred using the bank’s “excess deposits” — namely the balance of customer funds that exceeded the banks loan portfolio.

What that means is that instead of using these funds to loan out to America’s large and small businesses that are screaming for capital, or homeowners anxious to refinance their mortgages at historically low rates, JP Morgan was using these funds in its own terms to hedge against risk of loss in its existing loan portfolio.

Ironically, it now appears that it might have actually been LESS RISKY for the bank to loan some or all of the excess of deposits — totaling $300 billion, $100 billion of which was tied up in this particular trade according to press reports – out to worthy borrowers rather than play counter-positioned games in the non-cleared (i.e., opaque) shadow credit default swap/index derivatives market.

Let’s put aside Dimon’s mis-statement that this trade did not involve ”client” money — he apparently doesn’t consider “depositors” as “clients.” Let’s put aside the fact that Dimon last month referred to this very trade as a tempest in a teapot when the Wall Street Journal fingered it as an aberrant position that was perplexing the London market because it was moving the price of the very index it was betting on (something a true hedge by its nature would not intend to do).

Let’s just notice that this was a situation where JP Morgan first was using depositors’ money (insured to some considerable degree by the U.S. government) first to buy a CDS as a bet protecting against the possibility that an index of U.S. corporate bond credits would deteriorate in price (presumably because the overall U.S. economy falters, thereby increasing default risk on the bank’s loan portfolio). The value of the CDS would rise to offset the loan losses.

Then, as the U.S. economy showed signs of strength in late 2011 and in early 2012, they decided to ‘hedge the hedge’ by selling the same derivative, which was essentially a countervailing bet the U.S. economy would strengthen, whereby the loan risk would fall and the banks profits from the sale of the CDS would offset its losses on the CDS position the bank had previously bought — as its value would go down if the U.S. economy continued to do well. These CDS dealings aggregated $100 billion, and after the French and Greek elections, the markets essentially turned against the second hedge, causing the bank to begin to sell off its exposure at a loss.

Indeed, the timing of these trading moves leads to the obvious question (which no one has yet asked) whether the London-based French and Greek traders (you can look up their nationalities) who just happened to run the desk at Morgan London that pushed and executed this strategy were in reality making a bet on the outcomes of the French and Greek elections themselves (had Sarkozy won and had the Greeks elected a pro-bailout/austerity majority, the second hedge might have performed quite well and the bank would be sitting pretty).

Put simply, was JP Morgan using depositors’ funds to make a massive bet on the outcome of Eurozone elections to cover the fact that they might have over-hedged their exposure on U.S. loan losses out of fear that the U.S. economy would fall back in the spring as it has the past two years, partly because of concerns about the survival of Eurozone economies and bailout plans? If so, we don’t need just a Volcker rule, we need a “sanity clause”!

Follow Terry Connelly on Twitter: www.twitter.com/deantrc

Putting aside the fact that conventional wisdom on the economy has generally been pessimistic for four years running; putting aside the competition among media commentators and journalists to be the first to call the next financial meltdown; and putting aside ideological trading patterns and media commentary designed to talk down the economy until the November election so as to hurt President Obama’s re-election chances — the facts show a solid case that the U.S. is now the best-positioned large scale economy in the world just now.

Almost all commentators and journalists, of course, missed calling the 2007-2009 “Great Recession” much less the housing market and housing finance collapse that triggered it, so it’s understandable that they would have bias toward predicting the next meltdown. And over the past three spring trading seasons we have heard plenty of worst case scenarios promoted as base case scenarios in order to qualify for the Cassandra Sweepstakes on cable TV.

Greece was going to leave the Euro and have a disorderly default; Germany was going to get fed up and go back to the Deutschmark; the euro itself was going to fall in value to arithmetic parity with the U.S. dollar (it still stands at about 1.31 as this is written); then the U.S. was going to default; now its Spain, Italy, France!

And of late we heard aggregate Standard & Poor’s 500 stocks for the most recent quarter were going to come in at only a one percent rise or even less, with a some predicting a downturn (thus far into reporting season, they are already up four percent and rising.).

We can forgive just trying to be the next journalist to land a big book contract for pinpointing the next market crash; what is unforgivable is the willful ignorance of cable network editors and anchors. They should know that a lot of these negative sentiments are coming from hedge-fund and other investors who missed the surprise first quarter rally in stocks and are trying to catch up by shorting the market down so they can buy in cheaper after earnings come in. They keep putting on the same old pessimists, without asking them to explain their miss-calls in 2009, 2010 and 2011.

Some of these commentators also cite the notion that the U.S. is having a sub-par recovery because we have been showing only one to three percent GDP growth, compared with growth of three to four percent at this point in time after past recessions; but they ignore the fact that prior recessions typically showed GDP drops of only around three percent, while the Great Recession took us down five percent in GDP. A climb back from a negative five percent to a positive two percent is indeed and even more robust recovery than a rebound of up three percent after down three percent! Big lies work by repetition.

U.S. investors are now so skittish that canny hedge fund traders can now manipulate the U.S. stock market into a swoon simply by investing relatively few dollars bidding up the cost of credit default swap insurance contracts of Spanish bank debt (thereby causing rates on Spanish government bonds to move up and the Euro to slump down). By thus moving shares out of “weak hands” scared by the now annual rites of springtime disaster scenarios, these hedgies can buy in cheap and wait for stocks to rally again as they have each of the last three years.

Of course, there are real problems in Europe, which is in a recession that will hurt the returns of many U.S. multinationals, but in aggregate, will only dent GDP growth even if every export dollar relating to Europe went away. And we know China is slowing down; Brazil is in a funk and its central bank is fast cutting rates to re-stimulate the economy; India has political discord and corruption scandals; and Russia is learning to live with Putin again (as if he ever left). And lets not even mention the Mideast as we wait for a resolution of the Iranian nuclear issue that will please nobody but perhaps keep us out of war and the price of oil under enough control to keep gas prices within reason.

But all these facts really convey the sense the U.S. is in the best shape going forward of any of these other economies, is experiencing a modest resurgence now that domestic manufacturing has saved and strengthened its domestic auto industry, has the healthiest banking system in the world, has several airlines that are making profits, is growing again in Silicon Valley and similar high-tech environments around the country, and has a stock market (and 401 (k)’s) much higher than in Q1 2009.

In short, we have a chance to have an “American decade” economically. All we are missing is a little optimism — well, OK, a lot of optimism, and lot more skepticism about the folks peddling pessimism as if it were the new true religion.

It already seems clear that Americans do not have a basic, even constitutional, right to health care. We continue to enjoy our unique place among Western democracies in that regard. But Congress has “obligated” care for the uninsured in our nation’s emergency rooms — a right that opponents of Obamacare in their arguments before the Supreme Court characterized not as an achievement, but rather as a “problem” Congress created for itself and now cannot be permitted to solve with an insurance mandate. Or, as Justice Scalia chillingly put it, “Don’t obligate yourself.”

We can discern fairly clearly now from their oral commentary in three days of oral argument what Scalia and his judicial-activist colleagues would permit Congress to do under their restrictive reading of the “regulate commerce” clause of our Constitution:

1) Let the uninsured die in the street — namely, Congress could permit or indeed even require hospitals and urgent care facilities to refuse care to anyone who could neither pay not produce proof of insurance. (The “Drop Dead” option — and we thought the death penalty was on its way out.)

2) Require the uninsured to “purchase” insurance when they show up at the emergency room seeking care for themselves or their children — at God-knows what ungodly price. This provision would seem to require some sort of “presumption of consciousness” to validate the insurance “contract” to comply with the “point-of-sale” theory of constitutional validity espoused by Obamacare’s courtroom opponent. (Let’s call this the “Alice in Wonderland” option.)

3) As Justice Ginsburg pointed out, if Obamacare had simply been set up like Social Security — i.e., as a fully-governmental process where all are taxed to pay for health care through a federal single-payer — then there would be no question of its constitutional validity under the “conservative” justices analysis. (One hesitates, but must reluctantly call this the “Public Option.”)

4) Just penalize those who “default” on their hospital bills because they are uninsured — but bare in mind that these defaults occur generally because the typical catastrophic illness bill far exceeds the average American annual income. (Undoubtedly, this option can only be called “The Rack,” as all that will be left to get under such a constitutional penalty will be blood.)

5) Let the states decide whether or not to impose an insurance mandate, which the conservative Supreme Court majority concede the states can do under their “plenary” power, as they do when they require insurance proof from those who wish to drive cars. (We can only, with some irony, call this the “Romney Option.”)

6) Require that persons only buy insurance coverage that they specifically need: only catastrophic care for the “healthy” young adult, per Justice Scalia — of course, he doesn’t mention prostate cancer care coverage for women, but then Roberts doesn’t always seem to focus on the situation of women. (We’ll call this the “No Size Fits All” option.) Here, the free market conservatives, of course, are attempting to impose judicial will on the structure of the insurance industry.

The Court’s conservative majority seems to be caught up in what we might call the “broccoli patch.” The Right Wing’s absurd analogy (now adopted by Justice Scalia) is not apt. The insurance market (as Justice Kennedy belatedly recognized near the close of argument) has distinctive “network effects.” Like a stock exchange, the more people who use it, the more valuable (and usually the less expensive) it becomes. This is obviously not true in any material degree with respect to broccoli — and again, Justice Kennedy also acutely observed near the end that all big issues are matters of “degree.”

If I buy broccoli, it does not make it cheaper, or taste better, for you. The same is true for the “car” analogy put forward by Justice Scalia — if I don’t buy a car, it does not make a car intrinsically more expensive — any price effect is due to the laws of supply and demand, not to the nature of cars. It is precisely the nature of insurance, however, that it thrives on diversity of risk and a large scope of participants.

If the Court concludes that excising the mandate from the entire act without examining each and every issue of severability is just too onerous and inherently “political” a task, they might find a way out from the broccoli patch by remembering the route that essentially the same conservative majority took in their previously most political decision, Bush v. Gore. There, Justice Rehnquist opined that the decision was uniquely limited to its specific circumstances and would not hold as precedent for any other case. Why not do the same here, with what Justice Kennedy, and to a degree Roberts, seemed willing to consider a truly distinctive market for health care and insurance?

In any event, the bet here would be that the Chief Justice will write the opinion in the Obamacare case — either as author of a 5-4 purely “party line” rejection of the statute, or, if he perceives Justice Kennedy will vote in its favor, as author of a most narrowly-circumscribed affirmation of the law’s constitutionality.

College student debt in America just passed $1 trillion dollars outstanding. That’s more than the Obama stimulus program; more than the infamous TARP bailout; more than Europe’s sovereign debt rescue funding; more than the latest federal deficit reduction plan.

California’s state university students have taken to the streets of their campuses to get to the heart of the matter: the ever-rising tuition and fees bills they face every year is the trigger for all that borrowing against their future income. This is the new “mortgage crisis,” as today’s young people are forced to mortgage their future income stream to pay ever-increasing amounts for ever-decreasing quality of learning opportunities.

With the onset of the Great Recession, California had cut its support for higher education by two-thirds from the baseline level of the early ’90s, and forced the Cal State and Community College systems to cut over 300,000 student positions and hundreds of courses and faculty jobs.

Both the UC System and Cal State leadership estimated that a billion dollars would be required to restore the universities to their level of functioning back in 2001, but that level funding was nowhere to be found in 2011, especially as federal stimulus funding ran out. Instead, along with continued double-digit tuition and fee increases, another 200,000 student positions were cut from the Community College system, and 40,000 from the Cal State universities. Some schools were forced to cancel classes — especially during the summer sessions.

When you think about it, for centuries, colleges have been able to get away with an enviable business model — they have conditioned their “customers” to accept year after year price increases well above any measured inflation rates in exchange for no improvement in the service actually delivered. As soon as you sign on and show up, you are told by those in charge how lucky you are to be there with the privilege of paying the latest toll increases.

Imagine being any other business that could get away with that — here’s your newest model iPad: it’s slower, has fewer features, but we’re going to up the price 11% on you, this year and next and next, etc.

And that “etc.” tells a story in itself. Remember the movie Animal House, when John Belushi’s Bluto character laments, after his fraternity is banned from campus, “Seven years of college down the drain.” In the 1980s, that was a funny exaggeration; in 2012, it’s all too true and not so funny.

Right now, the average American college graduate takes six years to do so — and that’s just the average, many take a Bluto quota and more. Not because they have been goofing off at the frat house — but because of the combination of college workforce rules and budget cuts that have shrunk class availability down to a virtual lottery opportunity at best.

And that’s if he or she actually graduates – 45% drop out. That’s right — the American university system is producing drop-outs at about the same rate as the worst of our inner-city high schools. For every Bill Gates and Mark Zuckerberg, there are thousands who have to quit college while they’re behind — on their coursework, on their majors, on their debts. They have been forced to go back to work to make ends meet while they study, but most academic calendars are not set up at all to accommodate working students, so they have no choice but to borrow more if they can even get their courses, or quit and face their debt loads without a degree.

So what can Senator Blutarski from California do about this downward spiral of American higher education? California once led the world in providing affordable access to college to all classes of its rising generations who were qualified. Today, our taxpayers have said no to this commitment. Their attitude is in part a sort of generational war for resources argument of “I’ve got mine, who needs yours” shortsightedness that gets worse as recession and the monetary policies that go with curing it cut the income stream of retirees from bank accounts and savings bonds.

But in another part, the taxpayer revolt against the ever-rising cost of higher education has the same element of logic as the students who closed off the Santa Cruz campus and marched through Berkeley in their tuition protest. They want universities to get with the program that the rest of commercial and non-profit society has been forced to adjust to since the financial meltdown of 2007-08.

The California taxpayer is looking at the state’s campuses like the Germans are looking at the Greeks. They want the campuses to get their act together and produce better outcomes at a lower cost. And here is where California has an opportunity that is far better than the Greeks have.

California, if it sets its mind to it, can produce a new model to lead the nation out of its student debt death spiral to a new era of “no frills, four-year” college degrees. All it takes is a new academic calendar that uses the whole year to do the job (like the rest of us do in our daily lives); that employs the vast capacities of the Internet to enhance delivery of digitized course data and dialog (like the rest of us do in our daily lives); and that uses both the above new approaches to keep the shop open to accommodate customers who work (like every other enterprise does in our modern society).

Universities have long sung the merits of sticking to their traditions of faculty guilds and 15th century academic calendars by boasting that colleges, like the army and the church, are among human society’s few long-term surviving institutions. But even the Church has changed more than the colleges — at least there was a Vatican II that worked. And as we know all to well, it’s not your granddad’s army anymore, either — just ask the folks at the other end of a drone attack.

Ironically, universities that continue to refuse to get down to the “business” of adapting to the modern realities of their students’ lives and instead force them into a form of indentured servitude for a good deal of their adulthood have collectively forgotten that their precious traditional academic calendar was itself invented to serve a purely commercial 15th century reality. The college world’s leisurely working schedule mimics the agrarian calendar precisely because farming was the “business” of 95% of the families who sent their students to college way back when — summers were off not for faculty R&R&R (the third “R”, to be fair, is for Research) — but for students to return for tilling the soil and harvesting the grain.

California can lead the U.S. in harvesting the talent of its youngest citizen-voters by providing a new mode of access to college degrees that fits the times and the economy, and meets the challenge of the rising world around us. The need is there; the opportunity is there; the technology is there; the roadmap is there. What is lacking is imagination, willpower, and acceptance of the reality that we are sowing the seeds of national economic decline by our indifference to America’s “graduation gridlock.”

The United States has exchanged its former world leadership in college completion for the dubious honor of just racking up the most college loan debt! America’s jobs of the future — Rick Santorum notwithstanding — will require at least 15% more college graduates than we are now producing. It appears the next generation of illegal immigrants to these shores won’t be the agrarian workers of yesterday, but rather the B.A.s and Master’s degree holders and Ph.D.s smuggled into the country by U.S. businesses desperate to retain a competitive posture with respect to the rest of the world’s emerging powers, whose leadership and taxpayers have not despaired of the value of higher education.

But the biggest gift to the recovery in the world’s eighth largest economy may be the unsettled republican Presidential primary field. If Mitt Romney doesn’t win his erstwhile “home state” Michigan, or Arizona on February 28, then we could go on to a two- or three-way split decision on Super Tuesday among the Midwestern and Southern states. We have got ourselves a real horse race just in time for the Kentucky Derby!

So if among Sanctum Santorum, Mobility Mitt, Newt the Coot and RuePaul, we still have no clear front-runner in May, and all of the Final Four keep pledging to go “all the way” (with or without birth control), we could find that the race comes down to California in the first week in June, for the first time in ages.

What a bonanza for the California economy: all the campaign advertising and SuperPAC splurging on local TV and radio; all the plane-loads of reporters scrambling across the state trying to cover the biggest gaffes; all the Cable TV pundit shows relocating here for the week to set up ESPN-like “Game Day” sets in various Republican enclaves (how would Atherton handle the traffic?).  Not to mention the spending on food and drink, the hotel bookings and short-term house rentals, the suspiciously well-timed Sarah Palin bus tour of the Central Valley, and the sheer novelty appeal of candidates coming out here looking for votes and not just money. This could be bigger than Jeremy Lin!

Of course, a continued improvement in the California economy would undercut a central premise of the Republican campaign narrative – namely, that we are heading for a Grecian economic meltdown if Obama is re-elected. But never mind, they can always fall back on the new theme that Obama is a closet French (of course) revolutionary who would off the heads of anyone who doesn’t use contraceptives. Somehow, one doubts that line will play in California. They’ll have to come up with something new, just for us!

Having finally seen the “details” of further austerity measures, Greece’s political leadership has signed up to it. At the 11^th hour, it outlines the related bond restructuring  “volunteered” by the country’s private-sector creditors. Europe’s council of Finance Ministers has added three new pre-conditions to the release of bailout funds in time to stave off a Greek bond default around the Ides of March. Let’s call these conditions the Ides of February, as they must be fulfilled by Wednesday the 15^th:

1. The Greek Parliament must approve the austerity measures in a vote scheduled for this weekend – the leaders signed promises are obviously not enough to take to the bank, as it were;

2. The Greek Government must also come up with specific savings in the budget for the current year to take the place of the cuts in pensions that the political leaders refused to agree to – mere promises to “cut defense spending” are clearly insufficient;

3. The Greek political leaders must also agree not to scuttle the deal after the election in April installs one or the other of them, or some combination, as the new Greek Government.

None of these conditions is either surprising or unduly onerous, but will no doubt be interpreted by some in the markets as another frustrating delay in a solution to the crisis. Americans like results. But in this case, patience not only should be rewarded but also respected — this is the only path to avoid the chancy “solution” of disorderly default, which will occur otherwise.

We should have learned by now that in terms of Greece, everything goes down to the wire, and then some. But it remains better than the quick trigger we pulled on Lehman, sparing us about $30 billion in moral hazard in exchange for trillions in real hazard, three years of recession, a couple or three banks, and eight million jobs.

As this site correctly predicted just recently, the European Central Bank’s hook-slide around German orthodoxy by flooding the European banking system with enough cheap Euros (QE on the QT) has had the desired effect not only of reducing the serious risk of a bank funding crisis but also of underwriting the ability of those banks to support their countries’ sovereign debt refundings – and at a profit, no less!

As a result, the alarming rise in Italian and Spanish and French sovereign debt interest rates has been arrested. Therefore, the threatening risk to the future stability of those countries’ budgets is now in remission.

US Economy Moves from ICU to Outpatient Care

Likewise, the US Federal Reserve has, again as we predicted, underwritten another two years of reliably low interest rates for US investors and business executives.

Chairman Bernanke, the Republican’s favorite punching bag next to President Obama, seems to recognize that the US economy’s problem has now shifted from the Intensive Care Unit to Outpatient care, while not yet being “out of the woods”. The Republican’s seem to think (wrongly) that they need to keep up the sense of an apocalyptic economic collapse to make their case. (Could it be that Central Bankers really do know what they are doing, despite what virtually all the Tea Party talking heads on CNBC say day-in day-out?).

Friday’s weaker than expected 4^th quarter 2011 GDP estimate on the surface seems to buttress the Fed’s case, and surely 2.8% growth is a weak turn of recovery by most historical standards.

As this blog has observed in the past, most initial estimates of GDP are wrong, by large percentage factors, because the early report includes actual data (as opposed to financial model projections) only for the first half of the quarter. In particular, 4^th quarter GDP tends to understate the trend, in either direction, i.e., if the initial data shows the quarter up, then more reliable data later will show it up even more, and the same for down trends.

While this is a small comfort to those who lost money on the stock market last week, perhaps they can bide their time and recoup their losses by buying back their shares before the corrected report comes out in late February!

One things for sure – the Fed will still be underwriting the economy this February…and next February…  and next February …

2. Did the stock market get traded down by the big funds on this friday get traded down despite the good employment numbers because those numbers tend to help Obama, whom the  hedgies hate? (yes again.)

3. Are the Euro currency and bond vigilantes driving down sovereign  bond prices this week to force “Markozy”to give in to market pressures at their meeting next week and turn loose the ECB to directly support bond prices? (Not a chance.)

4. Will the ECB lower interest rates next week? (My guess yes, but the market thinks no because of the falling Euro. But  note that Germany must really, secretly like the falling Euro, at least for a while — helps their exports outside Europe.)

5. Is Standard and Poor’s holding off downgrading France because it has become afraid they will be blamed for killing Sarkozy’s re-election and ushering in a Socialist government in France in this April’s election?

6. Will the US Fed announce QE III in the mortgage bond markets sometime shortly after its January meeting? (Y

7. How many governors (and current opponents) has Romney promised  to be on “really  short list” he VP nomination to? (at least six.)

Europe, on the other hand, remains tangled in its own underwear: in particular, the German strict construction of the European Union treaties to the effect that the European Central Bank can never act as a “lender of last resort” to its sovereign states, even to prevent a financial panic and  the collapse of the Euro currency. (German authorities seem to be most fond of enforcing the rules they themselves are the first to break: originally, by violating the Euro limits on national debt; and now, by their own political interference in ECB decisions, which they separately argue should be “independent” from such influence  –at least from other governments.) In effect, if the German position is not merely a negotiating posture to force recalcitrant Mediterraneans to get their budget acts in good German order — as many market participants seem to hope — the Euro currency is essentially a suicide pact!

All this could come to a head as soon as the first quarter of 2012 when Italy and Spain are forced to refund billions of maturing debt. At prevailing pricing trends, they cannot afford to do so without bankrupting their budgets. They need a financial  backstop to effectively put a lid on their sovereign debts’ interest rates by massive and timely market intervention — exactly what the Germans say the ECB cannot do.

Among Europe’s financial eminences, only the semi-disgraced Dominique Strauss-Kahn  seems to understand just how serious the situation is, but he is effectively without political force.

As we approach year-end, however, the ECB has attempted an elegant  hook-slide around  Germanic obstinacy by extending to three years its virtually unlimited lending facility to EU banking institutions at a rock-bottom short term rate that normally applies only to very short term borrowings. This yield curve tinkering –let’s call it QE on the QT  by the ECB — enables these banks to hold on to their existing holdings of Eurozone sovereign debt purportedly to maturity, thus deferring further write-downs impairing their capital or  the dumping of such bonds on a highly nervous market. It also invites the banks to buy into the refunding rollovers due. $500 billion of this offer was taken up by Europe’s banks, and another opportunity will be in place by February to continue  shoring-up the banking sector, which in turn helps the sovereign sector (which would have to bail out failing  banks to prevent Lehman-lke economic collapses int their economies).

The main fly in the ointment as we end 2011 remains the rating agencies’ posture toward Euro sovereign credits. These agencies collectively failed to downgrade the  US mortgage debt instruments that brought on our own financial meltdown in 2007 and the Great Recession that followed. They now seek to display their new-found backbone by following up Standard and Poor’s questionable downgrade of  US  credit on political grounds with threats of downgrading Europe’s safest credits, including France and Germany.

Ironically, a quick-trigger downgrade in Europe in early 2012 could have the same effect as the slow trigger in the US of 20005-07 — a massive collapse of global confidence this time in Europe’s financial structure, and a potential global depression along with it. If we are lucky, the agencies will notice the subtlety of “Super Mario” Draghi at the ECB — he may be the first Italian politician to outwit the Germans. As the US begins to sense its own economic recovery (look for a great jobs number on at the end of January’s first week), we can only hope this is the case.

Doc = Paul

Dopey = Perry

Grumpy = Gingrich

Happy = Romney

Sleepy = Santorum

Sneezy = Cain

Snow White = Bachman