A Potential Pothole on Rally Road

In previous times of such financial market stress, "somebody's derivatives book gets out of whack," Hamzei said, recalling Victor Niederhoffer's hedge fund in 1997 and Long Term Capital Management in 1998, among others.

Because J.P. Morgan was intimately involved as a lender to Enron, Global Crossing, WorldCom, Tyco (TYC Quote), Kmart and a host of other bankrupt or teetering telecoms, investors' faith in its risk management strategies has eroded.

Concerns abound that, among others, the firm's financial models are not functioning properly in the current environment of 40-year-low interest rates and extensive year-to-date declines in major equity proxies for a third-straight year. Former employees say the current leadership, which is largely the old Chemical Bank team, is ill-prepared to handle such extreme market events.

Thus, the firm's repeated declarations, which a spokesman reiterated Friday, that its derivatives exposure is far less than the notional value of contracts it's engaged in and that the bulk are with highly rated counterparties, are increasingly failing to mollify its critics.

"Everyone knows J.P. Morgan Chase is in deep trouble," commented Jim Puplava, president of Puplava Financial Services, a Poway, Calif.-based firm with about $200 million under management. "It is a bank in all the wrong places and it is hemorrhaging from multiple sides of its businesses."

Puplava, whose firm has no positions in J.P. Morgan, compared derivatives to an insurance policy, and derivative dealers as providers of such policies.

Describing today's financial markets as a "100-year storm" or a "major earthquake," the money manager suggested "the problem we have today [is that] risk has been concentrated on one particular insurer: J.P. Morgan."

Because much of J.P. Morgan's derivatives book are "highly specialized and customized contracts," Puplava suggested it's difficult to assess the true value of the portfolio. It is "highly illiquid and vulnerable to panic selling in the event of a crisis," he argued, recalling that when credit spreads widened in 1998, Long Term Capital Management's risk multiplied as it found itself unable to offload losing positions.