The Times article seemed to indicate it was both. See my comment on the old risk model assigning double the loss possibility of this strategy as the new one.
I don’t understand why anyone is acting as if Dodd-Frank bans derivative trading. What would have helped here was the increased transparency of the market, which would have shown the losses to everyone before they blew up. I don’t know if Dimon is against this also, but I suspect so.
As for complaints about complexity, the added complexity seems to be coming from the lobbyists, as they wish to add loophole upon loophole.
Good one. In keeping with that theme, right wing regulatory policy seems to owe a lot to “The Arkansas Traveler.” During the crisis you can’t do anything because the banks are too weak. Between crises you shouldn’t do anything because there is no current problem.
Trom, thanks for the Whale of a Tale. It’s a pretty good explanation of what is going on.
The FT is good too but most laymen won’t have the context to understand.
As the Whale of a Tale explains, it is hard to say if this was a screw up or if it was an outright (partial) bet on red 21. Hedging is tough, especially in unregulated OTC markets. I mean you can hedge Chicago futures until the cows come home, but you can’t make any real money doing so. The money is in OTC options. Remember that these are dynamic hedges, eg they have to constantly be rehedged as the market, interest rates, exchange rates, etc change. It’s not like you have a ton of gold, and sell a 1 year gold future and arbitrage the difference.
Let’s be clear, this hedge complexity did NOT come from lobbiests or Doobs Frank. It came from the very nature of trying to hedge complex things in a relatively illiquid market. Then, in a tale as old as time, once the market figures out what a single player is doing, that single player is fucked 8 ways from December. Ask ye Merry Ol’ Bank of England when the pound got crushed back in what '92 or '93. Lost a billion pounds a day trying to defend the pound before throwing in the towel. Soros made his rep on that but he was a bit player compared with Swiss Bank Corp, Goldies and some of the other big swinging dicks that took down the BOE.
Net Net, we should re-institute Glass Seagal to remove the systemtemic risk to the banking industry. Otherwise, this will happen over and over again and governments and their tax payers will bail them out.
I like China Guy’s synopsis. And agree Whale of a Tale gives a good view. Here’s part I think deserves attention.
It may be appropriate that a bank hedge its “long credit” positions that accrue because lending money is its business, but this extra “$100bn CDX long credit position” was a hedge against the short positions hedging the ordinary long positions. :smack:
Those who want better financial reforms do not claim this peculiar hedge was malicious, clearly illegal, counter to the bank’s self-interest, or even necessarily large enough to risk a repeat of 2008. But it certainly was complicated. Such complications, which arise from what I’ve called “the quest for hyper-efficiency,” certainly increase the systemic risk to financial markets and do this with little or no compensating gain to the general public.
Contrary to upthread confusion, no one is claiming the $2 billion loss is a big deal. Compare it with a successful poker player who nevertheless often loses $1000 pots – if he didn’t it would mean he’s not playing aggressively enough. I suppose clever poker players develop elaborate systems of fake tells they can deploy in their zero-sum games that have little public benefit. Society tolerates poker because it’s just “boys having fun.” But do we really need this level of gambling at our big banks?
Debate is difficult because there are two competing models of human economic society and its purpose. (For simplicity I’ll ignore shades of gray in between.)
[ul][li] Governments grant charters to banks and corporations to further the public interest. Profits and bonuses earned at banks can be viewed as the just rewards for serving that public interest. Government is by the people for the people and of the people.[/li][li] Human society is better viewed as a jungle, operating under dog-eat-dog rules. Government is by the powerful for the powerful and of the powerful, and exists mainly to ensure that the defeated dog submits to being eaten. I disagree with this view but it is at the heart of some “libertarian” philosophies.[/li][/ul]
The issue isn’t whether JPM “did something wrong.” The issue is whether the present financial system is well adopted for general prosperity and stability.
Good analysis. The evidence is that these increasingly complicated hedging schemes are actually introducing MORE instability into the financial markets.
For example-you (a banker) decide that its a good idea to bet on Greek bonds (you reason that the Germans won’t risk losing their investments. So you buy up billions in heavily discounted bonds-you can make a killing on. To cover your bet, you simultaneously buy credit default swaps, and also short the euro.
So now, euro currency traders learn that is big new player has entered the market (you)-so they pile on (sensing you might be right).
Now the fun starts-your lenders get uneasy-so they call their loans to you-and you have to sell the bonds-a guy like Soros will happily take them off your hands-providing you knock the price down-so your bank now loses 90% of their investment-and you get a nice bonus and your bank tells the shareholders-“sorry, we got in over our heads-but we only lost $2 billion-we’ll just get the Fed to make it up!”
Talk is cheap. Warren Buffett’s very own Berkshire Hathaway not only invests in companies that use derivatives but also trades derivatives for their own account.
[QUOTE=Berkshire Hathaway 12/31/11 10K]
BH Finance also enters into derivative contracts and assumes foreign currency, equity price and credit default risk. Management recognizes and accepts that losses may occur due to the nature of these activities as well as the markets in general. This business is conducted from Berkshire’s corporate headquarters.
[/QUOTE]
The basic problem with the Volcker Rule is that there is a question of exactly how it should be implemented. When they place limitations on proprietary trading, what does that really mean. The Volcker Rule is not intending to limit legitimate hedging activities, but depending upon how it is implemented, it may actually do just that. The question is what is the line between making a market and proprietary trading. It’s not as clear cut as some might think.
That’s not really true. Dimon has openly been in favor of reasonable and increased regulations. What he doesn’t like is the Volcker Rule since it is so ambiguous.
Just as you say: talk is cheap. He is assuredly in favor of reasonable regulations, in fact, he is perfectly willing to write such legislation, to ensure such reasonability. We should all take inspiration from his willingness to bear his civic burden. Yes. Quite.
I don’t see that the Volcker Rule would apply here. Even if proprietary trading was somehow explicitly defined and banned, the JPM trade could still have happened. It was a hedge - a bad and poorly executed hedge - but still a hedge. The fact that the trade lost a ton of money doesn’t mean it was a proprietary trade.
What about the Fed’s philosophy of allowing banks like JPMC to borrow at zero interest? Then gamble with it? How does this benefit the public?
How can you lose if you can get all the money you want, and pay nothing for it?
It proves it because Dimon claimed that Morgan Chase was well run, Morgan Chase was an example of the kind of adult, intelligent institution that would NEVER get caught up in the kind of mess that precipitated the 2008 recession (can we call it that now?) and yet they DID!
NO financial institution is safe to trust with the kind of murky financial instruments with NO oversight we got running around today.
But I take your point, while I’m still all for reinstating Glass-Steagall (Congress will never do it so long as it is owned by Wall Street) to keep bank depositors’ money out of the roulette table, I will admit “cutting them off at the knees” might have been overly broad language. How about a more specific remedy: an end to all naked credit default swaps? We can keep the credit default swaps for people who are involved in the initial transaction, it’s good to be able to hedge your bets. But making bets on bets as a matter of business? BAD idea!
I don’t have a problem with re-instating G/S, but if you think a $2B loss is all it takes to prove that more regulation is needed, then you don’t know anything about finance. So what if the CEO said his company is well run? What CEO isn’t going to say that?
If you’re going to freak out every time a company has a big loss, I don’t want you calling the shots on regulations. (And that’s the generic “you” in both instances.)
[QUOTE=LonghornDave]
The basic problem with the Volcker Rule is that there is a question of exactly how it should be implemented. When they place limitations on proprietary trading, what does that really mean. The Volcker Rule is not intending to limit legitimate hedging activities, but depending upon how it is implemented, it may actually do just that. The question is what is the line between making a market and proprietary trading. It’s not as clear cut as some might think.
[/QUOTE]
I’ve read several pieces today (including, IIRC, one article linked into this thread) that say the Volcker Rule wouldn’t even have affected this, regardless, so it seems moot to me. I suppose re instituting G/S WOULD have prevented this, but I remain unconvinced that this would ‘fix’ the ‘problem’ either.
To me, I still think that this is about risk and a risk averse public (and various risk averse 'dopers) who think that somehow the government can shield us all from any sort of risk or problem by preventing business from doing anything risky…and that this will lead to a healthier economy. I’ve read through many of the links in this thread, including the one in the OP, but I’ve still seen nothing that really convinces me that this is the path of wisdom.
JPM took a risk and it didn’t pay off for them. Ok…I get that many here and lots of pundits think it was stupid and even reckless. They are certainly paying the price for their mistake both in the losses they took directly and in the fact that their stocks have gone down quite a bit, and it’s going to take a long time to regain the markets trust. To me, that’s all exactly as it should be…and exactly how the market is SUPPOSED to work, and there is nothing here to ‘fix’. It just doesn’t seem a problem to me that NEEDS fixing at this point, I guess.
Except that this time they didn’t lose so big as to require a government bailout to protect the financial system (and life as we know it).
All the big banks have implicit and explicit guarantees so they gamble with other people’s money. Glass Steagle2 would remove the implicit guarantees.
I’ll take Volker implemented in less than 100% perfection versus Lehman Bros running amok. And, unlike most pundits in this thread, I worked at Lehmans Hong Kong fixed income in 1996 before they lost their ass in the 1997 Asian crisis on poorly managed risk that I highlighted and was told to shut the fuck up about because it might impact bonuses.
[QUOTE=China Guy]
Except that this time they didn’t lose so big as to require a government bailout to protect the financial system (and life as we know it).
[/QUOTE]
shrug Don’t bail them out, or if you do then legislate a break up a la AIG.
Correct me if I’m wrong here, but wouldn’t G/S merely prevent banks from engaging in any sort of non-banking trading? How would it remove the ‘implicit guarantees’ (i.e. the federal FDIC or other protections of banks failing)? I thought that was all G/S did.
How would US legislation effect offices in China?? Regardless, ISTM that the answer to this is, again, simply let them fail if they fuck up by the numbers…or, if they are ‘too big to fail’ then legislate to nationalize them if they require a federal loan to stay afloat with the proviso that the assets would be managed until they could be sold off to repay the tax payers for the bail out. I mean, that seems to have worked out well the last time this happened, and that was a systemic failure, not just one company running amok. I believe that most of the banks have repaid their bailouts, and I think we (the US taxpayer) actually ended up in the black as far as AIG went…no?
The banks are closing in on the Holy Grail, the investment return that reflects a risky investment so cushioned by carefully designed hedges that its not really risky at all, it just pays like its risky. And if it all goes south and ker-blooey, most everybody keeps their hard-earned money and their jobs. Some retire in disgrace. Rich, of course. But in disgrace.
And how it unleashes the creative,unregulated juices of our financial wizards! Get it wrong, pretty rich, get it right, rich as shit.
