Saturday, May 12, 2012

Thank you Jamie Dimon for showing that pundits calling for ultra transparency were right

In Joe Nocera's NY Times column on JP Morgan's $2 billion trading loss, he quotes Jamie Dimon, the chief executive of JP Morgan Chase saying
It plays right into the hands of a bunch of pundits out there.
Yes it does and particularly for pundits like Nobel prize winner Joseph Stiglitz and myself who have been calling for transparency.

In your humble blogger's case, for ultra transparency where banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

For much of the last three years, as the Obama administration and Congress have grappled with how to rein in a financial system that had lost both its moorings and its ethical compass, no one has been more vocal in his opposition to a more regulated banking system than Dimon.
Actually, I happen to agree with the vast majority of Mr. Dimon's criticisms of the regulations that the Obama administration and Congress have proposed since the beginning of the financial crisis.
He has complained repeatedly about higher capital requirements.
If there was anyone who would understand how meaningless higher capital requirements are when banks are not required to mark their assets to market and under the policy of regulatory forbearance can practice extend and pretend with trouble loans, it is Mr. Dimon.
He has said that some proposed regulations were “anti-American.” He has consistently flayed the Dodd-Frank financial reform legislation, which was ultimately Congress’s attempt to prevent another Lehman Brothers-style meltdown.
Regular readers will recall that this blog awarded a grade of a D-F to the financial reform legislation as there is almost no chance that it will prevent another Lehman Brothers-style meltdown.

The first evidence that it is unlikely to prevent another meltdown is that Congress did not wait for the Financial Crisis Inquiry Commission to determine what caused the crisis before Congress passed the legislation reforming the financial system.

What were the chances that any reform is actually going to address any of the underlying causes?
As for derivatives, Dimon took the view that most of what Dodd-Frank proposes to do — such as make derivatives more transparent, while eliminating the ability of banks to make proprietary trades, thanks to the so-called Volcker Rule — was unnecessary if not downright counterproductive....
I agree with Mr. Dimon that what Dodd-Frank proposes to do with derivatives is unnecessary if not downright counterproductive.
The big loss — which, it’s worth pointing out, was not the result of a rogue trader, but was rather part of a strategy that had the backing of the bank’s risk executives — gives the lie to Dimon’s antiregulatory rhetoric like almost nothing else could.
Actually, the big loss would not have been prevented by the Dodd-Frank reforms.  This is a point that Mr. Dimon kept making with his anti-regulatory rhetoric.
As Michael Greenberger, a law professor at the University of Maryland — and a former official at the Commodity Futures Trading Commission — explained in an e-mail that landed in my in-box early Friday morning, it is quite likely that the loss would never have occurred if [the right reform and not] Dodd-Frank’s proposed rules about derivatives had been in place. 
For starters, if the trades turn out to be proprietary trades — and we don’t yet know if they are — they would have been forbidden under the Volcker Rule.
We need to trust Mr. Dimon when he says the trades were suppose to hedge a risk that JP Morgan has and therefore would not have violated the Volcker Rule.

Due to current disclosure practices that leave JP Morgan looking like, in the words of the Bank of England's Andrew Haldane, a 'black box', we have no way to say Mr. Dimon is not telling the truth.
But even if JPMorgan wasn’t trading for its own account, the transparency Dodd-Frank mandates would have alerted the markets and “losses would not have piled up opaquely,” Greenberger wrote.
Actually, Dodd-Frank does not mandate the type of transparency that would have alerted the markets.  Dodd-Frank mandates 'price' transparency by putting derivatives on exchanges.  It does not mandate 'ownership' transparency so that market participants know who owns the derivatives.

In fact, as reported by Bloomberg six weeks ago, the market understood that JP Morgan had a large position.

What the market did not know because there was and is not the requirement for JP Morgan to provide ultra transparency was the answer to the whether this was in fact a hedge as Mr. Dimon claimed or a bet.
The Federal Reserve would have seen the trades, and would likely have forced JPMorgan to back away from them....
As discussed in a previous post, by its own admission, the Fed does not look at trades and therefore would not have forced JP Morgan to back away from them.

Which is one of the reasons that ultra transparency is needed.
Even at a bank as ostensibly well-run as JPMorgan, the incentives still exist for giant, risky bets to be made that can go very wrong. JPMorgan can withstand a $2 billion hit, but not every bank can — and who’s to say that the next derivatives debacle won’t be $5 billion or $10 billion?
ZeroHedge has already placed this debacle at $5 billion and counting.
Jamie Dimon is undoubtedly a very good bank chieftain, but he’s only one man in a large institution; he can’t oversee every trade. 
The only way to change incentives industrywide — and get bank risk-taking under better control — is through a combination of tougher rules and more transparency....
Specifically, ultra transparency.  While Jamie Dimon cannot oversee every trade, the market can.

Let me repeat that, while Jamie Dimon cannot oversee every trade, with ultra transparency the market can.  Not every market participant will oversee every trade, but in total the market participants will oversee every trade.

In addition, with ultra transparency, there will be some market participants who think that engaging IBM's  Watson (of Jeopardy fame) or its equivalent will be valuable as these systems can look at every trade.
It is unlikely, of course, that Jamie Dimon will come around to that view in the wake of this debacle. But, with any luck, the rest of us will, Congress and the regulators very much included.

 If Jamie Dimon wants to show true leadership, he will adopt ultra transparency now.

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