2 They assume the future will look nearly identical to the past;
3 They use lots of leverage to generate profits without enough capital in reserve;
4 And everyone always pretends to be surprised when the trades eventually go bad.
As to Dimon’s statements, I am not sure which is worse: whether he knew about it and was not forthcoming, or whether he (as claimed) simply had no idea.
Regardless, the error at JPMorgan unwittingly reveals much about the present state of finance:
● Bankers remain imperfect, overreaching and bonus-driven participants;
● When using other people’s money, the promise of enormous bonuses is still weighed heavily toward excess risk-taking;
●No major U.S. money center bank has demonstrated an ability to manage proprietary trading risks. None.
●If traders have forgotten the lessons of the financial crisis less than four years later, what sort of reckless speculative risks will mis-incentivized persons be doing after 10 years?
● Trades that are so enormous as to be “credit index distorting” are not hedges but pure speculation.
● Within banks, apparently the word “hedging” loosely translates as “speculation.” Actual hedging of existing positions appears to be nonexistent.
● This trade was called “hedging for profits” — there is no such thing. That is speculation.
● Value at Risk (VaR) as applied by banks today is a mostly useless concept. This model is such that even minor deviations have devastating consequences.
●Dimon, formerly praised as the Capo di tutti capi of bank CEOs, apparently has been more lucky than brilliant. This past quarter, his luck ran out.
●Because of the enormous built-in leverage in derivatives, they are inherently dangerous. They remain financial weapons of mass destruction.
● “Too big to hedge” is a threat to the stability of the global economy.
● Wall Street in its current configuration is trying its hardest to be “unregulate-able.”
Although this was “only” a $2 billion loss, it easily could have been much greater. That banks such as JPMorgan are still putting on trades that distort indices is, quite bluntly, astonishing.
Back to 1998!
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. You can follow him on Twitter: @Ritholtz
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