Wednesday, May 30, 2012

Argument for National Safety Board for Financial Crashes really is case for ultra transparency

In his Bloomberg column, Simon Johnson puts forward why he thinks we need a National Safety Board to investigate financial crashes.  While doing so, he highlights the need for ultra transparency throughout the financial system.

There are growing concerns that the regulatory bodies overseeing the financial sector are incapable of understanding, preventing or even properly investigating excessive risk taking that threatens to ruin the economy.
All of these reasons suggest that regulators should not have the information monopoly they have on all financial institutions' useful, relevant data in an appropriate, timely manner.

Instead, this data should be made available to all market participants.  The way to do this is to require  banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.
This issue was raised before the 2008 financial crisis and received more attention during the debate that led to the 2010 Dodd-Frank financial-reform law....
In light of the $2 billion-and-counting trading losses at JPMorgan Chase & Co., the issue is back on the table.
Previously discussed on this blog is the simple fact that bank regulators do not approve or disapprove of the individual positions.  They see this as interfering in the allocation of capital across the economy.

Rather, regulators try to estimate the potential for losses from these positions and try to ensure that the bank has adequate book capital levels to absorb the losses.
If anything, the key points have been sharpened both by what we know and don’t know about JPMorgan’s losses. ...
The JPMorgan trading losses of 2012 are much more specific and focused. We know that something went badly wrong in a high- profile trading unit, staffed with people who were considered to be the best in the business. We know that Jamie Dimon, the chief executive officer, approved in general what was happening, yet appears not to have been informed about key decisions. 
We don’t know the exact nature of the initial mistake or mistakes. We don’t know the details of reporting within the JPMorgan management structure. And we also don’t know what Dimon knew and when he knew it..... 

Because JP Morgan's current disclosure practices leave it resembling a 'black box', we know that we don't have the position data that Jamie Dimon wanted so he could understand what was going on.

We know that without this data, market participants cannot assess the risk these trades pose to JP Morgan.  As a result, we know that market participants cannot properly assess the risk of JP Morgan or exert market discipline.

It is in the public interest to have a proper, independent investigation of the losses at JPMorgan. But here we run into a number of practical and political difficulties. 
First, the obvious parties to conduct an investigation are also the regulators and supervisors of JPMorgan -- and thus face a potential conflict of interest. Would the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Office of the Comptroller of the Currency or the Federal Reserve really want to uncover and explain what they previously overlooked? 
The Federal Bureau of Investigation has launched a probe, but its focus is presumably on whether to bring charges, rather than to figure out how to make the financial system safer. The Office of Financial Research, established by Dodd-Frank to monitor financial risk in the larger picture, so far has had no discernible effect.

Second, Dimon has the best possible political connections, including at the White House, where one of his former executives, Bill Daley, was until recently the chief of staff. Dimon also sits on the board of the Federal Reserve Bank of New York, a supervisor of large banks and the source of expertise on financial markets within the Federal Reserve system....
Your humble blogger has a preference to focus on what could have been done to prevent the losses in the first place.

Please note how JP Morgan is not disclosing the position level data related to the CDS trade because of its concern that the market will trade against it.  If the market could have seen what JP Morgan was buying when it initially started buying, this concern would have stopped JP Morgan from putting on the position in the first place.

Bottom line:  ultra transparency would have prevented the loss.

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