Sunday, May 13, 2012

Did JP Morgan's trading loss shoot Wall Street in the foot?

The question is what, if any, fallout will there be for Wall Street as a result of JP Morgan's $2 billion trading loss.

The best outcome would be the adoption of rules requiring the Wall Street to provide ultra transparency and disclose on an on-going basis its current asset, liability and off-balance sheet exposure details.  This would end proprietary trading.

Absent requiring ultra transparency, your humble blogger expects a result similar to the financial crisis which produced the Dodd-Frank Act and its related regulations.  A lot of sound and fury, but effectively nothing much will happen.

In his Wall Street Journal Heard on the Street column, David Reilly discusses some of the potential fallout for Wall Street.
J.P. Morgan's stumble, along with questions of whether it resulted from the kind of proprietary bets Congress hoped to ban, may blow holes in Wall Street arguments that firms have become less risky since the financial crisis and don't need to be reined in further. 
For Morgan Stanley, the blowback could be rapid. The firm has labored recently under the threat of a multi-notch downgrade from Moody's Investors Service, which has been conducting a review of bank ratings in the U.S. and Europe....
For months Morgan Stanley has been pressing the argument that it is a far safer and stronger firm than pre-crisis and doesn't deserve such a downgrade. On its first-quarter earnings call, chief James Gorman pointed out that the firm had recently passed the Fed's stress tests and posted strong results.
However, without providing ultra transparency, there is no way for Morgan Stanley to prove its claim that it is far safer and stronger.
And all of Wall Street has rounded on the ratings company, claiming its contemplated actions are unjustified given firms' beefier capital buffers and new, tougher regulations. 
Speaking on his firm's call, Goldman finance chief David Viniar said, "We think that if you look at every single credit metric there is for Goldman Sachs, and frankly for many of our competitors, none of the actions they talked about are warranted." 
Maybe that would be the case just looking at capital measures. But as Sanford C. Bernstein analyst Brad Hintz pointed out, Moody's seems to be taking into account other factors. 
Namely, Wall Street's penchant for frequent blow-ups over the past 30 years, ranging from Drexel Burnham's bankruptcy to the treasury trading scandal at Salomon Brothers to the failure of Bear Stearns and then Lehman Brothers. 
"Having dealt with Wall Street over many years Moody's knows the answer to the question, 'Can a…leopard change its spots?' " Mr. Hintz wrote in a recent report....
The beauty of adopting ultra transparency is it forces Wall Street to change.
Goldman faces less ratings risk. But J.P. Morgan's misstep could nullify its own arguments against more stringent regulation. Goldman, for example, has launched a fight against a proposed rule to limit counterparty credit exposures among the biggest banks.
As your humble blogger has previously observed, rules limiting counter-party credit exposure are nowheres near as effective as providing ultra transparency and making sure the big banks know they are responsible for all losses on their exposures.
Likewise, there could be a hardening of the way the "Volcker rule" ban on proprietary trading is implemented, another sore point for Goldman. 
At the least, renewed scrutiny of Wall Street is likely to cause Goldman, and other firms, to keep their risk appetite in check.
Who is going to subject Wall Street to renewed scrutiny?  By its own admission, the Fed does not look at individual positions until after they blow up.  Without ultra transparency, no other market participant has the information they need to assess the risk Wall Street firms take.

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