Federal Reserve officials are gathering more information about the trading position that led to a $2 billion loss at JPMorgan Chase & Co. (JPM), which they have known about for several weeks, according to a person familiar with the matter.
Fed officials don’t view it as their role to approve or reject individual trades at banks, the person said. Rather, their job is to ensure the firms have sufficient capital to withstand losses, said the person, who wasn’t authorized to discuss the matter and asked not to be identified....
At the same time, JPMorgan’s announcement points to gaps in the Fed’s enforcement of governance and risk management, said Robert Eisenbeis, a former research director at the Atlanta Fed.
“The fact that Jamie Dimon could come out and make some of those statements” raises “lots of questions about who was watching the store,” said Eisenbeis, who is now chief monetary economist at Sarasota, Florida-based Cumberland Advisors.
Please re-read the highlighted text again as it shows the danger of allowing the Federal Reserve to have a monopoly on all the useful, relevant information on banks like JP Morgan.
While the Fed was aware of the position, it is only after $2 billion in losses that the Fed is beginning its assessment of the risk of the position. The reason that the Fed did not bother to assess the risk until now is it sees its primary job as ensuring that the bank has sufficient capital to withstand losses.
Which raises the interesting question of how does the Fed know that a bank has sufficient capital to withstand losses on a trading position if it does not assess beforehand how much the bank could lose on the trading position?
From the standpoint of investors, the way the Fed defines its supervisory role makes requiring ultra transparency mandatory. Given the way the Fed handles its supervisory responsibilities, the Fed cannot communicate how much risk there is because they do not look at an exposure until it blows up.
Without ultra transparency, there is absolutely no way that investors will be able to assess the risk of the bank and exert market discipline.
The contrast between how market participants would use the information disclosed by banks providing ultra transparency and how the Fed uses this same information is extreme.
Market participants would look at the information daily, assess the impact of any changes and adjust the amount and price of their exposure based on this assessment. The banks would constantly be subject to discipline and as a result would reign in their risk taking.
By its own admission, the Fed doesn't look until a problem shows up. Not only does the Fed's monopoly on all the useful, relevant information prevent market discipline, but the Fed exerts no regulatory discipline on the risks the banks can take. The Fed engages in mopping up after the fact.
Unfortunately, as the financial crisis showed, the Fed's bank oversight strategy is flawed as banks are capable of losing far more money than they have capital to absorb the losses.