Why does transparency bring an end to gambling?
Mr. Leopold discusses JP Morgan's frantic activity to prevent anyone from finding out about the Whale trade for the simple reason that with this information the market could trade against JP Morgan and drive up its losses.
This fiasco is a wake-up call to all those who thought that Dodd-Frank might rein in financial gambling. The so-called Volcker rule supposedly prohibits running a casino in a federally insured bank.
But the moment JP Morgan Chase smelled big winnings, it jumped into the riskiest of all Wall Street casinos -- synthetic credit derivatives....
The Chief Investment Office of JP Morgan Chase was set up to invest $350 billion dollars that the bank claims are excess deposits that it can't, or doesn't want to, loan out to businesses and consumers. That fund alone would make it the seventh largest bank in America.
Within that pot of money, the bank set up the Synthetic Credit Portfolio to play in the hot derivatives market. That's where the Whale and his London trading team swam....
In early 2012, the Whale hit the shoals. He and his trading team in London were losing money both when they wrote financial insurance and when the took out financial insurance.
So what do you do if you're losing in a casino and desperate to get even? You double down, of course. And when that doesn't work, you double down again.
But, these were not your typical gamblers. They knew they could drive the market up or down by making bigger and bigger bets, hoping to turn their previous losses into gains. In short, the Whale team acted like any other devious hedge fund -- it tired to manipulate the market.
Unfortunately, the word got out that the Whale was reaching his limit and that his big bets couldn't continue. So the hedge funds began manipulating the market in the other direction. In short, they harpooned the Whale, forcing more and more losses.
Catch this: The Whale and his traders suspected that some of the traders who bet against them may have come from within JP Morgan Chase's own investment bank. Further, they wondered if the traders at the investment bank also tipped off certain of its client hedge funds so that they all could gang up on the Whale and make a killing. ...The text in bold is that reason that transparency ends banks gambling through proprietary trading.
When market participants know a bank's positions, they can trade against it. This minimizes the profitability of the gambles and maximizes the losses on the gambles.