For example, when everyone can see a bank's proprietary trades, banks don't make these bets. JP Morgan demonstrated this fact by closing its position as quickly as possible after the position had been "leaked" to the marketplace.
In his Guardian column, Nils Pratley looks at how the trading scandal demonstrates that JP Morgan is too big to manage and too big for regulators to oversee. If it is too big to manage or regulate, the logical conclusion is that it should be shrunk.
But how do you effectively shrink JP Morgan or other similar Too Big to Fail bank and exert restraint on it so it doesn't become a problem in the future?
By requiring the bank to provide transparency into its current global asset, liability and off-balance sheet exposure details and letting the market exert discipline.
With transparency, the first thing to go are its proprietary bets, as oppose to the market making positions, as the bank doesn't want the market to trade against its bets. Hence, we get compliance with the Volcker Rule without 500+ pages of regulations.
With transparency, the second thing to go are the thousands of subsidiaries that exist for regulatory or tax arbitrage.
In short, with transparency, market discipline gives each bank the incentive to reduce its risk profile and organizational complexity as the failure to do so results in a lower stock price and higher cost of funds.
Too big to manage? Too big to regulate? Both criticisms of JP Morgan should ring loud and true for readers of the various regulatory postmortems on the bank's "London Whale" trade.
From chief executive Jamie Dimon's initial dismissal of the affair as a "tempest in a teapot" to the various botched internal investigations, this was a corporate calamity.
And the worst part was JP Morgan's high-handed attempt to deceive regulators. The UK's Financial Conduct Authority says it was "deliberately misled" by London-based executives on one occasion.Please note that requiring exposure detail transparency would have prevented this entire scandal.
First, the bank wouldn't have made the proprietary bet.
Second, even if it did make the proprietary bet and take on the risk of the market trading against it, management would have been able to get a clear picture as it too could have seen the trades.
Third, there would have been no reason for management to lie to the regulators as the regulators could easily verify, with the assistance of other market participants, what they were being told by the bank.
Total fines of $920m (£574m), to add to the $6bn loss from the trading activities themselves, will destroy any lingering notion that JP Morgan was the smartest manager of risk on Wall Street.
The FCA's report reveals the bank's almost comical inability to get a handle on its credit derivative exposures even after senior management realised there was a crisis....
Incompetence is one thing, of course. Misleading regulators is the serious part of this scandal.
JP Morgan's behaviour was brazen and extraordinary. In a discussion with the UK regulator in March 2012, JP Morgan staff in London didn't mention that traders on the synthetic credit portfolio – the source of all the problems – had been told to stop trading.
That was a basic piece of information to reveal.
The following month, on a conference call, London executives said there had been no material changes to the portfolio since the March meeting. In fact, the portfolio was expected to lose a significant amount of money that very day, pushing losses for the year beyond $1bn, as London management had been told by their traders prior to the call with the regulator.
Thus the FCA's damning assessment that it had been deliberately misled.