Much has been written about JP Morgans blow up and I have read very little with the exception of Kid Dynamite’s post. The guy is relentless in his research and is way more qualified to talk about it than most people who have. I did not even want to talk about this but the conversation interrupted my dinner. And I like to eat.
I was at a restaurant this weekend and the table next to me was talking about it. Of course their solution was more regulation. Because regulation works so well. Here are the issues as I see it:
Transparency is fucking up markets. It does so by making it possible for people to see your pain point. To counteract this the market has created a million instruments. Some are illiquid, many are untested. Created in a lab on theory, hopes, dreams, wishes and the right amount of unicorn blood. They say that all politics is local and the same can be said about most markets. I trade the S&P 500 and that is at least one except. There is more to that market than just the bids and offers in it. This is because it is one of the most hedged markets in the world and liquid. But that is all an aside, the news of potential JPM problems broke at least a month before they admitted it. I do not know what their losses were at that moment but they probably weren’t as steep.
Solution: I do not have a solid solution because that is not my expertise but this is not working. But can we please take a second to look at the unintended consequences before we do something. Why was this information revealed but we do not know what banks exposure to Euro CDS is? Is JPM being punished for doing the right thing?
Models break because they are based on assumptions. The work does not stop when a model is created. It actually starts. Because once an model is introduced into a market it has the potential to change that market. This is at least the first time where assumptions change. There is a research term for this but it escapes me at this moment. But to see the phenomena look at reality tv or any person, they act differently in front of a camera. A model on a simulator can act differently in a market and probably will. Look at the housing models, they all assumed that the price of a home would continue to rise. It didn’t.
Solution: Just a realization of the limits of model. If even one person does not follow the assumptions it creates a problem, the more money this person has the faster the breaking down of the model comes. We are or will see a shift from analytic approach to markets to human. We are a couple of models blowing up from this happening.
Regulation has created a safer environment, right? Nope. What it has created is the idea of a safer environment. Just like we see with air travel. The TSA has taken a less strict policy on children and older people. Although it is the right thing to do, it is not creating safer travel. In fact those moves have hurt the idea of a safer environment. Regulation is not a bad thing. But regulations that create idea’s is bad. It gives us a false sense of security. It is a waste of time and resources and creates loopholes that the wrong people can get through while punishing everyone else.
Solution: Stop creating idea’s and start doing things that work.
Limits of trading/investing
When you are dealing with people anything can happen. People do not always act in the way we expect them to, just like markets. In finance this is especially true. Risk is everywhere. A risk by its nature means a bad thing can happen. I can get hit by a bus. If I do not want to get hit by a bus I can take action. Some extreme some not so extreme. The more extreme the more likely it is to take me away from my original goal. Getting to the other side of the street in this example. Whether I recognize it or deal with it, as long as their are buses there is a chance I can get hit by one. If I stay in my house this wont happen. But it wont prevent me from dying. The biggest risk of living is dying. Just like any trade can be a losing trade.
We hold finance to such a different standard than we do with other professions that involve people. Do we blame a teacher for a student failing? Do we blame AA for not fixing an addiction? The risk of teaching a child is that they may fail. The risk of taking a drink is that we become addicted. The risk of a trade is we lose.
We can’t always change an outcome when it comes to people but we can put them on a different path.
Solution: Know thy risk and it can be argued that they took too much risk. But I do not think it was intentional.
I am in no way saying JPM is without blame. They messed up. In the conference call, Jaime Dimon basically said that they were stupid and this is a one time event. He is wrong. This can happen again and probably will under the current situations. Whether it is as publicized or not, it probably is not first. I understand why he said it, to not create panic, but was not being truthful. A market is only as solid as its participants. We are losing participants. They should know this so they are to blame.
There are far too many people more qualified than I to fix the problem. I could be wrong, just throwing it out there and maybe the people who ruined my dinner will read this and have a few different talking points other than more regulation.
I fully expect to be wrong. I do not know everything about the situation and by my own standards should probably just be quite. This post makes me the type of person I hate but I can say with certainty that these are the problems and what we are doing now is not working. May we not waste this disaster.
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