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Real Time Insight

Watching Jamie Dimon earlier this week, part of me couldn’t help but feel frustrated with the commentary (from both sides), but I also had to agree with J.P. Morgan’s CEO on several points and in a way I feel his pain.

No, this doesn’t mean that I condone frivolous actions that put customers’ deposits in danger. But at the same time, banks are almost forced to take on more risk than normal.  My issue lies more with our regulatory system than it does with JPM.

With all due respect, it seemed to me that majority of The Senate Finance Committee had no clue what really happened, other than the fact that a bad trade was made and they were trying to figure out if it was a “hedge” or a trade made for profit.  I bet that not one of them would be able to reconstruct a collateralized synthetic obligation, which is essentially a CDO backed primarily by credit derivatives, nor do I believe that a majority of them understand how its value fluctuates in real time. (I feel the same about Dodd, Frank and Durbin)

Even Paul Volcker, who has been out of the investment community for a long time, would have a tough time building a model and trading some of these securities in real life. 

It just seemed to me that the committee was trying their best to use this incident as grounds to push forward a an even more restrictive form of the Volcker Rule (which still needs refinement and wording) to quell these sorts of losses and potential damage to customer accounts. In reality, it’s a political boost for those on the committee, period. 

While I do believe that there may be good underlying intentions by the committee and the Senate,  I also know that no matter how extensive the rules and regulations are, incidents like this can still happen. 

In fact, if you look at the Savings and Loan crisis back in the 80s and 90s, a great deal of it was fueled by the Tax Reform Act of 1986.  An end of ballooning inflation, among other factors also contributed, but it was more government policy and changes that accelerated the damage.

Complex regulations like the Volcker Rule will only make things worse!  Thanks to Dodd-Frank, most banks are charging more for their services and less likely to lend to consumers.  So instead of helping us, it has cost the average American taxpayer big time.

I can also tell you that as a derivatives trader of 17+ years, I know the ways the “real investments” can be disguised as hedges and the other little tricks that can be played.

In my opinion, the major changes that should be made would be to standardize and list these complex credit and swap products on an exchange.  Have the exchanges and clearing houses maintain proper position limits, capital requirements and monitor the transactions as they are traded, holding the traders responsible and preventing another “London Whale” from taking on a position he can’t afford.

The more you constrict the capital markets, the more creative banks and brokerages will have to get to make money, especially in a low interest environment.

What’s worse is that in order for banks to “hide” and make money, they have gotten so creative with their investments that the instruments and securities themselves are nearly impossible to analyze and trade in and out of.

I am sure that JPM was looking to make some money off this trade that went south; the issue was the fact that these complex securities can have a multiplier effect when things really hit the fan.   Most of the models that these traders use cannot predict real human action in extreme conditions.  This was what caused the crisis in the first place.

My solution is not to regulate the hell out of the banks (they’ll go broke that way and none of us will be happy), but simplify, standardize and clarify.  Measure risk not just by the ‘amount’ of securities that are long or short, but what the worst case scenario would be if things went wrong.

We option traders do the same thing when we sell a put option.  We know the ramifications on our accounts if a stock were to go bankrupt as do our clearing houses.

It’s worked for us for almost 40 years and we don’t have a Volcker Rule…

Do you think a Volcker Rule is necessary?   Would it really help us or hurt us?

 I think the Volcker Rule belongs in the same place that the bulk of Dodd-Frank belongs – In the trash

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