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August 16, 2013

Will banks be safer if the London whale gets harpooned?

And so the drama moves on to a courtroom. Two prime traders in JPMorgan Chase’s “London whale” misadventure have been indicted. Side plots may unfold, perhaps via extradition proceedings. But here is the big question: will the indictments lead to better, stronger financial markets? Well, yes and no.

Recall the problem: JPMorgan’s London trading desk made trades that would be profitable if the post-crisis American economy remained weak. As the economy improved, the traders sought to reverse the investments, but could not, ultimately losing the bank and its shareholders $6bn.

The indictments are not for the loss, but for deliberately misstating the size of the loss to higher-ups at the bank. That, in turn, led to misstated financial statements to the public and the bank’s regulators. Whether higher-ups pushed for lower reported losses remains to be seen.

Misleading the regulators is serious: if the losses threatened the bank itself, the regulators would have needed to know early so they could act. True, JPMorgan is well capitalised so a $6bn loss was painful but not life-threatening; and, the indictment says, the deception was sized in hundreds of millions of dollars. But regulators still want to be alerted, to see if other big institutions were making similar bets. The financial crisis hit in 2008 because too many made similar (bad) bets on the American housing market’s ability to support its massive levels of poor-quality mortgage securities. An early warning system will not work if financiers hide problems.”


Read full Financial Times article here

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