Over the last few weeks, the financial community has paid rapt attention to trading losses at JPMorgan Chase, estimated to be anywhere from $2 billion to as much as $9 billion. The sudden emergence of such a large loss sent a disturbing tremor through an already vulnerable economic landscape. The lesson to be learned here is emphatically not about the bank or its leadership, but about the structure of our financial system.
The loss by the much-admired bank was more than a case of a private sector company taking a private sector hit because of a private sector error. First, if a bank this important were to become endangered, the contagion to global financial confidence would surely necessitate a bailout. Losses in institutions to which we entrust the soundness of our money, or where deposits are guaranteed, put the rest of us at risk. Second, and less widely appreciated, JPMorgan’s trading loss is a minuscule fraction of the bank’s more than $75 trillion in notional value of its current positions in derivative securities. The trading of derivatives — securities whose prices are dependent on valuations of underlying assets but do not represent direct ownership claims on those assets — is exempt from the sensible regulation of disclosure and leverage normally applied to stocks, bonds, and other direct claims. This is still, despite all recent attempts at financial reform, the Wild West of trading markets.