The unexpected $2 billion - or is it $5 billion? -- loss incurred by JPMorgan Chase (NYSE:JPM) "whale" trader Bruno Iksil shows only too clearly the flaws in Dodd-Frank and other regulatory activity.
Big banks are still taking risks they simply don't understand. Worse, there's no reason to believe the regulators understand them, either.
While the banks do employ "quant" mathematicians to analyze risk, the problem is the quants are also paid to help maximize the profits from the banks' trading desks.
Not only is this a bit of a conflict, but they are working off a market model that has failed repeatedly in the past.
It's a dangerous mix for investors and taxpayers alike.
The Failed Trade at JPMorgan (NYSE:JPM)JPM's trade that failed had been to build up a major bullish position on corporate debt defaults -- in other words, betting there wouldn't be many of them.
In a sensible financial system JPM would do this simply by going out and lending lots of money to corporations, or by buying their bonds.
However, according to The Wall Street Journal, in the magical fun palace of today's trading room, JPM achieved this instead by buying an obscure credit derivatives index known as CDX.NA.IG.9.
The key is that this is a "mature" index. Conceived of 10 years ago, the index JPM bought only had 5 years of life remaining.
In other words, not only did JPM use this foolish roundabout as a way to take a position on credit, but it did so through an old index, which could be expected to be less liquid than a newer index that attracted the most trading volume.
Then sharks began to circle.