The news of massive trading losses in JPMorgan's Chief Investment Office renewed calls for strict implementation of the Volcker Rule, the section of the Dodd-Frank Act restricting banks from proprietary trading. In my mind, the episode highlights the importance of intelligent and comprehensive risk-management procedures. While provisions such as the Volcker Rule can play a useful role, they cannot serve the desired purpose of mitigating risks to the financial system without robust risk-management standards enforced by regulators.
Without direct insight into JPM's practices, we must rely on press reports describing both the trades and the bank's risk-management practices. An emerging story describes the weakness of the bank's board-level risk oversight committee. (The three-person committee included the president of the American Museum of Natural History.) However, the facts also point to failures in the bank's risk-management culture. As with the financial crisis of 2007-08, outsized losses are primarily a function of bad management practices. The bank clearly failed to institute basic controls on the CIO's overall positions, including simple limits on the unit's gross and net positions; while such limits can be arbitrary, the unit's huge positions should have been a red flag to the bank's risk managers. (When one of your traders is likened in the press to a whale, you're too late.)