Half of today’s financial news stories are about how some government enforcement agency is looking into something you already knew about. This is very boring for me! Remember when Goldman lost a bunch of money by fat-fingering some options trades?1 That still happened. Remember how JPMorgan did some naughty things with California electricity markets? Those historical circumstances continue to obtain. Remember the Whale? Still a thing.
You could wonder about the substance of some of these investigations. JPMorgan’s electric boogaloo, while intensely naughty, also seems pretty clearly to have followed FERC/ISO rules to the letter, so it’s hard to imagine charging anyone with a crime, as the FBI is apparently contemplating.2 And while I don’t know much about the SEC rules re: electronic options trading, the actual thing that Goldman did was sell options really cheaply, and it would be pretty weird if there were a rule against that, so I don’t know where the SEC is going with its enforcement investigation.3 (The Whale, I’ll give you, that stuff seems bad.) But basically, yeah, sure: bad things happened, rules might have been violated, market safeguards were shown to be less robust than had previously been thought, it is altogether fitting and proper that someone look into it. Or a lot of someones I guess.
Still the stories carry a whiff of looking for the keys under the lamppost: why would regulators bother to look for new bits of wrongdoing when they haven’t exhausted all of the charges they can bring from the old, already admitted bits of wrongdoing? It might not increase your confidence in financial markets to know that every regulator on earth has now devoted a task force to investigate FERC’s already-concluded investigation of JPMorgan, or that the SEC’s method of discovering options-market instability is by noticing someone losing $100 million on erroneous trades, but you can understand the thought process. I mean, one, it is August, lower your standards. And more generally, it’s perfectly natural for anyone with a good gig to hold on to it for as long as possible rather than wrap it up and step off into the unknown. Steve Cohen is putting a lot of regulators’ and prosecutors’ kids through college.4
And there’s probably some diminishing marginal deterrence to punishing banks over and over again for the same activity. There’s a binary-ness to a lot of this stuff, at sophisticated heavily lawyered banks: you do the things that you think are okay, and not the things that you think are not okay. It’s just that sometimes you’re wrong about what’s okay. Fining JPMorgan $400 million for its (perfectly okay under the letter of the rules but otherwise obviously horrible) electric bidding racket sends the message of not okay, so they won’t do it any more. And even without any more investigations, nobody at JPMorgan is exactly looking forward to repeating the whole Whale thing.
Because doing dumb stuff tends to be its own deterrent. The idea that “prosecutors in Manhattan are separately exploring ways to penalize the bank over the trading blowup that has come to be known as the ‘London Whale’” is sort of absurd: a trading blowup penalizes itself. JPMorgan lost six billion dollars on the Whale but oh, sure, fine them a couple hundred million more, that’ll show ‘em.5 “Potential regulatory fines should be muted” for Goldman’s options misadventure, so that’s nice for them I guess, but again losing money by fat-fingering options is its own reward.6
FBI Said to Hunt for Criminal Acts in JPMorgan Bid Probe [Bloomberg]
SEC scrutinises Goldman’s trading failure [FT]
UK’s Serious Fraud Office liaising with U.S. on ‘London Whale’ case
1. Ooh, re: that, the FT happens to have Myron Scholes right here and if you’re algorithmically fat-fingering your options trades then you know nothing of his work:
Mr Scholes, co-author of the Black-Scholes formula of options pricing, said a change in policy would teach brokers to be more careful when adjusting their automatic trading systems.
“If trades are not cancelled, and Goldman (and others) internalised all of the losses associated with programme errors and bad algorithms, they would be more careful,” he said.
While I appreciate that the FT called up Myron Scholes to scold errant options traders, I’m more of a Coasean on this. Someone is gonna internalize those losses! Whoever it is has incentives to be more careful! Right?
2. If I had to guess though I’d say that the ISO at various points asked JPMorgan why they were bidding the way they were and JPM was all “for good supply-and-demand reasons” whereas it was actually for bad manipulative reasons. So I guess that’s, y’know, Fraud About Your Feelings. But the actual stuff they did was all super-disclosed; the ISOs were just dopes.
3. Here you can read a Themis discussion of the SEC’s Reg SCI, about technology robustness, though even they don’t think it’d trap Goldman. The FT says “The SEC’s enforcement attorneys are actively looking into Goldman’s trading glitch to determine if any rules were violated before, during and after the trading error,” and I suppose there are things Goldman could have done before/during/after other than just, like, sell options too cheap.
4. Though to be fair he does seem to have presided over, like, quite a lot of insider trading. Still. It must get a little old. “What are we doing today Bruce?” “Oh, the usual, charging SAC with more insider trading.” Ten years later and there you still are.
5. “But the fine is for the mis-marking, not the trading loss!” Well, sure. And I get the case for prosecuting the guys doing the mis-marking. But from the perspective of JPMorgan as a bank, they really want their traders marking their books right, because that is how they know if they’re losing money. The trading loss was “caused,” from the bank’s perspective, largely by the mis-marking: if senior management had known what was going on they’d probably have stopped it sooner. The $6 billion trading loss provides lots of incentives to make sure that traders are marking their books right. But yes a couple-hundred-million-dollar fine will provide, y’know, 5% more incentive.
Also let’s not even talk about the incidence of corporate fines being on shareholders and thus sort of a convoluted and weak deterrent to managerial behavior, it is too depressing a topic.
6. “Not if they’re unwound,” you say, but remember that at least some of the exchanges don’t unwind at least some of the error trades, they just reprice them at regular price plus/minus a stupidity penalty. So the penalty is right there in the rules. Also not all of the erroneous trades are “clearly erroneous” under the relevant standards; here is a good Bloomberg story that mentions, among others, the well-named Entropy Capital making some money on Tuesday off trades with Goldman that were not unwound.