Wednesday, June 13, 2012

If I Had to Testify About a Bank’s Multi-Billion Dollar Trading Losses

Trading gains and losses go together. All of us who hold stocks, derivatives, and other securities know about this. It is the nature of the risk of these investments. They go up, they go down. We employ whatever strategies and precautions we know to make it more likely that we have gains and less likely that we have losses, and for the most part, the gains exceed the losses, but this cannot always be the case. On some days, and perhaps in some years, there are large losses, out of proportion to the gains we were seeking.

Trading losses are a part of banking as it is currently organized. The banking giants that hold most of the deposits in the United States and in many other countries are too large to compete efficiently. Their operating costs are higher when compared to the amount of service they are able to provide to their customers. They are naturally driven to take greater risks to make up for their operating inefficiencies.

These greater risks run counter to the conventional public policy goal of a stable, sober, and reliable banking system. How much risk should banks be permitted to take? To what extent should policies tolerate or encourage banks to operate on a scale so large that they are forced to take disproportionate risks? These are policy questions. They cannot merely be left for the market to decide.