Tuesday, May 15, 2012

Agency theory and JPMorgan

Nice WSJ blog post pointing out the real reasons why JP Morgan Chase lost $2b on derivatives trades.  It has nothing to do with regulation and everything to do with incentives.  The traders stood to land massive bonuses if the trades went well and stood to lose relatively little (at least compared to JP Morgan's stockholders) if the trades went sour.  MBA 505 veterans will instantly recognize this as a basic agency problem: heads we rake it in, tails someone else gets stuck with the loss. 

My own take: this has been very embarrassing for JP Morgan and very costly to them financially.  But the costs have been limited to the shareholders, not to mention the fired employees.  JP Morgan was big and lost a lot of money, but did not need any help from the Treasury or the Fed.  Which is a good thing because it would have been very damaging for the Obama administration to have had to step in during an election year.

I am amused by all of the politicians using this incident to make a case for more stringent financial regulations.  If Morgan CEO Jamie Dixon could not prevent this from happening (and he had every incentive to do so), what are the odds that a band of federal employees could prevent it?

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