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The world hasn't learned anything since The Kreuger Crash

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The reason no one wanted to lend to or trade with the banks during the fall of 2008, when Lehman Brothers collapsed, was that no one could understand the banks’ risks. It was impossible to tell, from looking at a particular bank’s disclosures, whether it might suddenly implode.

Take the loss of JPMorgan last year. According to JPMorgan, the division invested in conservative, low-risk securities, such as U.S. government bonds. And the bank reported that in 95 percent of likely scenarios, the maximum amount the Chief Investment Office’s positions would lose in one day was just $67 million - the value at risk.

The bank generally considered to have the best risk-management operation in the business, and it had badly managed its risk. As the bank was coming clean, it revealed that it had fiddled with the way it measured its value at risk, without providing a clear reason. Moreover, in acknowledging the losses, JPMorgan had to admit that its reported numbers were false. A major source of its supposedly reliable profits had in fact come from high-risk, poorly disclosed speculation.

Federal prosecutors are now investigating whether traders lied about the value of the Chief Investment Office’s trading positions as they were deteriorating. JPMorgan shareholders have filed numerous lawsuits alleging that the bank misled them in its financial statements; the bank itself is suing one of its former traders over the losses.

Professor Frank Partnoy is the George E. Barrett Professor of Law and Finance and is the director of the Center on Corporate and Securities Law at the University of San Diego, who recently co-wrote a very interesting article in the Atlantic. He is one of the world’s leading experts on the complexities of modern finance and financial market regulation. He, was interviewed by SVD, the largest financial newspaper in Sweden. In this interview he makes references to the Kreuger Crash in the 1930s.  Kreuger acquired Deutsche Unionsbank in Germany and Union de Banques à Paris in France, often with the acquired company's own money. These maneuvers were made both necessary and possible by his invention, decades ahead of his time, of Enron-style financial engineering, which reported profits when there were none and paid out ever increasing dividends by attracting new investment and/or looting the treasury of a newly acquired company. In SVD he thinks that banks should not be saved again (moral hazard...), that we are keeping the same dys-functional banks capable to cause new crises. In his opinion, companies like Google and Microsoft could take over the role, as the basic function of the financial system is to create a link between those who have money and the many others that need it.

 

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