Listen Wall Street (and everyone else for that matter), when is everyone going to wake up and realize how these kinds of losses happen?
They start in the fact that we misunderstand our own mental machinery of perception and in the fact that we both perceive everything through a social-emotional filter and that markets themselves are social mechanisms. If you are human, you do this. You can talk all day long about the complicated math of hedges, credit-default swaps and Wall Street's darling—"VAR" (or value at risk) but at the end of the day, holding any kind of position is like playing musical chairs. As long as the music is playing, everyone is safe. When the music stops, the market drops and someone gets burned.
This has happened before—word gets out that one market player has a position and a whole bunch of other market players conspire to take their chair away. Long Term Capital Management—the hedge fund run by Nobel Laureates—was just one in a slew of examples.
Point #2 - you have to have emotion to make a decision. That is a fact.
And the emotion most common on Wall St is the fear of missing out on a good trade. This is human nature. It is the competitive instinct. No one who takes risk for a living escapes feeling this. (And they shouldn't). The problem is not however in having the feeling. The problem is in acting it out without any conscious awareness that you are doing so. This is Dimon's "sloppy". In other words, when you realize that you can taste the profits from a potentially huge trade and you are already ording a second dessert before the entree comes, you are in trouble.
Nevertheless, the answer is not for Washington to outlaw eating but for everyone to face up to the fact that from the boardroom on down, we have to integrate what psychological science now knows about perception, judgment, emotions and risk-taking into the process of risk analysis.
Regulation will just push the risk into murkier hedge fund waters and across the big ponds to Singapore and Switzerland. Instead, Wall St. and everyone who analyzes it needs to get up to speed on the fact that our brains build themselves into a social labyrinth where emotion ALWAYS provides the meaning. Frankly, this fact is also the behind the other hot Wall St. news this week—Facebook.
Denying the social-emotional environment at work is what actually causes the losses. This isn't about thinking harder it is about thinking better about the subjects that are soft. Yeah I know - they didn't teach us that at school. But it is where the paydirt lies. Let's stop rehashing the same old, same ole and use what we recently have learned about how we all really make decisions.
It's too late for this trade. Firing people won't do any good and might make it worse. The social market war games are on and the enemy is going to squeeze Jamie for as much as they can. He might be able to play it slightly smarter if he takes into account these social-emotional realities but in the end, this is about the next trade.
If this didn't happen at JPM, it would have and will happen again, somewhere. If you don't want it to happen to you, your hedge fund, trading account or bank, then take seriously the excellent outline in David Brooks "The Social Animal" or David Eaglemen's "Incognito". Yes most of this is unconsicous -but the risk protection and the reward lies in making it conscious.
Psychological Risk Management—or a basic but institutionlized emotional awareness—is the only answer that will ever work.