Andrew Lo, legendary MIT finance professor and noted world influencer, believes everyone needs to hold their blowholes on regulating the London Whale trades.
In an interview with MIT’s own news crew, Lo said that while the trades were obviously a bad idea, new rules are not necessarily the remedy.
“…it’s tremendously costly to implement any new regulation, never mind the existing ones, so before we propose new rules, we really want to make sure we know what we’re doing.“
In the first place, no one really knows how the trades blew up. Lo has previously discussed his admiration of the NTSB, and he again cites that agency’s rigour as a model for any future legislation.
“I could rattle off three or four different narratives about what may have happened at JP Morgan, and one of them may even be true, but if we’re going to make rules in response to this event, we have an obligation to the American people to get it right. And that’s where accident investigation becomes essential.”
At the same time, it should be fairly obvious to tell whether the London Whale was engaging in prop trades or hedges.
“That question is: How were they compensated on an annual basis? Were they paid a salary and a bonus, and was the bonus a function of the profitability of the group, or was the bonus a function of the hedging ability of the group? If you can answer this question — and it definitely has an answer to it; it’s not a metaphysical question — you will have your answer as to whether it was proprietary trading or hedging.”
Lo concludes by saying we really need to look beyond the mechanics of the trades themselves and more at how risk is managed at behemoth firms — and proposes a specific solution for doing so.
“This goes to a much broader question about modern capitalism: How can any small number of individuals manage a $100 billion company…all corporations need to structure their governance so that risk management is a separate function that reports directly to the board, and that the chief risk officer is compensated and incentivized to identify risks and create financial stability for the company. Unless we do that, we’re going to be constantly subjected to this endless cycle of fear and greed, fear and greed, fear and greed.”