Matt Levine, Bloomberg, Commodity Trader Didn’t Really Believe in Market Prices, here.
So: That’s not supposed to happen! My colleague William Cohan recently wrote that JPMorgan’s “biggest mistake” in the London Whale situation was that the bank relied on traders to mark their own books of over-the-counter derivatives, rather than having an independent valuations group rigorously test valuations against third-party data. You need that rigorous valuation control because valuing structured over-the-counter trades is hard, and leaves some room for judgment. And the Whale traders used that wiggle room in bad faith, mismarking their opaque unlisted positions by something like 2 percent to 4 percent.***
Interesting, Levine is one of the best at outing fools and clowns publicly, gladly, and most mirthfully, but here he has allowed impurities to slip into his latest examination of Tomfoolery. Wisty knows Tomfoolery and insists on its purity for the discriminating Pink I reader.
The case made here is that there is no sensible reason to ever mark a liquid instrument away from mid. So therefore every trading desk that allows variance in the m2m marks away from the commonly accepted mid is a fool being wiggled by a Whale. But this is obviously not true – Interest rate swaps model conversion to OIS mark to market during the recent credit crisis, QED. The confusion is assuming a m2m mark is like the location of a ball moving on a frictionless surface in a closed system (no exogenous forces). They are not the same:
A. there is typically no commonly accepted security valuation model, like f=ma, to give you a mark and a series of future marks that are correct for any frame of reference , and
B. Markets are not closed systems – there are exogenous forces (e.g., Congress, The Fed, China, CFTC, The SIP feed, etc., etc.).
One of the reasons it is difficult to regulate trading desks is there are numerous circumstances where the trader’s mark is in fact the “best” mark ( aka shinola). The regulator’s job, the controller’s job, and the journalist’s job is to distinguish shit from shinola. The fun part is, since these guys cannot remember STEM after Algebra 2, they can’t reliably tell if you are quoting Ito’s Lemma or reading from Buzzfeed. Read the Cohan piece, he obviously has no idea what is going on with JPM/London Whale P&L marking, but he has read a bunch of articles and wrote a book about something and so is guessing that he’s looking at marking fraud and wants us to do something about it. Here, Levine and Cohan left some shinola in the shit, and that’s nasty.
Barry Ritholtz, The Big Picture, An Illustrated Book of Bad Arguments, here.
I deal with bad arguments all the time, constantly swatting away silly arguments and foolish rhetoric. This little book does a nice job summarizing them all.