The $2 billion loss by J P Morgan Chase is a failure of risk management, the US Treasury Secretary Timothy Geithner said, as the FBI launched an investigation into the issue.
He also called for tough and effective reforms so that when such mistakes happen, they are modest in size and the financial system can handle them well.
"I think this failure of risk management is just a very powerful case for financial reform. The reforms we still have ahead and the reforms we've already put in place," Geithner said at the Peter G Peterson Institute - a Washington-based financial thank-tank.
He added, however, "The test of reform is not whether you can prevent banks from making mistakes, errors of judgment of risk management. That's going to happen. It's inevitable. "The test of reform should be do those mistakes put at risk the broader economy, the financial system or the taxpayer?"
The best way to prevent that from happening is to make sure that banks are forced to hold more capital against risk, to fund themselves more conservatively, to bring down leverage and to make sure that the rest of the financial system has better cushions against these kind of mistakes, Geithner said in response to a question.
The government has been very forceful and effective in managing the broader financial rescue, forcing much more capital into the system, he noted.
"But we are going to work very hard to ensure that these reforms are tough and effective, not just the Volcker rule, but the broader complementary reforms on capital and liquidity and derivatives markets, again, so that when firms make a mistake, which is inevitable, those mistakes don't put at risk the broader fortunes, the broader health, the broader security of the economy as a whole," Geithner said.
J P Morgan Chase CEO Jamie Dimon had admitted last week that a $2 billion loss on derivatives trades had jeopardised the bank's credibility and given regulators a fresh opportunity to target Wall Street.
Following the loss, the company said its long-serving chief investment officer Ina Drew is retiring. The staggering loss, unveiled last Thursday in a hurriedly organised analysts call, came due to trading by risk management group led by Drew.
Meanwhile, Geithner said the American economy has had four pretty serious tests even after this crisis.
"You had a profoundly difficult, challenging shock from Europe, the financial crisis in European. You had the failure of a pretty large financial institution in -- non-bank in MF Global," he said.
"You have the debt limit trauma, where we actually saw money flow into the US banking system because of confidence in the basic strength of the system. You had this pretty significant risk management failure.
"And our system is much stronger than it was before the crisis. And credit and capital is growing again," he said.
Geithner said all this points out as to how important it is that reforms are strong and effective enough so that they can meet the key test.
"Not to protect shareholders from losses, not to prevent the unpreventable in terms of mistakes in judgements, but to make sure when those mistakes happen -- and they're inevitable -- that they are modest enough in size and the system as a whole can handle them.
"And we will work very hard to make sure that we meet that basic test," Geithner said.
Image: The JP Morgan Chase & Co headquarters in New York. | Photograph: Eduardo Munoz/Reuters
