What Is Systemic Risk? Does It Apply to Recent JP Morgan Losses?, Edward V. Murphy
Specialist in Financial Economics, May 24, 2012
“JP Morgan recently disclosed that it suffered significant losses in a unit that traded complex financial instruments. Congress will be examining the JP Morgan trades and oversight by JP Morgans regulators. Two of the questions that policymakers might ask are could the JP Morgan losses or similar trades trigger another financial crisis and how would the Volcker Rule in the Dodd-Frank Act have applied to the JP Morgan trades? This report explains general systemic risk analysis. It evaluates recent JP Morgan trades in light of our understanding of sources of systemic risk. If the sizes of the losses remain small, it appears extremely unlikely that JP Morgans reported losses in its asset liabilities management unit could trigger a financial crisis or systemic event. Systemic risk refers to the possibility that the financial system as a whole might become unstable, rather than the health of individual market participants. Stable financial systems do not transmit or magnify shocks to the broader economy. A firm, person, government, financial utility, or policy might create systemic risk if (1) its failure causes other failures in a domino effect; (2) news about its assets signals that others with similar assets may also be distressed, called contagion; (3) it contributes to fire sales during price declines; or (4) its absence prevents other firms from using an essential service, called critical functions.”
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