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Banking is a complex business. But it shouldn't be.
Banking used to be about taking in deposits and paying interest on those deposits. While the bank has access to these monies, they lent them at an interest rate. The difference between what was paid on deposits and what was earned on loans is profit.
Pretty simple, huh?
Of course, over the decades, the ups and downs of the lending business pushed banking managers to look for other ways to potentially even out this fluctuating profitability. That drove the interest in other ways to lend, including the bond business and investment banking. Wealth management was another leg of the stool. And as the businesses got bigger, it became important to manage more aggressively the risks that were being taken in any particular line of business.
Meanwhile, the banks were making so much money that they looked for ways to invest those profits and that's when proprietary trading took on a greater focus. These guys were smart and advised other smart people on how to make money. Why couldn't they make money for themselves off this smart advice? Of course, the trading became bigger and more complex and -- problems resulted.
This isn't exactly how banking grew and became more complicated -- but you get the idea.
And now we come to my question -- how much does "don't know" cost? Don't know refers to the complexity of the banking business and the lack of transparency. Over the past few days, I've heard this "don't know" description a number of times when describing what happened at JPMorgan Chase.
"Don't know what the specifics were of the trade." "Don't know how much of the trade is still on." "Don't know how many more losses will be taken as these trades are unwound." "Don't know who else might have similar transactions."
That's a lot that investors and analysts don't know. And when you don't know, a few things happen. Investors sell until they do know. And buyers request this lack of knowledge be reflected in the valuation i.e. a lower price-to-earnings ratio.
In the case of JP Morgan, the value of "don't know" is a little more than $18 billion US in lost market value and at least one p/e multiple point. And until they know, some investors will continue to stay away. Others will think that the value of "don't know" is already reflected in the share price. And that's what makes a market.