The nature and timing of JPMorgan Chase's (NYSE:JPM) Chief Investment Office (NYSE:CIO) portfolio loss of $2 billion was unfortunate both for the reputation of the bank and the recovering financial sector. Mr. Dimon's exemplary response and clear acceptance of the bank's responsibility should form the template for any CEOs in this type of predicament

However, the source and nature of the loss reveals the challenge for financial markets. As its CEO stated, JPM is "not in business where we won't make mistakes." This is a key and crucial statement, underlining the nature of the banking business, financial services broadly and the risks inherent in investing in financial sector stocks. An investment approach based solely on numerical analysis that lacks the benefit of experience and insight into these businesses is generally the basis for disaster. However, avoiding investment in the sector is not feasible either.

A review of disclosure pertinent to these losses is as follows: at the end of Q1/2012, debt and equity trading assets in the CIO portfolio totaled $299.1 billion, out of the bank's $2,320.3 billion balance sheet. This CIO portfolio is 5% higher than the 2011 year end balance. However, as was clearly pointed out during yesterday's call, value-at-risk* (VaR, 95% confidence level) for this portfolio has increased significantly: during Q1/2012, $129 million average daily loss vs $60 million during Q1/2011 and $57 million during full year 2011. Furthermore, the segment's loss profile has changed dramatically, with a new range of $85 million - $187 million.

Overall, the distribution of VaR for the bank is significantly skewed towards fatter losses vs. its profile during all of 2011. JPM experienced 29 trading days during this quarter where losses exceeded its expected $114 average daily revenue. A modest shift in either the asset correlations underlying VaR or its loss probability would materially change the loss realized from the current portfolio. In other words, the current $2 billion loss is not indicative of this portfolio's future result magnitude or direction.

Unsurprisingly and to its credit, JPM's CEO was at pains during the call to point out that quantification of future losses is extremely difficult, as these would be the result of on-going management of the portfolio, near-term correlation changes, market trends and volatility, availability and cost of hedging instruments-- and most importantly, market liquidity. An external assessment of potential losses requires additional portfolio details well-beyond what is disclosed in the notes and its VaR loss probability distribution.

Ultimately, the underlying source of JPM's $2 billion loss is process related - specifically, poor risk management and oversight-- and Mr. Dimon owned up to this. A key implication is that estimating loss potential and corresponding impact on the bank's market valuation consequently has a high degree of error.

Furthermore, any regulatory implications have yet to be determined. Simply put, it is particularly difficult to estimate this ultimate loss externally (actually, even internally!) and estimates will have a wide error. The market has been privy to the difficulties in estimating losses in similar situations - LTCM, Swiss Re, UBS and AIG amongst others. Given all of the above and its current valuation (P/B 0.77x, P/E 7.6x), at best JPM is characterized as a trade, on either the long or short side in response to emerging details.

*For a helpful discussion of VaR, its measurement, and impact on risk and trading see "A Practical Guide to Risk Management" by Thomas S. Coleman, Research Foundation of CFA Institute, July 2011 (see here).