JPMorgan Hedge

The recent scandal involving JP Morgan’s hedging loss of $2.3 billion (and is growing by $100 to $150 million per day),  has refocused attention on the Volcker rule, a key provision of the 2010 Dodd-Frank bill that initiated a new set of regulatory restrictions on the banking industry.  At more than 800 pages, the law spawns millions of new regulations, many of which won’t be finalized until July of this year, when the Federal Reserve is to start supervising the banking industry to bring them into full compliance with all the regulations by 2014.  The Volcker rule was ostensibly designed to curb the gambling type of hedging that brought the banking industry and the economy to its knees in 2008.  The JPMorgan fiasco has ignited a debate among politicians and pundits, bankers and regulators as to whether this trading strategy would have fallen under the purview of the Volcker rule.

As always, the devil is in the details.  Section 619 of a draft version of the bill stated that banks might initiate hedging trades “in connection with and related to individual positions.”  The banking lobby wanted to insert two small words “or aggregated” so that the final version of the bill would read “in connection with and related to individual or aggregated positions.”  They may have argued that banking and/or investment firms do aggregate a position over time through a series of trades, a common practice to avoid “moving the market” with a single large trade.  This, in fact, is the final language of the Dodd-Frank law (pg. 249)
Some argue that these two simple words effectively negates the effect of the Volcker rule because it allows an investment bank to engage in any hedging strategy as a tool to ameliorate the risk of any portion of the banks portfolio of investments.  The entire bank’s portfolio is, after all, an aggregated position in the market.  In effect, the language of the law allows investment banks to engage in the same kind of risky bets that the Dodd-Frank law is supposed to curtail. Jamie Dimon, the Chairman and CEO of JP Morgan, insists that the failed hedge would not have fallen under the Volcker rule.  There are about 150 bank regulators who work in the home offices of JP Morgan, constantly monitoring the operations of the largest bank in the U.S.  Either those regulators did not know of the hedge or did not understand the risks involved.  The trades were initiated in London so it might be feasible that the regulators did not know of the trades – except that both Bloomberg and the Wall St. Journal had called attention to the risky trades in April and Jamie Dimon had dismissed any concerns about the risks.  This example should refute the arguments of those who champion ever more regulation and more regulators of all business activity as the solution to keep the public safe.  The housing, securities, banking and insurance industries are all heavily regulated yet the confluence of poor risk management in these industries led to the debacle of 2008.  Regulations too often morph into a job programs for regulators and lawyers without achieving the desired goal of protecting the public from grievous harm.

The voters elect representatives to go to Washington to write competent laws.  Instead, the voters get poorly written laws written by a mish-mosh of inexperienced lawyers, industry lobbyists and passionate but impractical partisans.

JPMorgan gives the impression that Bruno Iksil, the London trader responsible for these aggressive trades, was a rogue trader  –  that the bank’s risk management team should have supervised him more closely.  What JPMorgan doesn’t readily disclose is that Mr. Iksil made the bank almost a half billion in profit just six months ago using equally aggressive trades.  Why supervise someone who apparently has the golden touch?

Where does JPMorgan get the money to engage in this risky gambling?  Your money.  JPMorgan had about $1.3 trillion in deposits from small depositors and large customers on its books but only about $700 billion in loans, leaving it with a lot of extra money, insured by the taxpayer, to gamble with.  They lost.  For now, the stockholders are the ones who have paid the price.  The stock has lost 24% of its value since the trading loss was confirmed by Jaime Dimon.  The amount of money lost so far is less than 1% of JPMorgan’s assets.  But it raises the question raised so alarmingly just a few years ago:  WTF????!!!  When I put my money in a bank, I expect them to keep it safe.  I don’t want the bank to take my money and gamble it.

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