Jpmorgan loss could impact rules on hedges
When is a hedge not a hedge?
That’s the question regulators from the Federal Reserve to the Office of the Comptroller of the Currency are confronting after JPMorgan Chase & Co. reported a $2 billion trading loss from a credit-derivatives position Chief Executive Officer Jamie Dimon called a “hedge.”
Regulators are under pressure to respond to JPMorgan’s loss as they finish writing the Volcker Rule, which restricts banks’ proprietary trading and is the most controversial provision in the Dodd-Frank Act. They’re scrutinizing the hedging exemption in the proposed regulation and probably will narrow the exceptions for trades banks say are designed to mitigate risk, according to two people familiar with the matter.
JPMorgan’s loss “will reinforce the position of those who want to be tough,” said Rep. Barney Frank, D-Mass., co-author of the financialoverhaul legislation. “I do think it will mean Volcker will not allow” such trades.
The rule, named for former Fed Chairman Paul Volcker, is intended to reduce the chance that banks will put depositors’ money at risk. Dodd-frank, signed into law in 2010, largely left regulators to define the provisions, and in October, they released a proposal for the rule, which is scheduled to take effect in July. In April, the Fed said banks would have two years to implement it, as long as they make a “good faith” effort to comply with the ban on proprietary trading.
Under the proposed version, bankers would be permitted to do “risk-mitigating hedging activities” for “aggregate positions.” That means using derivatives or other products to reduce the risk of an entire pool of investments, as opposed to a single transaction or position.
The Jpmorgan loss has ignited a debate whether aggregate or portfolio hedging is appropriate at all and how to define and spot these trades.
Frank said he hopes regulators will prevent such positions, allowing banks to hedge only against specific investments to offset potential losses.
“Aggregate hedging isn’t hedging, it’s a profit center,” he said. “They are talking about making money out of it,” when “hedges break even.”
Wall Street has aggressively lobbied against the Volcker Rule. The five regulators implementing the provision received more than 17,000 comment letters — the most for any part of the law.
JPMorgan employs 12 lobbyists and spent $7.6 million on these activities in 2011, according to the Center for Responsive Politics in Washington. Dimon led Wall Street bosses in a closed-door meeting with Fed Gov. Daniel Tarullo on May 2 to press the central bank to ease regulations, including the Volcker Rule.
Dimon publicly challenged Ben Bernanke in June 2011 on tougher oversight, asking whether the Fed chairman had “a fear like I do” that overzealous regulation “will be the reason it took so long” for banks, credit and job creation to recover from the financial crisis.
Fed spokeswoman Barbara Hagenbaugh declined to comment.
Dimon, who asked regulators in a February letter to loosen their definition of portfolio hedging, said on a May 10 call with analysts that JPMorgan’s chief investment office made “egregious mistakes” by taking flawed positions on synthetic credit. He previously pushed the unit, which oversees about $360 billion, to seek profit by speculating on higher-yielding assets, former employees said in April.
The positions were “done with the intention to hedge the tail risk for JPMorgan” and could result in an additional $1 billion loss or more as they are wound down, Dimon said. “But I am telling you it morphed over time; and the new strategy, which was meant to reduce the hedge overall, made it more complex, more risky, and it was unbelievably ineffective.”