Saturday, May 12, 2012

JPMorgan Chase looses $2 billion on excessively risky derivatives trading

The giants of Wall Street continue in their pattern of pushing their risks to the edge and beyond, or so it appears to me.  Jamie Dimon of JPMorgan Chase was considered the golden boy of Wall Street after the terrible crash of 2008 since he and his institution escaped some of the more dire consequences of that crisis.  Unfortunately for him, his firm, and America Mr Dimon apparently led the charge to carve out a loophole in the "Volker Rule" of the Dodd-Frank financial regulation bill that was passed as a result of the crisis.  

As I understand it, the Volker Rule forbade the financial institutions from trading in their own money in the derivatives market.  But there was an exception that was granted as a result of the intense lobbying led by Dimon - hedging was allowed.  But the hedging was to be a hedge against a specific, individual trading position.  JPMorgan Chase's hedging looks like it was a violation of the law, as it was a "portfolio hedge" rather than a targeted hedge.  

Edward Wyatt of the New York Times explains:

The loophole is known as portfolio hedging, a strategy that essentially allows banks to view an investment portfolio as a whole and take actions to offset the risks of the entire portfolio. That contrasts with the traditional definition of hedging, which matches an individual security or trading position with an inversely related investment — so when one goes up, the other goes down.

The way the loophole was justified was that it was supposed to mitigate risk by hedging against failure.  But once the hedging was expanded to the entire portfolio it became a risk again rather than a conservative insurance type position.

I hope that these trades were a violation of law.  I hope that JPMorgan Chase and its management, including Dimon, are found guilty of violation of that law and that they pay real consequences for those violations.  

As far as I can tell, the overall zeitgeist of Wall Street has not really changed.  It looks to me like they are still in the grip of their traders' mentality, which seems to be bet the farm on riskier and riskier investment schemes, and if they win they make huge fortunes for themselves (without any substantial benefit to the economy as these derivatives are zero sum gambling games rather than investments in the economy or businesses), and if they lose they don't pay much of a price, and if they lose big enough they can count on Uncle Sam to bail them out with our taxpayer money.

I am not enough of a financial expert to know the details; I am just reading and trying to figure it out, but this event looks like it is more of the same greedy overly risky behavior that is still the guiding principle of Wall Street.