The claim is being made that JP Morgan’s $2 billion trading loss was in a trade that was a “a hedge.” It doesn’t take much review to easily disprove that position.

We first learned of this particular trade when they began to distort credit indices. Any trade so huge that it impacts its markets – that becomes the market – cannot be credibly thought of as a hedge. Simply stated, once you are the market, you are no longer a hedge. Sheer size of this trade makes it far more accurate to describe this as speculation than hedge.

Of course, the loss was the tell. A true hedge would have been offset by the underlying position that was being hedged — so any loss should have been insignificant. Even a minor correlation error should not lead to a $2 billion dollar hit.

Which begs the question, what is a hedge? It is a position taken in order to curb the risk of a specific (or arguably, general) trade. This is not a new concept: The word “Hedge” has been used as a verb in English since at least the 16th century (See Shakespeare’s Merry Wives of Windsor).

Looking at the question a little differently, what isn’t a hedge? There is always the other side of the trade, and that side (if not position) is what  you can theoretically claim to be hedging. Hence, for a huge bank with trillions on its book, there is the rationale that any trade, any position, any financial transaction, is potentially a hedge against some other position the bank is holding. Recall that Goldman Sachs, who has been rather silent on the JPM trade, used the same logic when arguing they were not betting against clients; rather they were “hedging other bank positions.”

Poppycock. Both the JPM and GS arguments fail, for a simple reason: If we are going to define this trade as a hedge, then there is no other conclusion to reach except that everything at a huge bank is a hedge.

And once you define everything as a hedge, well then, nothing is a hedge.

Category: Bailouts, Derivatives, Regulation, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

41 Responses to ““Everything is a Hedge””

  1. ConscienceofaConservative says:

    What the CIO office , as Bloomberg pointed out was not a hedge in the way FASB hedge accounting would permit. To say it’s a macro hedge makes anything a hedge and when you look at the size and scope of positions, it makes the claim laughable.

    It may be true that the price of ausie dollars in Japanese Yen correlates well with the S&P 500 but if a bank were to tell me that a currency swap was hedging a stock portfolio.. Well I’m from Missouri…

    Few things are not lost on me, First that this unit operated out of London, which seems to be the favorite locale for companies up to mischief(AIG?) and secondly often firms will set up small hedge operations, and over time these turn out to be profit centers and the mission changes from hedging to taking on risk. Lastly, defenders of JP Morgan keep pointing out that two billion was small in the context of JP Morgan’s balance sheet, but these same people fail to admit that this loss occured at a relatively benign time and it could have been a lot worse.

    Sheila Bair, Thomas Hoenig and Chris Whalen are again pointing out that these banks are simply too big and if we created seperate legal entities(back to Glass Stegall) between the commercial entities and the investment banking entities we would not be exposing the Tax Payer and extending subsidized financing for what is non-commercial essential banking activities.

    Lastly, The Fed had an indirect role in this. By engaging in ZIRP the gov’t has killed bank NIM and effectively made non-economic bank carry and the business of lending securities.

  2. constantnormal says:

    Once a “hedge” grows beyond a certain size, it becomes less of a flotation vest and more of a suicide vest …

  3. Jim67545 says:

    Interesting interview with Prez of Toronto Dominion on Bloomberg. Basically he advocated more capital and banks “sticking to their knitting.”
    As banks grow in size they take on risks that are different from those “knitting.” Markets multiply and become so numerous they may not be able to understand their risk. What the housing crash showed is that lenders engaged in securitizing were seemingly blind to the effect of many lenders pumping out the same stuff.
    It reminds me of an incident when I was a kid. A local tour boat almost capsized because, on a very hot day, first a few, then ALL passengers on the boat moved to the side in shade. Each individual’s decision made sense given their overheated condition and was not, they thought, of any risk. But, in aggregate, the crowd’s action almost overturned the boat.
    This is why regulations and limitations are needed. Otherwise there is nothing to prevent a number of systemically important banks from making simulataneously what seems to them to be individual ordinarily risky actions and capsizing the financial boat.

  4. constantnormal says:

    [sigh] … the Glass-Steagall Act was such a marvel of simplicity and elegance, and would have severely impeded, if not blocked entirely, nonsense such as what we now observe daily. We will likely never again see the unlikely combination of desperate and competent legislators arise to produce anything similar. It exceeded even the US Constitution as an legal instrument that pointed us toward a better tomorrow (albeit in a much narrower context).

  5. [...] Barry: "Everything is a hedge."  (TBP) [...]

  6. AHodge says:

    heres a gross understatment
    this is a complex question

    1 a hedge could move a small illiquid market and still be a genuine hedge pass maybe
    2 any hedge losses must be offset by gains elsewhere-you have neutralized the position -fail
    3 any hedge generates hedge accounting treatment gains and losses that are not separately taxable– dont know— probably fail
    any hedge position must have a a defined hedgeable offset expected to behave opposite but equal—- fail
    4 to me even if you have a hedgeable right, if you are applying it conditionally or partly, or only if you like the market you are speculating–a massive grey area obviously fail here
    5 you could bankrupt youself doing this– hedging/ losing/ covering/ rehedging– i saw a couple of customers do this. BPs “Hedging” spec shop blowup inthe 80s was like this

    if only you buy side guys knew how the sausage was made!!!
    i invented a structured product to get non marked hedge treatment for hedging future earnings which was not allowed then
    we also helped Abbott Labs manage their annual earnings growth to a compound 15.0% per year. meaning not 14.9% and not 15.1%. 15 F ING %!!!. maybe some old timers remember?

  7. Moss says:

    Right.. just like Financial Innovation, Arbitrage, Mark-to-Market, Value at Risk, Capital Ratios, Stress Tests, Risk Management..
    the lexicon used by the banksters is all meant to obscure the real motive of the industry. BONUS POOL. Everything they do has one purpose… maximize short term profits. This is what their Compensation Scheme is aligned to.

  8. AHodge says:

    this is how nonfinancial corporate treasurers and CFOs misuse their time
    and occasionally bankrupt their company. “hedging”
    it is a substantial source of financial sector profits. in this case.
    Bilaterally it is a onesided zero sum game.
    bank wins you lose

    this is a case apparently of the predator fooling itself,
    i really would expect better of JPM for its own account
    we will see if there are any bonus clawbacks for the ” lady” in question

  9. AHodge says:

    moss of course is right
    and for the nonfinancial treasurers too
    this lets tem get in on the wall st bonus fake profits game
    i run a hedging shop
    this hedge oh that was my great trade
    that loser over there? that was a hedge!!!
    OMG look at that P/L!!!

  10. denim says:

    Focus on the word:
    http://financial-dictionary.thefreedictionary.com/Hedge
    http://www.investopedia.com/terms/h/hedge.asp#axzz1uqcCNt6s
    They are bets. Bets have winners and they have losers. Who has the money? The winner. There is always an interesting story about the winner…where is it here?

  11. Moe says:

    Yawn.
    Another day another “too-bit-to-fail” fiasco.
    It’s all getting a bit tedious, especially the part where nobody ends up being taken behind the woodshed.

  12. Been Around 1963 says:

    On CNBC, when Prof. Michael Greenberger stated that JPMorgan’s trade was not a hedge, four CNBC hosts and “contributors,” plus the president SIFMA, piled on to him, claiming that he did not know what he was talking about.
    http://video.cnbc.com/gallery/?video=3000089838&play=1

    It’s not possible that CNBC is biased against anyone who challenges the veracity of the banks, is it?

  13. AtlasRocked says:

    Why is Dimon still on the NY Fed board?

    http://www.politico.com/news/stories/0512/76265.html

  14. efrltd says:

    The offset to most so-called hedges are mounting levels of leverage–not just a single level of debt at the bank, but mounting layer after layer of “debt” obligations on the top. And when the asset value is surpassed by the leverage the deal collapses.

  15. rd says:

    2008-2009 showed that many of the hedges, including CDS’s, were only hedges to the extent that the United States government was willing to stand behind and guarantee the insitutions issuing them.

    A true hedge is when a counter-party will be able to payoff when your insurance is needed because your primary position is taking a large loss. 2008-2009 showed that the so-called counter-parties are all in the same game overall. They all are going under at the very moment when you need your hedge-proviiding counter-party to be solvent. The fact that their position had grown to the point it was distorting the markets meant that the counter-parties may not be there if they really had to pay-off big.

  16. Oral Hazard says:

    Apparently, $2 billion rounds to zero at JPM also.

  17. WFTA says:

    Dimon: “…There is almost no excuse for it…”

    Now that is a hedge.

  18. USSofA says:

    Which begs the question, what is a hedge? It is a position taken in order to curb the risk of a specific (or arguably general) trade. This is not a new concept: The word “Hedge” has been used as a verb in English since at least the 16th century (See Shakespeare’s Merry Wives of Windsor).

    As long as we are in instructive mode… Begging the question is a fallacy of circular argument.
    Should read “raises the question”

  19. Mark Down says:

    HEY DIMON

    JUMP YOU FUCKER

  20. AHodge says:

    Been around points out that
    not only CNBC but SIFMA the securities industry spokesman
    doesnt know and doesnt want to know, they are in some respects the worst
    i spoke to a mixed group of central bankers, sell side, and buy side
    and suggested major accounting flaws, in particular the related prices for an individual deal dont match
    the sell side and most central bankers got it immediately
    most of the buy side said impossible!
    how can that be!
    prove that?
    willful ignorance i say.

  21. DarthBeta says:

    And even with this fail the stock has only moved from 41-36.
    Where is the action being taken by share holders?

  22. cynical says:

    It is easy to be results based and everyone – BR included – needs to try not to be.

    I would agree being too huge in a market to the point that there is no other side is just dumb etc etc. This is so basic it seems shocking that the mistake was made. It does happen though and no having a threat of a PB pulling your line seems to make it happen more often.

    Yes everything is a “hedge” – this is political/pr speech and not a white paper.

    It is not a hedge because it worked! It is a hedge based on the purpose for it. There are no perfect hedges (unless we are looking in a Japanese garden). All hedges have a risk of failure, adding risk through basis, and magnifying losses. It happens.

    JPM has a ridiculous balance sheet and losses are going to happen. Large losses are going happen. Taking on risk does not equal a positive return. Taking on risk equals the expectation of a positive return.

    All that said – it is incredibly dumb to put that huge of a trade on into that market.

  23. VennData says:

    Do any of you really think Congress will get anything restricting business last the Roberts Court? Cm on, you voted for the Bushes and Reagan, you are getting what you wanted, a court that will take the reins off anything and everything.

  24. wally says:

    Do you think Dimon used the word ‘hedge’ deliberately in order to mislead?

  25. obsvr-1 says:

    Dimon just another evil banker wrapped by a facade of “Responsible Manager of Capitalism”.

    Nothing worse then “Intelligent” criminals. If Dimon wanted to show he was taking “personal responsibility” regarding the $2B Bet, then he should have come out and said I will pay the first $20M back to the shareholders by NOT taking my bonus, Now that would be a sign of responsibility and accountability. It is very easy to say “I take responsibility” when there is no pain associated with the statement.

    Jamie Dimon sounded good in the MTP interview, but I am sure it was all political theater, he should win an academy award for best actor.

  26. [...] morning, Barry Ritholtz takes issue with the “Everything is a Hedge” argument, but I think that what he really does is [...]

  27. housepoor says:

    So, do we really know how these trades evolved? If it started as simply selling the far Index then what is the fundamental difference between that and lending money to the corporates who comprise the index? Would there be all the sturm und drang about derivatives and hedging if they had blown $2 bio on corporate loans? Would they even have had to take the full MTM hit is these were corporate loans?

    If the trade was a curve trade (buy shorter dated protection on the index, sell longer dated protection), then this really does look like a hedge vs. catastrophic risk. Credit curves invert in really bad times and this trade would have made money. The reason it lost so much seems to be more about bad delta hedging, the oversized nature of the trade, and the press/transparency of the positon. Good ideas badly executed are impossible to differentiate from a bad idea.

    Hedges are never meant to offset risk 1 to 1. Then there would be no money made. But they are there to create protection against tail risk. The curve trade, properly executed and managed, should do that. But it costs money to execute and in “calm times” will, by design, lose money.

    Maybe this is really a cautionary tale about the size of one institution and what happens when they need to do trades which fit their scale but the the market depth isn’t there?

  28. cognos says:

    Constant – Yes, Glass-Stegall was the RIGHT way to do things (regulate, increase competitiveness, fairness, etc.)

    Lots of the rest of this is moronic, mob ignorance.

    SO WHAT?

    JPM just had a minor conference call to announce a loss that is around 1/3 of QUARTERLY PRE-TAX PROFITS… EVERY F-ING QUARTER. Do you think business is not without risk or mistakes? Do you think “regulators” help businesses create profit?

    It may not be as tiny as JPM let off a few months ago… (strategically protecting themselves as they should!)… but $2bln is not some BIG deal. Its tiny. JPM has a $2T+ balance sheet. JPM has 100s of $2bln private wealth clients!

  29. AHodge says:

    not that anybody knows anything yet
    but synthetic bond is basically a product for bozo customers to look like they have an asset
    its basically a treasury bond combined with the sale (short position) of a CDS
    this may allow accounting hedge treatment for what is basically selling CDS?
    but nobody knows and we dont know if the position is long or short this synthetic “”asset”"
    Jamie increasingly looks like he wants to keep it that way
    couple heads roll, move on move on

  30. NMR says:

    A hedge is bs, this was speculative proprietary trading. Rule one with a hedge is you have to be able to get out without taking a bath.

  31. AHodge says:

    bozo customers including in particualr all” you” buy side losers and pension managers

  32. NMR says:

    “SO WHAT?”

    You’re missing the point which isn’t the size of this one bet in the context in the context of JPM it’s the potential for the existence and/or development of more and even large similar bets and their ability to destabilise the financial system again.

  33. Sisyphus says:

    I don’t recall what Glass Steagall had to say about CDS. Could one of you advocating its return as the solution to this type of problem remind me please.

  34. [...] Barry Ritholtz, “And once you define everything as a hedge, well then, nothing is a hedge.”  (Big Picture) [...]

  35. Sunny129 says:

    JPM/Jamie Dimon playing CASINO with 350B ( instead of investing in real Economy)and definitely NOT hedging as he is lying to defend himself ! He is the face of intellectual DISHONESTY pervasive out there!

    LA Times:

    What Jamie Dimon didn’t tell you on ‘Meet the Press

    ‘..There’s not that much mystery about the actual trade. Leaving aside the sophistication of the transactions themselves, JPMorgan’s trader, a London-based derivatives expert whose portfolio was so outsized he became known in the markets as the London Whale, essentially bet that corporate debt was becoming less risky as corporations were getting stronger — in trading parlance, he was long corporate debt. But he did so in a way that even a tiny hiccup in the index he was trading could be exploited by rival traders. And that’s what happened.

    Dimon continues to explain this trade away as a “hedge.” It may not have been anything of the kind. First of all, a hedge reduces risk: If one investment might lose a lot of money if markets move in one direction, you create a hedge that will make money under those circumstances so your losses are limited.

    Yet JPMorgan already is massively long corporate debt as a result of its normal course of business, which is lending money to corporations. A “hedge” that replicates that same position isn’t a hedge at all. There’s evidence that the department where the Whale worked was, in fact, replicating Morgan’s real-life business of lending to corporations, but using fancy derivatives to do so — creating a “synthetic” bank, as traders would say, without actually lending to corporate customers as real banks do.

    If that’s true, the question is why? To put it another way, if JPMorgan had $350 billion sitting around idle (the sum the Whale’s department appeared to have to play with), why not use it to do something that helps the economy — such as, you know, lending it to businesses? Instead, JPMorgan used the money to buy chips to play in the derivatives casino, which doesn’t help the economy one bit…’

    http://www.latimes.com/business/money/la-mo-dimon-sunday-20120512,0,6700867.story
    ——
    He is a personification of what’s wrong in the Financial industry!There will no recovery in the Economy or the return of ‘free market capitalism’ as long as rampant institutional fraud continues without any serious prosecution by the DOJ.

    SEC, CFTC, OCC, FED, Treasury and FASB are all, shamelessly and disgracefully complicit on this on going national financial and Economic tragedy. The Interests of the public appears to be nowhere on their agenda as attested by the facts on record, so far!

  36. ToNYC says:

    Righto! ChaseMan Dimon calls it a hedge because it is quite the opposite and he is trained to report the best lie that sells for opacity purposes. Jaime and Loeb think of their bags of tricks as pinatas. There are no real people and personal dedication involved in their calculus.
    This Geek Tragedy will be repeated just like Meriwether played Martingale. The smart guy who has zero human empathy ruins everything as Homo sui amor vs Homo omnia amor.
    Eat the dancer that lives to kill you or spit it out and start learning how to grow your own away from these baboon legacies.

  37. cognos says:

    NMR – Exactly wrong!

    Speculative bets DID NOT, CANNOT, HAVE ZERO TO DO WITH – “destabilize the financial system”.

    Only a giant bubble… built by billions of humans can… see “real estate bubble” or “internet bubble”.

    These are not remotely relevant as “speculation” or “prop trading”. It just has nothing to do with the financial crisis. Which is why… Paul Volcker is a fame monger and a dolt.

  38. cognos says:

    So systematic policies can work against giant bubbles…

    Margin requirements, capital requirements, disclosures and risk management.

    But some acceptance the “bubbles” are a part of the natural investing process must be recognized. Ideally fiscal and regulatory policies would work to be COUNTER CYCLICAL.

    Which is kinda the opposite of the attitude and regulation we now have… which is ironic, funny and just repeats the cycle. By naively working to stop “drugs” you just make drug dealers very rich and powerful. Its classic.

  39. Pantmaker says:

    A hedge is in the eye of the beholder-

    The only party qualified to say whether a certain trade is a hedge or not is the party that initiates the trade in the first place. A trade is a unique bet with an expected outcome. A hedge initiated in combination with a trade can be put on to achieve many number of things or combinations of things relative to the original trade and relative to the expectation of outcome ( ie. to lower risk, minimize loss, maintain a neutral position, protect against market crash, numerous timing issues, etc. etc. The hedge can be short, fat, tall, whatever as long as it fullfills the needs of the trader.

    Messing around with what JPM can and can’t do is misplaced attention. Take the incentive/safety net of government bailouts off the table and let them destroy themselves if they choose to. Equity and bondholder value can be the source of bailout funds the market intended.

  40. DeDude says:

    @Sunny129;

    So Dimon is basically trying to convince us that JP is run by a moron who does not know what a hedge is – or is he trying to convince us that JP is run by someone who is willing to fire off some half-assed lie in a futile attempt to distract from wrongdoing in his company. Either way it is kind of scary if you have any money in that company. Even more scary if you consider that they are actually big enough to cause society serious damage if they go down.

  41. MavInsight says:

    Very simple explanation. They made money on this “synthetic” instrument and added to it until it was a “whale ” of a trade …then, as Barry pointed out, became the market. Their position is now “crowded” and they have no market. They are now simply an epilogue for the next print edition of “Bailout Nation”. Hopefully enough equity remains when this unravels to keep them away from the Fed…