At Jamie Dimon’s hearing before the Senate on Wednesday, the JPMorgan CEO proved that even the most cynical observers underestimated the depths of the financial industry’s duplicitousness.
The hearing revealed that JPMorgan appears to have found a solution to the pesky problem of the Volcker Rule. No, it’s not buying off members of the Senate Banking committee, though given what passed for “questions” in the hearing, that is certainly Plan B. JPMorgan’s solution is far simpler. It has relabeled proprietary trading: it’s now called “portfolio hedging.” This is a convenient rebranding, because portfolio hedging is explicitly allowed in the current draft of the Volcker Rule.
The Volcker Rule (which was part of the Dodd-Frank Wall Street Reform bill) has a noble goal: create a firewall that bars banks that enjoy FDIC insurance from risky, speculative gambling. On Wall Street, gambling with the firm’s funds is known as proprietary or “prop” trading.
The banks hate the Volcker Rule because prop trading is very profitable when you’re on the right side of a bet. And when you’re a “too big to fail” bank on the wrong side of a bet, the government will bail you out, and the Fed will secretly give you billions of dollars in emergency loans. The Volcker Rule aims to prevent the need for these bailouts by prohibiting banks that enjoy customer deposits and FDIC insurance from making these risky prop trades.
But the Volcker Rule’s current draft is full of exemptions, including one for hedging. What is at stake in the yet-to-be-written final version of the rule is what, exactly, will be considered “hedging.”
A “hedge” is an offsetting trade you make to reduce risk on an initial trade. A true hedge works like a seesaw: if my original trade goes up in value, my hedge trade goes down in value—and vice versa. If I buy shares of Apple stock, and I worry that Apple’s stock price will go down, I can hedge this trade by purchasing what’s called a put option. A put option on Apple will increase in value as the price of Apple’s stock decreases (put option up, Apple stock down). The put option works to hedge the risk of my Apple shares losing money.
One of the central battles over the Volcker Rule today is whether its hedging exemption should allow what’s called “portfolio hedging.”
In one corner, we have Senators Jeff Merkley and Carl Levin who warned in their Volcker Rule comment letter that the portfolio hedging allowance was a loophole that could be used to hide prohibited proprietary trading. In a recent letter to the regulators, the Senators crowned the portfolio hedging exemption the “JPMorgan Loophole.” Occupy the SEC also warned of the dangers of portfolio hedging in its comment letter (full disclosure: I was a co-author of the letter), as did Americans for Financial Reform.