No Pain - Or Gain

While bankers are prone to complain
That hedging is hard to explain,
It's fairly alleged
That you aren't really hedged
If you're also expecting a gain.

One of the many talking points employed by JPMorgan Chase CEO Jamie Dimon in his closely watched Senate testimony this week was that "this particular synthetic credit portfolio was intended to earn a lot of revenue if there was a crisis. I consider that a hedge; what it morphed into, I will not try to defend." The Chief Investment Office's loss - $2 billion and rising - on its London Whale position was simply well-intentioned risk management gone bad. In this, Mr. Dimon deliberately muddied the waters and his senatorial inquisitors failed to impose any clarity on the discussion. Anytime you say "I expect this position to make a profit if X happens," you are making a bet, not a hedge. The fact that market turmoil is expected to trigger the profits does not remove it from the realm of speculation. The only one who is truly hedged is the one who can say: "My results are locked in regardless of what the market does."

A Whale of a Tale

Said the boss of a trading facility,
Whose job was to crimp volatility:
"While I'm away jettin',
Be sure you don't threaten
The global financial stability."

Though much has been written about JP Morgan's "London Whale" and the $2-billion-and-growing loss that arose from his credit index trades, there has not been much focus on the interpersonal management dynamics of the case, until yesterday. The New York Times' Jessica Silver-Greenberg and Nelson Schwartz looked into the story and concluded that "Discord at J.P. Morgan Unit is Faulted at Loss." In a modern, highly-leveraged twist on "when the cat's away, the mice will play," it appears that the egos and ambitions of Bruno Iksil (the Whale) and his boss Achilles Macris could not be contained once the bank's chief investment officer, Ina Drew, was out sick for an extended period. Without Ms. Drew's "coolheaded, steely resolve", the internecine tensions between the CIO's New York and London offices devolved into daily screaming matches with no clear leader to to set limits and keep discipline.

Betting One's Hedges

There's a false sense of immunization
In many a hedge operation;
Positions one places
On ill-conceived bases
May end up as wild speculation.

JP Morgan Chase CEO Jamie Dimon stunned investors on Thursday with the announcement of a $2 billion trading loss in the bank's risk management unit. Some reacted with schadenfreude, in view of Mr. Dimon's previously dismissive attitude toward reports of the firm's massive credit default swap positions. The Chief Investment Office's head trader, Bruno Michel Iksil, had been dubbed "the London Whale" for his huge, market-distorting CDS bets on the so-called CDX IG 9 index of the credit risk of 125 companies. Mr. Iksil sold protection on the index during the first quarter, essentially writing an insurance policy that the indexed companies' credit would not deteriorate.

Based on his limited knowledge of this case, Dr. Goose is at a loss to explain how the selling of credit protection constitutes a risk management function for a bank (one would sooner expect them to be buying credit protection). Nevertheless, even the most well-intentioned hedge position can go awry if the underlying assumptions do not hold, and many a "hedge" entered into on the basis of a particular market outcome is just speculation by another name.