This hedging hiccup could lead to even tougher rules
IT’S only 74 days to go now before the start of the London 2012 Olympics and organisers are clambering over themselves to tell us how it will be the cleanest games yet. Drugs cheats will have nowhere to run, masking agents will be unmasked and only the truly virtuous will get to the winners’ podium. I’ll take that with a pinch of salt. In fact, the same pinch of salt I take when investment banks tell me they are no longer prop trading.
Last week we heard that JP Morgan had a hiccup with its Chief Investment Office hedging activities. A hedging operation carried out by someone called the Parisian Porpoise, London Wall Walrus or some such name landed JPM with an embarrassing $2bn loss. Gosh, poor chap. I guess that means he’ll now have to give back a big chunk of the handsome sums he has been earning at JPM for carrying out these activities?
Back on planet Earth, I find it hard to understand how anybody can generate that kind of money merely by hedging risk positions. Hedges on client positions can usually be offset by the creation of a synthetic position which negates your absolute exposure to near zero.
In fact, if JPM had really wanted to hedge position risk, couldn’t it have just gone into the market and closed the position? Or in this instance did JPM become the market, take on the rest of the market and make a huge positional bet that has badly misfired?
Once again the poor old chaps in risk management will be wondering what on earth their role is at investment banks. Time and time again, it seems that these highly paid middle office staff ping over their e-mails to heads of investment banking and group boards saying there could be a problem with Position X taken by Prop Team Y (sorry, make that Delta Hedging Team Y) only to be told to go back to their dark cave and crunch some more numbers but not make too much of a fuss. Or at least that is the impression one gets from the outside.
As for what happens next, the ammo given to the regulators and politicians on both sides of the Atlantic is now more like gold dust. And yet, I’m more interested in how JPM actually extricates itself from this position if it is actually still “open” and live. Surely those nice hedge fund chaps on the other side of JPM’s $2bn loss will say enough is enough, you can get out now? That’s just as likely as me lining up against Usain Bolt in the 100 metres final.
Maybe we should just treat the investment banks in the same way as some realists have suggested we treat drugs cheats – that is, let them all take drugs and see how fast they can run. It’s going to happen anyway, so why bother to fight it?
The answer of course is that while in athletics we may get a sub-nine seconds 100 metre time, with the banks the losses wouldn’t be $2bn, or even $200bn. It could be far, far worse for all of us.
Steve Sedgwick is an anchor for Squawkbox Europe, CNBC