Could misdirection over the meaning of a simple, five-letter word - hedge - be at the heart of the roiling controversy over JPMorgan Chase's embarrassing $2 billion loss in European trading?
CEO Jamie Dimon tried to quiet the storm at JPMorgan Chase & Co.'s annual shareholders' meeting Tuesday, just days after he called the bank's actions "stupid" and "sloppy" in a TV interview and the bank announced that chief investment officer Ina Drew, whose London office orchestrated the costly trades, would resign.
But proponents of stronger U.S. financial rules say Dimon and others continue to cloud the debate by portraying the trading that went wrong as a hedge - a strategy designed to reduce risk - rather than as financial speculation aimed at generating large profits.
"It is a huge, self-serving myth to say this was a hedge," said Michael Greenberger, a professor at the University of Maryland law school and former director of trading and markets at the U.S. Commodity Futures Trading Commission, which oversees the complex financial instruments that were apparently central to JPMorgan Chase's errant strategy.
Greenberger and other market-reform advocates say the incident highlights the importance of a pending rule required by the 2010 Dodd-Frank financial overhaul. Named for Paul Volcker, the former Federal Reserve chairman who proposed it, the "Volcker Rule" is supposed to draw a bright line barring commercial banks from speculating with assets protected by deposit insurance and other government guarantees.
"That's what the law calls for, and that's what the reckless activities of Wall Street in 2008 require," said Dennis Kelleher, president and CEO of Better Markets, a nonprofit that says it promotes the public interest in financial-market debates.
Kelleher said that draft regulations implementing the Volcker Rule need to be strengthened to prevent the kinds of speculation that underlay the 2008 credit freeze and financial collapse. Instead, he said, Dimon and his Wall Street allies are pushing to weaken the rule to protect a huge source of profits that is also a huge source of risk.
"Their latest gambit is to try to get the regulators to allow them to do proprietary trading but by a different name," said Kelleher, a former partner at the Skadden, Arps law firm. He said Dimon and others on Wall Street are trying to justify proprietary trading by describing it as something else, such as "market making" or "portfolio hedging."
That's where intentional confusion over the word hedge may come into play.
Dimon and other JPMorgan officials have volunteered few details about the London trades that led to the losses disclosed last week. But their own statements and news reports have repeatedly portrayed the problem as a poorly implemented hedge.
"We do continue to believe in the importance of being able to hedge risk as an institution," Dimon said at Tuesday's shareholders meeting, according to Dow Jones. "However, we also understand the need for rules and practices to ensure that hedging doesn't morph into something different. What this hedge morphed into violates our own principles."
Kelleher, noting that Dimon had dismissed the issue as a "tempest in a teapot" last month when asked about news reports on the bank's large London exposure, said Dimon was dodging responsibility.
"This wasn't something that morphed on its own. This was a corporate decision," Kelleher said. "He's trying to portray it as a hedge when it was a bet - just a pure, huge, high-risk leveraged bet."
Kelleher said JPMorgan Chase apparently owned a large portfolio of corporate securities. To protect against potential losses, it also invested in credit default swaps - insurance policies, in essence, against the evaporation of an asset's value.
But when its projections for the economy brightened, Kelleher said, Chase apparently decided against simply unwinding some of the swaps. Instead, it made a huge bet on the other side of the market - as much as $100 billion or more, by some reports - that turned out to be wrong.
Why was that different from a genuine hedge?
For one thing, Greenberger said, real hedges should be easy to explain, such as an airline buying crude-oil futures to guard against swings in jet-fuel prices, or an investor who owns a company's bonds buying a credit-default swap to protect against losses.
"If you can't explain in two sentences what your hedge is, then you're not hedging," Greenberger said.
Greenberger said some confusion may result from the poorly understood role of financial firms known as hedge funds.
Despite their names, hedge funds don't typically hedge their own investments. Instead, they make large, often complex and sophisticated bets on their reading of market trends, such as the investors whose story was chronicled in Michael Lewis' The Big Short and who made billions of dollars from the collapse of the recent housing bubble.
Greenberger said it sometimes makes sense for institutions to invest in hedge funds to mitigate risks elsewhere in their portfolios. The problem comes when commercial banks, eyeing the huge profits that some hedge funds have made, try to pursue similar high-risk strategies.
With rare and avoidable exceptions, he said, hedge funds can fail without causing systemic damage. "If JPMorgan or its ilk should fail, it's a worldwide calamity," Greenberger said.
Kelleher said Chase's large losses are evidence of more than risk.
"If you're making either big profits or generating big losses when you claim to be hedging, you're either grossly incompetent and should be fired, or you're lying," he said. "All the evidence right now leads to the conclusion that they were lying. They made a big bet, and it appears that somebody covered it up."
Contact Jeff Gelles at 215-854-2776 or firstname.lastname@example.org.