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Media Misinformation and JP Morgan

The New York Times' Andrew Ross Sorkin (above, Credit/David A.Grogan) and Jim LaCampJP Morgan Chase’s “terrible, egregious mistake” has touched off a firestorm of utter nonsense, ignited by the Jamie Dimon’s subtle spinning and fanned by the misinformation parroted by the media. Calling out these false statements benefits the public (and people like me who have been far too involved in the fight to preserve the Volcker Rule and other financial market reforms for our own health and sanity).

Fox News, of course, sets the standard for nonsensical rants. The most non-informative work is probably an interview by noted journalist Neil Cavuto of Jim LaCamp, a portfolio manager at Macroportfolio Advisors, but better known for his ready availability for conservative talk show appearances. Cavuto and LaCamp turned reality on its head by asserting that the JP Morgan SNAFU proves that Dodd-Frank Wall Street reform legislation does not work.  They agreed that reinstatement of Glass-Steagall would have been a better solution, “but that would have been too easy.”

That alone would have sent Jamie Dimon spinning in his grave, but for the fact that he is still alive (and well paid, thanks to the approval of his employment agreement by the JP Morgan Chase shareholders). One way to look at the Volcker Rule is as Glass-Steagall with far too many exceptions. The Cavuto/LaCamp proposition is not the kind of trade Dimon and his London traders would go for.

But Fox’s dynamic duo pushed on. They opined that the law merely put vague power in the hands of faceless regulators, increasing the number of cops on the beat that were so ineffective that they failed to spot the impending Morgan fiasco. First of all, I have had the pleasure of meeting many of the regulators and they each have faces. Many have families and pets and professional integrity, as well. But the ugly truth is that the congressional Republicans, with the help of some infuriatingly passive Democrats, have actually cut the budget of the CFTC -- an agency that is newly tasked with regulating the $30 trillion-per-year derivatives markets, among other things. This new work is a multiple of their prior responsibilities. The cynical tactic of starving the agency (whose incremental needs are actually quite modest, about 8 hours of cost of the war in Afghanistan) is designed by the heroes of Fox News to make certain that there will not be cops on the beat.

And how did Fox’s expert team ever get the idea that financial reform has ever gone into effect in any way meaningfully related to the shenanigans of JP Morgan Chase’s “Chief Investment Office?” The implementing rules are largely stalled because of the in terrorem tactics of the congressional budget process and the real and threatened lawsuits over picayune issues, each to be heard in the Bush-packed DC Circuit Court of Appeals. The banks’ bottomless pit of funds for lobbyists and litigators assures a slow and painful path to implementation.

Fox News is one thing, but the New York Times is quite another. It is true that the Times would never have put forth the bizarre rationale favored by Cavuto and his colleagues. But sometimes a lesser mischaracterization of the truth by a truly credible source can be far more damaging than a transparent rant.

Which brings us to the example of an article by Andrew Ross Sorkin. Since Mr. Sorkin has done some fine work in the past, I hope that he takes this as a compliment in that his missteps are particularly startling and so serve as effective pedagogical devices. He published an article that described the JP Morgan Chase trades in the context of the restrictions that would apply if the Volcker Rule legslation had been implemented already. The problem is that he seems to have accepted the widespread characterizations of the Volcker Rule naysayers rather than digging into the minutiae of the rulemaking.

In particular, he writes that the so-called “hedging” activity that was the source of JP Morgan Chase’s loss and embarrassment is inescapably preserved by the Volcker Rule’s exception for risk reducing hedges from the proprietary trading prohibition. Under the statute, a bank can hedge a risk position that was permissibly entered into originally. Sorkin approvingly quotes a former Morgan chief financial officer: “I don’t think you can hedge without taking a risk…The notion that you can very clearly draw a line between propriety risk-taking and hedging is a very difficult notion to implement.”

The proposed regulations do just that. There are three kinds of transactions that can logically be characterized as a hedge.

  • A transaction can be the precise inverse of a position held by the bank. In this case, after the transaction is entered into, the bank would have no exposure under the original position.
  • A transaction can offset some, but not all, of the risks associated with the original position and add no additional risk to the bank. The remaining risk is not new, but was on the books of the bank prior to the transaction.
  • A transaction can offset some or all of the risks associated with the original position and add additional risk to the bank. This additional risk is also an opportunity to make profit. This additional risk and reward constitutes a new proprietary position, nothing more or less.

The Volcker Rule proposed regulations permit the first two activities but not the third. A permitted risk can be “hedged, but only of the purported hedge:

[d]oes not give rise, at the inception of the hedge, to significant exposures that were not already present in the individual or aggregated positions, contracts, or other holdings of a covered banking entity and that are not hedged contemporaneously…

As long as this principle survives the onslaught of bank lobbyists (and “significant” is not warped into another meaning through interpretation), it would be virtually impossible to lose money on a hedge. This is a massively important feature of the Volcker Rule regulations and the regulatory agencies should be complimented on their effort, not have their effort belittled.

Even Mitt Romney has overtly called for the repeal of the Dodd-Frank Act. This is irresponsibly dangerous. It is no trivial matter when the tireless efforts of the regulators are described as futile or impossibly cumbersome. There are plenty of defects in the new regulatory framework, but it beats the heck out of the dangerous deregulation that existed before.