There has been a great deal of debate
surrounding JP Morgan’s hedging losses announced last week. There is some
mystery surrounding the nature of the transactions involved, without full
clarity yet on the amount of losses. Andrew Ross Sorkin has a brief
explanation of the episode in the New York Times:
surrounding JP Morgan’s hedging losses announced last week. There is some
mystery surrounding the nature of the transactions involved, without full
clarity yet on the amount of losses. Andrew Ross Sorkin has a brief
explanation of the episode in the New York Times:
… Here’s an overly simplistic primer, but
you’ll probably get the idea: The company’s chief investment office originally
made a series of trades intended to protect the firm from a possible global
slowdown. JPMorgan owns billions of dollars in corporate bonds, so if a
slowdown were to occur and corporations couldn’t pay back their debt, those
bonds would have lost value.
you’ll probably get the idea: The company’s chief investment office originally
made a series of trades intended to protect the firm from a possible global
slowdown. JPMorgan owns billions of dollars in corporate bonds, so if a
slowdown were to occur and corporations couldn’t pay back their debt, those
bonds would have lost value.
To mitigate that
possibility, JPMorgan bought insurance — credit-default swaps — that would go up in value if the bonds fell in value.
possibility, JPMorgan bought insurance — credit-default swaps — that would go up in value if the bonds fell in value.
But sometime last
year, with the economy doing better than expected, the bank decided it had
bought too much insurance. Rather than simply selling the insurance, the bank
set up a second “hedge” to bet that the economy would continue to improve — and
this time, traders overshot, by a lot.
year, with the economy doing better than expected, the bank decided it had
bought too much insurance. Rather than simply selling the insurance, the bank
set up a second “hedge” to bet that the economy would continue to improve — and
this time, traders overshot, by a lot.
This episode has given rise to renewed debate
on matters of regulation of the financial services sector as well as corporate
governance.
on matters of regulation of the financial services sector as well as corporate
governance.
On the regulatory side, the key question
relates to whether it will strengthen the hands of regulators around the world
to more closely scrutinize the financial services sector. The US has already
taken giant steps through enactment of the Dodd Frank Act, but the current
development would have an impact on the scope, nature and implementation of the
Volcker rule which curbs proprietary trading by banking institutions.
relates to whether it will strengthen the hands of regulators around the world
to more closely scrutinize the financial services sector. The US has already
taken giant steps through enactment of the Dodd Frank Act, but the current
development would have an impact on the scope, nature and implementation of the
Volcker rule which curbs proprietary trading by banking institutions.
There are a number of issues on the governance
side as well. For example, it raises questions regarding oversight of the
company’s board and whether they ought to have exercised greater vigilance
regarding activities undertaken by the chief investment office. Arguably, more
effective risk management systems might have mitigated the effects of such
transactions. Lastly, this has also triggered the debate regarding executive
compensation, on this occasion pertaining to the specific issue of claw back of
excessive compensation to affected officers of the company.
side as well. For example, it raises questions regarding oversight of the
company’s board and whether they ought to have exercised greater vigilance
regarding activities undertaken by the chief investment office. Arguably, more
effective risk management systems might have mitigated the effects of such
transactions. Lastly, this has also triggered the debate regarding executive
compensation, on this occasion pertaining to the specific issue of claw back of
excessive compensation to affected officers of the company.
While the enormity of JP
Morgan’s balance sheet size appears to have dwarfed the losses from the hedging
transactions, their impact on the mode of regulating Wall Street and on governance
concerns rings loud and clear.
