JP Morgan’s $2 Billion Experiment With TruthinessJune 12th, 2012 10:33 am David Cay Johnston
JPMorgan Chase & Co blames its $2 billion, and maybe much larger, trading loss on mistakes made in hedging the market. Bill Black, a finance criminologist, calls this “hedginess.”
“Hedginess” riffs on “truthiness,” the word the comedian Stephen Colbert invented in 2005. Truthiness means favoring versions of events that one wishes to be true, and acting as if they were true, while ignoring facts to the contrary that are staring you in the face. Fake hedges are to real hedges as “truthiness” is to truth. Hence “hedginess.” JPMorgan’s trades got around the Volcker rule, which tries to prevent banks from speculating in financial derivatives, by labeling as “hedges” bets that were clearly not hedges.
As Black puts it, JPMorgan is now defining as a hedge “something that performs in exactly the opposite fashion of a hedge.” A hedge is supposed to reduce risk, but according to Black, the losses came from deals that “dramatically increased risk by placing a second bet in the same direction, which compounded the risk.”
Actually, it isn’t quite as simple as Black says. While JPMorgan did not respond to my questions on its strategy, Reuters and others have reported that the trade began as a standard hedge. Subsequently, the reports say, it morphed into speculation as the bank layered bet on top of bet.