When Is A Hedge Not A Hedge? The Accounting For JP Morgan’s Bet
By Francine • May 18th, 2012 • Category: PricewaterhouseCoopers, Pure Content, Regulators, Laws, Standards, Regulations, Writing for Others
Overgrown Hedge
Yesterday’s column at American Banker digs into the accounting for JP Morgan’s reported “hedge”. I was shocked – OK, not really – that no main stream media outlet had explained the stunning announcement made by Jamie Dimon last Thursday of a $2 billion loss on a series of trades made by the Chief Investment Office in accounting terms. CIO is the group purportedly managing the investment of the bank’s excess deposits. In London. As in, the low risk sweep function. Uh-huh.
There’s lots of speculation about the nature of the trade itself. The best I’ve seen is the ongoing coverage at FT Alphaville by Lisa Pollack, in particular.
The gist of all the stories is that the CIO was selling protection on the CDX.NA.IG.9 (going long) to balance out the tranches on the high yield index that they’d bought (going short, which turned out to be profitable when Dynegy and AMR Corp defaulted).In this way the trade would be both a curve play and across indices — one high yield, one investment grade, with the high yield play levered further because it was a tranche. The long on the IG.9 also would have helped to fund the rather expensive short on the high yield tranches.
If you are an expert in this stuff, please get in touch. I’d buy a big steak for someone who can walk me through it, maybe at a quiet table at Gene & Georgetti’s.
I took a long look at the 10K and 10Q and the first clue was the pretty stark statement, all over the place that the credit derivative number, “Represents the net notional amount of protection purchased and sold of single-name and portfolio credit derivatives used to manage both performing and nonperforming credit exposures; these derivatives do not qualify for hedge accounting under U.S. GAAP.”
So from a financial reporting perspective, all the media and trader chatter about “hedge or bet?” is moot.
The bank may now be calling the positions an “economic hedge” but, in hindsight, they look to me like a series of trades designed to generate income that spiraled out of control on incorrect or ignored risk information and lack of control over traders.“It was there to deliver a positive result in a quite stressed environment,” Dimon said on the May 10 emergency conference call, “and we feel we can do that and make some net income.”
The rest of the American Banker column provides the details. .....
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