“Everything is a Hedge”

The claim is being made that JP Morgan’s $2 billion trading loss was in a trade that was a “a hedge.” It doesn’t take much review to easily disprove that position.

We first learned of this particular trade when they began to distort credit indices. Any trade so huge that it impacts its markets – that becomes the market – cannot be credibly thought of as a hedge. Simply stated, once you are the market, you are no longer a hedge. Sheer size of this trade makes it far more accurate to describe this as speculation than hedge.

Of course, the loss was the tell. A true hedge would have been offset by the underlying position that was being hedged — so any loss should have been insignificant. Even a minor correlation error should not lead to a $2 billion dollar hit.

Which begs the question, what is a hedge? It is a position taken in order to curb the risk of a specific (or arguably, general) trade. This is not a new concept: The word “Hedge” has been used as a verb in English since at least the 16th century (See Shakespeare’s Merry Wives of Windsor).

Looking at the question a little differently, what isn’t a hedge? There is always the other side of the trade, and that side (if not position) is what  you can theoretically claim to be hedging. Hence, for a huge bank with trillions on its book, there is the rationale that any trade, any position, any financial transaction, is potentially a hedge against some other position the bank is holding. Recall that Goldman Sachs, who has been rather silent on the JPM trade, used the same logic when arguing they were not betting against clients; rather they were “hedging other bank positions.”

Poppycock. Both the JPM and GS arguments fail, for a simple reason: If we are going to define this trade as a hedge, then there is no other conclusion to reach except that everything at a huge bank is a hedge.

And once you define everything as a hedge, well then, nothing is a hedge.

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