Should I be surprised that the president doesn't have his facts straight? Should I be surprised that the president spoke this week about the J.P. Morgan (NYSE:JPM) hedge position and messed it up because he either didn't know the difference between a hedge position and proprietary trading or he knows the difference but "elected" to present it wrong on purpose in an attempt to further his political agenda in support of the Volcker Rule?
Of course the president wouldn’t do that … right?
Let’s help the president out and set that facts straight: a hedge is not a trade, a hedge is position that is put on to reduce risk to a company. Coca-Cola (NYSE:KO), General Electric (NYSE:GE), Wal-Mart (NYSE:WMT), Apple (NASDAQ:AAPL) and most of the companies you know very well put on hedge positions.
They do this to reduce perceived or actual risk. Sometimes a hedge is put on to protect against the price of a commodity rising or dropping that could negatively impact the company’s earnings. On the complete opposite end of the spectrum is proprietary trading, or as it is called in the business, prop trading. Prop trading is what the Volcker Rule is focused on.
Let me make this very clear: what occurred at J.P. Morgan was not prop trading. It is crucial for everyone to know that this was a hedge position and was not trying to make money but to save money.
Companies such as Coke and Starbucks use hedge positions to ensure price clarity for planning purposes. I am shocked that there is such a media firestorm around a company putting on a position to reduce risk. At no time was the position not hedged, meaning, they always knew the risk. We all want our companies to have tight risk controls in place.
Let’s play devil’s advocate; what if the European economy fell more sharply and the loans that J.P. Morgan was protecting against failing and not being paid back, actually defaulted. The story-line would read, "How could a major bank not have hedges on to protect against this? We all knew the European economy was in terrible shape."
The issue at hand is that most people don't understand that this is business as usual and it happens everywhere around the world, every day. This was not proprietary trading, where the company was simply trying to trade its own money to make a profit. It was actually on the opposite side – it was using a small amount of money to secure profits for shareholders.
Banks have hundreds to thousands of these types of positions on throughout the year. At no time was there runaway risk of any kind, and the majority of these hedges work perfectly.