JPMorgan’s hedge was no hedge

Francine McKenna wrote a thought-provoking column last week explaining what happened at JPMorgan Chase.  Her blog explains more.

Francine points out that the JPMorgan Chase transactions were not accounted for as a “hedge” in JPMorgan’s financial statements.  This means one of three things:

  1. It wasn’t, from the get-go, an effective hedge or
  2. The Company chose not to account for it as a hedge.
  3. The Company decided that the benefits from hedge accounting did not exceed the cost of meeting FASB’s onerous documentation requirements for hedge accounting.

In short, according to Generally Accepted Accounting Principles, this group of transactions was no hedge; it was a bet.  What’s the difference?  A hedge is designed to reduce your risk (from some other factor).  A bet can be designed to do anything – reduce your risk or increase it (or both).

JPMorgan was probably trying to make a few bucks off of the grave risks facing European markets over the past year, similar to how Goldman Sachs (successfully) banked on mortgage failures a few years back.  This kind of trading is understandable, considering how much the bank could lose from a European financial catastrophe.

This (again) raises two questions:

  1. How large were these bets?
  2. To what extent is the US taxpayer at risk?

As always, Francine brings badly-needed clarity to the situation.

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About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

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