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Volcker Rule: Now or Never

Stocks in this article: JPM

The senator surely understands that the Volcker Rule, which he helped draft, was not meant to prevent all forms of hedging activity by banks, but he kept the language of his statement very short and very simple.

Lawrence Harris -- the Fred V. Keenan Chair in Finance at the University of Southern California's Marshall School of Business -- says that Banks are "trying to manage their risk through a hedging strategy and since it is not in the interest of the public to have banks overly exposed to risk, they will be allowed to continue to do so."

What happened at JPMorgan, according to Harris, is that "risk management models were either incorrect or the processes were out of control."

Harris goes on to explain that "hedging trades are often losing trades. If you have a true hedge -- selling the risk of an instrument through a hedging vehicle -- if the value of the instrument rises, you lose money on the hedge, but you have made money on your original investment. So the purpose of hedging is not to prevent losses on hedging trades but to minimize the volatility of the combination of the original risk plus the hedge."

While the Volcker Rule is with us, since Dodd-Frank is the law of the land, Harris prefers that Congress and regulators keep things more simple, since "it would be impossible for regulators to determine with any degree of accuracy if a bank is hedging or speculating. What is needed is adequate capital so that whenever they make a mistake the shareholders end up paying for it, and not the government or the bondholders."

This is exactly what happened with JPMorgan, with the shares dropping 12% during the two trading sessions following Dimon's announcement late Thursday.

Neil McGovern -- a senior director of marketing at SAP, specializing in financial services and capital markets -- agrees that Congress needs to act, saying that "when I talk to people in the industry, there is confusion on what the vocker rule is and what it applies to."

Among its many software offerings, SAP specializes in "real time analytics, which is the ability to, in real time, crunch huge amounts of information, to help analyze risk," according to McGovern.

McGovern says that "obviously JPMorgan Chase made some mistakes in their hedging but what I believe they were trying to do was reduce their risk exposure, while not trying to profit from the market."

McGovern adds that "the spirit of the Volcker Rule says that if you're in investment banking you should not also be an active player in the market. The concept is that you have customers relying on you to assist them in managing their money and trying to help them get the best out of the market. if you are doing that with one hand, while the other hand is playing the market, you might make a choice to play your hand more strongly than your customer's hand."

"That's not the way that these large organizations work," he says, and "it would be the kiss of death, i think, of these organizations used their inside knowledge" against customers' interests.

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