Dimon Loses Sparkle or “It’s not a hedge if you are the bar”

The news about Jamie Dimon’s JP Morgan losing over $2B has caused quite a debate. The point I’d like to address, is whether or not JPM was “gambling”. You see, on CNBC this week, Maria Bartiromo tried to make fun of Senator Harry Reid who intimated that JPM was gambling and should just move to Nevada. During her comments she also tried to make the point that (and I’m paraphrasing) “do we want to outlaw risk taking?” JPM’s misteps are being debated in entirely the wrong context.

To the question at hand, was JPM “gambling” or was this merely “hedging” gone awry? It helps to understand what a hedge is and why it might be used. Any business faces a variety of risks. Banks, in particular, face risks associated with the credit quality of the general economy. For an institution of JPM’s size, if the economy weakens, defaults are likely to rise or the bank is likely to need to increase reserves against potential losses. It’s obvious why a bank might attempt to hedge such risks.