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Unhedged? Unhinged!

 April 11, 2012 10:08 AM


By Thomas K Brown
I was on Bloomberg TV this morning talking about whether JPMorgan trader Bruno Iksil's supposedly ominous CDS trades in London somehow constitute evidence Morgan is violating the yet-to-be-written Volcker rule, and am still having trouble figuring out what all the fuss is about. A few points to keep in mind:

  1. Anyone outside of JPMorgan who says he can glean whether, based solely on their size, Iksil's positions are fully hedged, partially hedged, or entirely speculative doesn't know what he's talking about. There is simply no way for an outsider to know. What we do know is that the unit within Morgan Iksil runs is basically a souped-up treasury function that manages $350 billion and is presumably closely watched by Morgan management and regulators. It would be the last place that either Morgan, as an institution, or Iksil, as a rogue, would want to try to engage in improper proprietary trading. Actual evidence Iksil is engaging in such trading: zero.

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  1. The credit default swap market is not terribly liquid and is prone to distortion during periods of high volume, as we all saw during the credit crunch in 2008. If gaps between prices of indices and their underlying components are currently unarbitrageable, it won't be the first time.

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  1. The people doing the squawking that Iksil may be up to no good are either a) the anonymous counterparties that are getting clobbered by being on the other side of his trades or b) members of Congress (most notably, Rep. Brad Miller of North Carolina) who don't seem to understand how the capital markets work.

  1. JPMorgan is the largest player in the CDS market. It can be expected to take on sizable positions from time to time. Again, there is no way an outsider can know whether those positions are unhedged.

  1. Don't be thrown off by the $144 billion worth of volume in the index in question in the second quarter, which has everyone up in arms. That's the notional amount the CDSs cover, not the dollar value of the CDSs themselves. The total notional value of all CDS comes to over $700 trillion, according to the Bank for International Settlements.

I have great regard for the soundness of judgment of my colleagues over at Bloomberg, but suspect they're hyperventilating a bit on this one.

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