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It's not a hedge if it makes money, Bair says

by Ira Teinowitz in Washington | Published June 1, 2012 at 10:26 AM

The test of what sort of hedging banks will be able to conduct after the Volcker Rule's ban on proprietary trading kicks in should rest on whether a bank sets out to make a profit, the Commodity Futures Trading Commission was told Thursday.

Former Federal Deposit Insurance Corp. Sheila Bair and officials of several consumer groups urged regulators to ban banks from using their hedges as a profit center.

Banks, however, warned that setting too strict a limit on hedging could be counterproductive, increasing risk within the banking industry and causing difficulties for companies in illiquid areas by forcing them to raise money and possibly reducing regulatory oversight on hedging if the activity moves to the shadow market.

The debate came at an all-day CFTC hearing examining the Volcker Rule. The discussion played out in the shadow of J.P. Morgan Chase & Co.'s $3 billion loss on portfolio hedging last month.

CFTC Chairman Gary Gensler, noting the loss at the hearing's outset, suggested that it raised concerns about the current plan to permit "portfolio hedging," which calls for hedging against an institution's entire holdings rather than just one specific type of instrument. "Some commenters have said if we're too prohibitive in one area, we may limit banking entities' ability to engage in risk-mitigating hedging. On the other hand, if we follow comments of some of the banking entities, permitted hedging might swallow up Congress' intent to limit the risk of proprietary trading," he said.

Gensler said the CFTC is interested not only in when hedging should be permitted but also when hedging might need to be mandated.

He said one question that concerns the agency is whether banking entities with significant positions for many years in customized swaps could be creating prohibited proprietary trading if they fail to fully or partly hedge their positions.

Bair, now a senior advisor to the Pew Charitable Trust, said she would like to see regulators use their new authority to review living wills and simplify banking structures of systemically important financial institutions to push bank holding companies to engage in any hedging activities outside their insured banking subsidiary. Meanwhile, she would limit the hedging exemption that would be permitted for federally insured institutions.

"I would tighten the rule," she said. "A hedge should not be allowed unless you can identify specific risk."

Bair said identification of hedges and position should be disclosed, and a bank should also disclose its methodology and whether its hedges are working.

Marcus Stanley, policy director for Americans for Financial Reform, a coalition of consumer, labor and civil rights groups, said hedging shouldn't be a profit center and hedging profits shouldn't determine bank profits.

Lynn Stout, a Cornell Law School professor, also urged such limits. "If they are generating profits, I think that is prima facie evidence that they are not hedging," she said. "Hedging is buying insurance. Insurance costs money."

Banks and company officials issued warning about overly strict rules.

Jeff Agosta, executive vice president and CFO of Devon Energy Corp., said the company's ability to hedge with its banks gives the company some certainty over future revenues.

Peter Antico, managing director and head of North American rates trading for Credit Suisse Group, said any attempt to take banks back to the limits of the Glass-Steagall Act and limit what they can do creates risks.

"The fact is that a diversified bank is a safer bank," he said. "I'm concerned if banks go backwards, we will have another savings and loan crisis."

He was also wary of attempts to take hedging activities away from banks. "Do you want to have good visibility of the risk-taking that is going on in the system, or do you want to push it out to the dark reaches of the financial system and have random blowups?" he said.

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Tags: Commodity Futures Trading Commission | Federal Deposit Insurance Corp. | Sheila Bair

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It's not a hedge if it makes money, Bair says

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