The Issue of Hedging

In finance the definition of a hedge is making an investment to reduce the risk of adverse price movements in an asset.

In the wake of the JP Morgan severe hedging loss of at least $2 Billion dollars, that has made fear in the markets reemerge at a very fast pace, I wonder how this was even able to happen.  In the text of the lengthy Dodd-Frank legislation and the Volcker Rule, there are major liberal uses of language that annihilate the intent of the rules passed by the people in DC. Hedging against a single security is not allowed by banks, but somehow a bank has the ability to hedge against an entire portfolio, something much more risky!

How did this happen?  The short answer is lobbyists, the long answer is different, and needs to be answered by posing the question should banks be allowed to hedge?  The INTENT of the Securities and Exchange Act of 1933/ 1934 was to eliminate risky maneuvers by banks to protect the people who had their money in these supposedly strong financial institutions. If anyone is to hedge, doesn't that already say that the risk is too great?  There are very few if any sure things in life, but anytime a hedge is put into play, the strategy is on the basis of limiting a potentially devastating risk.  To an individual, I say go ahead and take great risks, and hedge the even greater risks.  To the financial institutions that make markets and provide liquidity and stability for global economies, I say stay out the risk business altogether.

One might respond to this by saying that banks ALWAYS take risks when they lend money to people to buy houses.  This is true, but the risks are not large, nor are these risks over leveraged when a home loan is created.  When a qualified buyer  purchases a home, a sufficient down payment is made to ensure that the buyers cash flow or other money will be able to cover every payment for the life of the loan.  At the height of the housing bubble that crashed and brought us to where we are today, people were given the opportunity to buy houses that they were not qualified to own or pay for with very little if any money down! In fact, there were loans that gave out 110% of the "value" of the house.  Those risks were evidently unacceptable, the problem ballooned, the bottom fell out, and here we are.  Housing prices have stabilized to the point that banks lending habits can't really be considered risky.  

Banks should be restricted to only the business that banks have thrived on for the better part of a century.  Hedge Funds, Private Equity Firms, Venture Capital Groups, and retail investors (not quite the 99%, but definitely not the 1%) should move cautiously when making risky investments, but at least these parties gains and losses do not affect the global economy like a big bank might in the event "something goes awry".  If banks took less risks, people would have more faith in them, that is just the logically sound way to approach the new investment world  that we live in.  Regulations on risk need to be strictly structured by the legislature. Loopholes need to be as narrow as possible to uphold the intent of the law.  Finally, everyone needs to be responsible for investment actions that either make a ton of money or lose a ton of money.  Finger pointing never leads anywhere.