December 5, 2013 4 Comments
This has gotta be a joke. When the idea of ‘banning’ ‘portfolio hedging’ was first kicked around, I thought it was a joke that would obviously never fly.
Now it’s apparently the rule, ‘because of the London Whale’. Regulators have just gone full retard. Never go full retard.
What on earth can broker-dealer banks do now? Take the simplest case and imagine they have a bunch of corporate or investment-grade mortgage bonds. Their risk calculation decides that interest-rate-wise those bonds amount to being long X amount of 10-year Treasuries. Typically they’d make sure to be short around X 10-years against them. But now they can’t, right? Someone help me out because how can a rule banning ‘portfolio hedging’ not ban that?
Okay, so (following the logic) they then have to hedge every single line item individually. Such-and-such bond is risk-equivalent to $137,232.73 worth of 10-years. So they short exactly $137,232.73 worth of 10-years against it. For some other line-item, it’s $937,767.99. For another, it’s $4,321,877.03. They have to go out and execute each of those individual, non-portfolio hedges separately – right?
And god forbid the risk moves around and changes the next day due to convexity and so on. We now imagine them executing Individual, Non-Portfolio Hedges perfectly on day 1 to make their risk $0, then coming in on day 2, seeing their (net) risk move to $X, and now being legally banned from doing anything about it. Or, if they do want to do something about it, they have to ‘individually’ hedge the risk change on a line-item by line-item basis. If the movement on the first item above was from $137,232.73 to $137,398.87 they’re supposed to think “well golly, that bond needs an additional $166.14 worth of hedge against it” and then go out and solicit offers for $166.14 of Treasuries. Then repeat for all other line-items.
Because NETTING IS EVIL AND PORTFOLIO HEDGING MUST NOT BE DONE.
Strictly speaking, I think what they have just done is to ban fractional-reserve banking. Fractional-reserve banking is a “portfolio hedge”:
“We’ve made a lot of commercial loans and whatnot. But it’s ok because on the other side of things, we’ve got all those deposits! Looky how the positive numbers and negative numbers cancel.”
Folks, that’s a portfolio hedge. Now banned by the Volcker Rule, if they’re consistent. Of course they’re not. (Because they’re retards).