Volcker rule co-authors Jeff Merkley and Carl Levin think that the JPMorgan Chase “Fail Whale” trade offers an opportunity to get the regulatory apparatus back on point with their vision of the rule, one that they say should be stronger in barring the types of risky trading from occurring at commercial banks.

Sens. Merkley and Levin sent a letter to the relevant regulators yesterday – the heads of the OCC, SEC, FDIC and CFTC, who are preparing the final version of the Volcker rule for July – telling them that the legislative history and language makes clear that portfolio hedging, the kind of activity JPMorgan Chase was engaged in, should actually be banned by the regulation. “Before the final regulations are issued in July,” Sen. Merkley said in a conference call with reporters, “we hope that the regulators go back, take out the loopholes put into these rules, and put in the bright lines that bar this kind of trading.” They are specifically calling the situation the “JPMorgan Chase loophole.”

Sen. Levin said that, in the letter, they included some “on target legislative history” in addition to urging the regulators to follow the law as written. He cited a passage from the Senate floor as they were about to vote on the conference report for Dodd-Frank, which included the Volcker rule. It reads: “We permit banking entities to engage in risk-mitigating banking activites… the final version of the conference report, in order to ensure that the hedge applies to specific, identifiable assets… it must be a hedge to reduce specific risks.”

Levin believes that the Fail Whale trade, with its nonspecific large bet on corporate bonds through an index fund of credit default swaps, violates what he sees as clear legislative language. What JPMC did was “proprietary trading under another name,” Levin said, noting that he and Merkley brought up the Fail Whale trade in a separate letter to regulators as a red flag when it was described in the media, but before the massive losses were announced, back on April 26.

And Levin has been making his case, not only in this letter, but in specific conversations with regulators and the White House. He spoke with the new head of the OCC, Thomas Curry, at some length, making the point that they wrote the Volcker rule to prevent big banks from using hedging to make proprietary trades. Levin pronounced himself optimistic that Curry “will read the law and read the history and reach the same conclusion,” though he didn’t want to give a prediction.

Moreover, Gene Sperling at the White House spoke with Levin on this matter, and Levin said he made his case known vigorously. “There is no way (the White House) should be silent in this matter because they signed the bill,” Levin said. “The President signed this bill and the language is clear. I hope the White House will speak out very clearly on this subject.” He hoped in particular that the Treasury Department, which has been rumored to be working as an irritant to subvert the Volcker rule, would make their opinion public.

Merkley and Levin have other issues with the Volcker rule interpretation by the regulators, but they are focusing on the portfolio hedging issue because that one is the most meaningful, in their view. “If portfolio hedging, not tied to a specific position, is permitted activity, you have a Volcker rule which is largely meaningless,” Merkley said. “This would be outside the realm of any form of common sense.” Merkley made similar comments in an interview with Brian Beutler.

Senate Banking Committee chair Tim Johnson yesterday called Jamie Dimon to testify in a hearing on the Fail Whale trade, which the Wall Street Journal characterized in a very damaging article today. Apparently, the executive in charge of risk management at the Chief Investment Office, the entity overseeing the trade, was not a risk manager but a former trader. And the unit had a separate risk calculation, lower than that of the bank, which allowed them to chase big bets like this.

Levin would not comment on the multiple investigations of criminal activity at JPMorgan Chase. He focused on the rulemaking process, which they feel they have a fresh start to influence. He concluded, “Our efforts have not been successful before, we hope now that they will be.”

UPDATE: Senator Merkley has a petition out on this issue, hoping to leverage some grassroots support.