May 14, 2012

Palling around

The recent news that J.P. Morgan lost around 2 billion "dollars" in a risky trade deal is abuzz in the media, and within moments of the news breaking anti-capitalists were already sounding the horn for more regulation.  This is likely a Trojan Horse which will only serve the well connected and crush those who don't do things like blow $2 billion on a trade.

As Bob Wenzel points out:

"In the wake of the JPMorgan loss, government officials will babble on about new regulations that will be needed to be put in place to stop banks from doing such trading. But these new regulations will benefit the politically connected at the expense of conservative banks, who do traditional banking. The connected, like Jamie Dimon, will gain even further advantages and opportunities to blow up even more money."  

Indeed, J.P. Morgan will "get by with a little help from their friends."  Chairman Jamie Dimon describes his view of the relationship here:

"In the meantime, the rest of us should hold hands, get together, collaborate, business and government together, to fix the problem.  It's going to be very hard for government to do this on its own.  And business can't do it without collaborating with the government."

With all this palling around, there will be an incentive to take unnatural risks with the availability of cheap loans and implicit guarantees in the case of a failure, and regulations will likely favor (and be written by) the big players.  Bob Wenzel again:

On an even more important note, one has to ask why there aren't any lines outside JPMorgan Chase, since clearly the bank allows blithering econometric modelers to run naked through the bank, with the ability to put billions of depositor/bank money at risk.

The answer is moral hazard. JPMorgan depositors know that the FDIC will back them up, even if there are even greater toxic trading bombs that could go off at the bank .

The FDIC, by backing these firms, serves to prop-up institutions that have made mistakes, and permit them to escape failure unscathed.  The effect of this action on the economy is multiplicative.  The firm itself now knows it will not be punished, stimulating it toward risky behavior in the future (moral hazard).  Also, the firm continues to draw investment- and at a much higher level than if it were allowed to fail.  This diluted and skewed pool of resources mean fewer investors are available for competing firms.  These effects are worse for society in the grand scheme than the ludicrous bill the taxpayers are stuck with in the case of a failure, for the insolvent firms are allowed to continue- promising more, but greater pain (due to an inflated currency) as the financial "bridges to nowhere" carry on.  Thus, too big to fail is a systemic problem that lies at the feet of the FDIC.

Because regulations merely tweak the current system and ignore the moral hazard, the fundamental problems of our economy can never be resolved.  Unless we address the special relationship these firms have with regulators and the government itself, we will only see more regulation designed to crush competition.  Would you lose $2 billion to make $10 billion over a period of time, as your competitors are forced under water by special regulations that were put in place for your "mistake?"  Perhaps this is why depositors are not running away...

The lesson here is that the last century of government intervention and central economic planning has been a dismal failure and is doomed to more of the same.  But, disconnecting government (and, of course, quasi-government institutions) from the financial market is not part of the paradigm our desperate overlords have in mind.  Quoting Edwin Vierra:

"They (the Fed) cannot face the consequences of a depression- can you imagine what a 1930's style depression in this country would be like?  That's what they don't want to have happen, and the one tool that they have that they think can prevent that in the short term is what?  Quantitative easing- inflation, generating money, generating paper currency, bills of credit- well, bills of discredit because they are not going to be paid.  We keep generating this stuff and we hope something will happen.  We are playing for time- financially.  But I think it was Machiavelli that said that's a fallacy because time brings all things- bad as well as good."

Since the current power structure chooses to perpetuate the status quo at all costs, we should consider Vierra's idea of using alternative currencies on the State level.  This way at least the States could provide a bulwark against a corrupt and dangerous system.  Crucially, this action would eliminate the relevance of moral hazard, and, at least, provides a working alternative to a crumbling "dollar":

"...The only solution here, I think, is to come up with an alternative currency- and a lot of people have proposed exactly how to do this.  This isn't something that's difficult, on the shelf technology, we could set this thing up in 30-60 days after the statute is passed- an alternative sound currency based on silver and gold.  Start using that in the marketplace, start transitioning the governments into using it for purposes of taxation and spending, and let the banks figure out how to solve their own problems."  -- Edwin Vierra

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