The Crux of the Problem in the Financial Industry

by Mike Kimel

The Crux of the Problem in the Financial Industry

A great set of lines from William Black posted at Barry Ritholtz’s Big Picture:

The Jamie Dimons of the world know that if they win the gambles they will be made immensely wealthy and that when they lose the gambles massively the federal government will bail them out. Every gamble a federally insured bank (or an implicitly guaranteed SDI) takes is a gamble with government money. Bank leverage is always extreme in the modern era; it vastly exceeds the reported (and often inflated) capital. The government is the true creditor through its explicit and implicit guarantees of the bank’s creditors.

Now, that isn’t necessarily a prescription for failure. Expectations of behavior, and public shame, make a big difference when it comes to determining whether people whose instinct are to act in their own best interests no matter how much harm it will cause to others will act on those instincts. 

In general, the Jamie Dimons of the world (to use Black’s phrase), if they somehow found themselves and a small child the only survivors of an accident, would protect the child until help arrived, though it might profit them to loot the child’s belongings and jettison the child as dead weight. But it isn’t merely personalizing a potential victim that keeps them from, well, making them into a victim. In general, the Jamie Dimons of the world, if told to charge a hill during a war, will charge said hill, even if the opportunities to profit are greater by staying behind. 

So what makes finance different? Or is that the wrong question, and if so, what is the right question?