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?
Mike,
Black’s statement is his summary of observations of recent history and current policies. On the other hand your assumptions, starting with the words “in general”, are just that. Black describes what was and will be and you assume characteristics of behavior that have no basis in facts. I wouldn’t disagree with the assumption that people like Dimon would save the child and not loot its belongings. I’m less inclined to agree with your assumptions regarding risk of life and limb charging up hills. There is no evidence of same.
What public face do these titans of high finance have to lose when the eventuality of high risk becomes real? Once you’ve been paid a king’s ransom for a few years there is no risk to one’s personal financial position and that assures little risk to one’s social standing. Remember Mike Miliken? Down and out? Or up and prosperous again?
If there is no personal risk involved the situation will not change. Saving the child may have little risk and great reward. Charging the hill is one’s last chance.
its like the dot com ipos in the nineties — a game played with paper airplanes
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.
This would be news to Bear Stearns, Lehman Bros, WAMU, AIG, and 400+ other banks that have gone bust since 2008. The bail outs were of the depositors and counter-parties, the shareholders were all wiped out and the executives all lost their jobs and a great deal of net worth. What more do want to happen to them? For them to be drawn and quartered?
Comparing Jamie Dimon to Bear Stearns is kind of ricidulous. Well, except that corporations are people. OK, I take it back.
sammy,
As Batmensch indicates, this post is about the people who place the bets, not the banks.
Bear Stearns may be gonebut Jimmy Cayne’s net worth is probably greater than the sum of the net worth of every individual who will ever read this post. Dick Fuld? Anthony Mozillo? The list of people who oversaw bets that lost hundreds of billions of dollars and yet walked away wealthy (not as wealthy as if the bets had paid off, grant you) is not small.
The list of CEOs that walked away wealthy, and their company later faltered, is extensive and extends to all industries, not just finance and banking.
sammy,
True, but the magnitudes seem to be different… in large part because when a Carly Fiorina or a Michael Armstrong make a bet that has a disastrous effect on the companies they run, in general the amount the company can lose is not a whole lot more than the company is worth. Yes, there are ways to lose more, but there are differences between betting on the wrong technology and taking out a bet on derivatives nobody understands and leveraging that bet 50-1.
If a bunch of people want to hire another person who has no idea what he/she is doing to gamble on their behalf, that’s fine. But if the person doing the gambling has the implicit guarantee of the US gov’t, they can lose a lot more money… and you and I get the bill.
But if the person doing the gambling has the implicit guarantee of the US gov’t
Who or what has an implicit guarantee from the US goevernment? What are you talking about?
Wait, wait, wait…you are asking who has an implicit guarantee in a discussion about fiannce, in the same conversation in which you are pretending to have an opinion worth hearing? There’s something terribly wrong with that.
Have you shut all talk of “too bit to fail” and “moral hazard” out of your mind?
sammy,
The post is short. Go back to it. It contains a paragraph written by William Black. It is easy to recognize that paragraph – on my browser it appears gray and indented. I imagine it appears the same way on yours. My whole post is based around that paragraph. Reread the paragraph – it should answer the two questions you ask.
Mike,
Your post is bad. It contains an assertion that the US Government has and will bail out bad decision makers in Finance, yet neither you (nor KHarris) can say how, or cite an example.
The bail outs that have occured so far have bailed out *depositors and counterparties*
Shareholders, executives, and bondholders have gotten wiped out, not bailed out. So there is no moral hazard.
So your meme is false, fit only for Occupy Wall Streeter consumption.
sammy,
Seriously?
1. I define counterparties as entitiies that didn’t do due dilligence about the precariousness of those with whom they were doing business. If a party contracts with a homeless guy on the street for him to deliver three yachts next Tuesday at the bargain basement price of $150, that party is an idiot and should not receive a bail-out from the government.
2. What exactly was the exchange of treasuries for toxic assets?