16 May 2012

Hot Money Bets Backed By Taxpayers: Extreme Moral Hazard of 'Too Big To Fail' - Credibility Trap

The professor makes some excellent points about the real world of finance that bear some serious thought. He certainly left the Bloomberg spokesmodels yammering in search of a sound byte.

He misses a key point however. It is not that Jamie Dimon does not know, or even that he cannot know, about the risky speculation in his firm. It is that the system is so designed now that in the long run he is heavily incented not to care, as long as he can maintain a plausible deniability.  There are management controls, policy, and objectives that flow down from the top in any large corporation.  Dimon had a personal hand in recrafting the CIO to do what it was doing in order to sidestep the Volcker Rule.  This was no rogue operation.

As long as the profits are rolling in, the band plays on and the players keep dancing.

It is the same problem that led to the financial crisis, and the collapse of so many of the brokerage and investment houses, followed by a policy that made a show of reform, but concentrated their recklessness selfishness into a few enormously larger vessels, making them all the more effective at gaming and corrupting the system.

That is the problem one faces when the public is apathetic, and the political leadership is composed of cynically pragmatic dealmakers and shallow but ardent ideologues driven by narrow personal expediency, not firmly rooted in history, moral principles, and stewardship for the broader public trust.

It touches on an age old scheme in the mix of banking and speculation that most modern day economists seem to have forgotten, perhaps conveniently. Better to keep one's nose buried in intricate obfuscation than speak to the heart of things, the things that really matter, and risk professional isolation.

It is a sweet deal when one is permitted to play with enormous sums of money and leverage, keeping the wins for yourself, and laying off the losses on the public, enabled by the Fed and a system thoroughly rotten with corruption.

And when they go along the road with you long enough, you can obtain permission to do almost anything, and have them turn a blind eye to it, rather than be exposed along with you. That is the credibility trap.

"Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country.

When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin!

Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, (bringing his fist down on the table) I will rout you out."

Andrew Jackson, original minutes of the Philadelphia bankers sent to meet with President Jackson February 1834,  Andrew Jackson and the Bank of the United States (1928) by Stan V. Henkels

(h/t Yves)