J.P. Morgan just lost $39 billion. The Senate Banking Committee wants to know why.

Jamie Dimon, Wall Street's darling CEO, presented his defense: plausible deniability. He was advised by his staff to not unwind risky positions, even though they started to show big losses.

Can any financial sector executive claim they fully understand the risks of their complex investments? We all know the answer is no. It's been proven over and over again.

Think about what this means. Bank CEOs who do not eliminate these mysterious, huge risks are not acting responsibly. They have no ethical claim to plausible deniability.
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Jamie Dimon
Remember Ronald Reagan and the Iran Contra affair? That was plausible deniability in action. Today's big-time CEOs use it all the time. Our government, especially the judicial branch, has essentially handed out stacks of "Get Out of Jail Free" cards to these executives. It has to stop.

The financial sector is trapped in a game of chicken. Huge CEO egos are involved. They have built fancy, souped-up cars with other people's money. And they are driving by remote control: if the cars crash, they don't get hurt. So nobody backs down.

All four large banks must simultaneously retreat to pre-Gramm-Leach-Bliley risk levels. Since the banks won't self-regulate, we need to re-post the speed limits. Gramm-Leach-Bliley eliminated speed limits, and all but a few of us lost. How long are we going to let this game of chicken last?
 
In Part 1 of this entry we reviewed the story of how modern-day money originated with goldsmiths, and how everyone benefited. Now we go to the second part of the story. Be forewarned; it does not have the same happy ending.

One day, a particularly crafty goldsmith noticed that his inventory of depositor gold hardly changed from day to day, or even from month to month. He wondered: "What if I start loaning depositor money? If I work it right, I can earn interest on depositor money, and my depositors will never know the difference!"
So the crafty goldsmith loaned some gold to a few enterprising friends who wanted to expand their businesses. He made a schedule for them to pay back part of the gold loan every month, plus one percent interest on the outstanding balance. After this worked a few times, he realized that there was still a lot of unused depositor gold in his vault. So he started making more loans, and earning more interest. To be safe, he paid the local magistrate to review and approve each loan schedule.

Before long, other goldsmiths heard what the crafty goldsmith was up to, and started to do the same thing. Eventually, many goldsmiths quit their craft and became deposit and loan bankers.

For centuries, this story has been told by economists and other members of the ruling elite as a glorious tribute to industrious enterprise. Some like Milton Friedman and his enthusiasts go so far as to say growth of the banking greatly increased our quality of life and even freedom itself.

But huge ethical issues lurk in the shadows of this tale.
  • Who actually owned the deposited gold: the goldsmith or the depositor?
  • Did the banker ask depositors if it was OK to loan out their gold?
  • Did the banker ask depositors how much of their gold could be loaned out versus held in reserve?
  • Did the banker share any of the loan interest with depositors?
  • Did the relationship between the goldsmith/banker and the magistrate compromise the role the magistrate was supposed to play in protecting the interests of common citizens?
  • What happens to depositors if the banker cannot satisfy their requests to redeem their gold?
  • What happens to borrowers who have trouble paying back the loan?
Each one of these questions call on us to make ethical judgments. The answers unavoidably involve value judgments, or bias. So, the critical issue is: Who's interests are being served by our answers to these big ethical questions?

The sad tale of human history is that these questions are almost always answered with a heavy bias favoring the one percent, or the wealthy few. Deep Economics embraces a different approach: answering big economic questions with a strong bias for the 99 percent. Isn't it about time? Isn't that what protests all around the globe are essentially about?
 
Many economists tell the story of how banking  started, but few question the underlying ethics of what banks do.

First, here's the story of how banking started.

Once upon a time there was a goldsmith who made lots of pretty things for people. He built a  room with very strong walls and locks to protect his gold at night. No one ever stole his gold.
Villagers noticed his success and asked him to keep their gold safe, too. He said "OK, here's what I'll do. I'll charge you rent for the space you use in my vault, and I'll give you a receipt for the ounces of gold I store for you." This experiment worked and the villagers were happy. Eventually other goldsmiths throughout the land started gold storage businesses too, and it became common practice.

One day, a farmer needed to buy a cow right away. His neighbor had the perfect cow for sale, and the farmer had the right amount of gold, but it was stored with the goldsmith, who lived pretty far away. He told his neighbor he had enough gold, and asked if he would take his gold deposit receipt rather than make him travel all the way into town. The neighbor said "OK, but sign the receipt so that the goldsmith knows you gave it to me."

The arrangement worked like magic! A few weeks later the neighbor went into town and showed the goldsmith the signed receipt. The goldsmith trusted the neighbor and the farmer, and gave the neighbor the farmer's gold. He also stopped charging rent for the gold. Villagers heard about this and also started to buy things with their goldsmith deposit notes.

To make things easier, goldsmith deposit notes eventually were written in standard quantities. This way, portions of stored gold could be exchanged in exact proportion to the cost of what was being bought. Eventually standardized goldsmith deposit notes were commonly exchanged instead of gold.

Everyone was happy with this approach. Why? Because everyone knew what was going on. There was nothing secret or underhanded about the use of gold deposit receipts instead of actual gold. Everyone benefited: buying and selling was easier, and the person who ran the gold vault was rewarded with vault rent payments.

But then things started to change. To find out more, read "Is Banking Ethical? Part 2"