The Shakedown

I have to ask – Do you feel safer because of the historically unmatched $13 Billion fine that will be imposed on JP Morgan? Do you feel as though the government is doing right by you by punishing those who were responsible for the crisis?

Ultimately, these are the only questions that can be asked in order to gauge the success of the United States Government’s recent lawsuit against JP Morgan. It seems abundantly clear that the government is attempting to simulate meaningful post-crisis restitution by persecuting banks for alleged misdeeds during the crisis. I am not of the opinion that the banks are holy or entirely guilt-free; I do think that they had an important part to play in the crisis. However, I strongly believe that this particular lawsuit emphasizes the extent to which the government’s prosecution is politically motivated and unjust. The government is looking to distract the public from the fact that it is unable to resolve America’s structural financial issues by feeding it moral catharsis in the form of show trials. The truth is that examining the structure of the debt market is not as glamorous as blaming the “1%” for bringing down the world economy out of voracious greed and moral vacuity. I hope to prove that this specific case against JP Morgan is not as clear cut as it would seem, and point to what I think the media consistently fails to identify as a core cause of the crisis – bad policy.

The Case Against JP Morgan

JP Morgan is a target. Its vulnerability ultimately lies in its status as the largest American bank in the world by assets under management. Although JP Morgan has a culture of sustainable growth and rigorous risk-calculation, its premier status yields itself it to its portrayal as the bastion of the debaucherous banking culture that the media loves to hate. Even though JP Morgan was one of the only major banks to refuse to put client funds in Bernie Madoff’s incredibly high yield funds and the only bank with a balance sheet sturdy enough to have weathered the crisis, it continues to be assailed by the media.

The current lawsuit against JP Morgan has its roots in the subprime mortgage packaging practices that took place under Washington Mutual and Bear Stearns before JP Morgan acquired them. In principle we can accept that JP Morgan has to take responsibility for the companies it acquired retroactively. However, when we consider that the move to buy Bear Stearns and Washington Mutual was heavily supported and encouraged by the government, the picture becomes murkier. During the famous bank run on Bear Sterns that began in mid-march of 2008, the Fed encouraged JP Morgan to provide an exit strategy to Stearns. Former Treasury Secretary Hank Paulson said in an interview with the New York Times that “Bear Stearns would have gone down if JP Morgan hadn’t acquired it … If that had happened it would have been a real disaster”. The Fed even provided $30 Billion in credit to cover Bear Stearn’s “less liquid” assets – effectively facilitating the acquisition by making it more desirable. There is no doubt that the government saw JP Morgan’s acquisition as beneficial to the economy and the American people. Now they are turning around and punishing JP Morgan for the move.

Additionally, the fact that the government is prosecuting the activity of Bear Stearns in relation to subprime mortgage fraud isn’t totally justified. If a large amount of blame is to be applied to the private sector, then Moody’s and S&P should bear more of the punishment for the misrepresentation of risk on subprime packages. Let us also not forget that everyone seemed to share the illusion that collateralizing homes was a sure bet because of the persistent historical strength of the housing market. Bankers seem to be characterized as having knowingly brought down the economy because of their completely irresponsible risk taking. In reality they were making bets that were consistent with market analyses and they had government set levels of capitalization. If you are going to blame someone for the pain that came out of the crisis, it is worth analyzing some of the less morally satisfying causes.

The Case Against Bad Policy

Why don’t we talk about Fannie Mae and Freddie Mac? Is it not worth noting that the bastion of populism and political economics played a huge role in inflating housing prices? We continue to assume the government sponsored agencies committed to making housing ownership a possibility for all Americans by artificially cheapening debt and loosening mortgage standards did not distort market conditions…really?

I have no doubt that because of their government subsidies, both agencies were able to make riskier loans to individuals that would not have otherwise obtained a mortgage. As government sponsored players in a free market, they forced unsupported banks to lower mortgage standards, and take on more risk in order to stay in the game. Higher risk levels soon flowed across the entire banking sector.

Moreover, the reason the bubble inflated so intensely was because of the persistently low interest rates borne from Chinese currency regulation. In order to keep the price of the Yuan from increasing, the Chinese developed an insatiable appetite for government debt. This, in turn, kept the interest rates in the US historically low long enough for the bubble to expand.

Perhaps the Central bank could have caught this potential bubble and raised interest rates, but it refused to react to non-core inflation. Thus it did not intervene in the bubbling housing market. Niall Ferguson expands on these market distortions in his work “The Great Degeneration”.

These elements were not part of an intentional policy of market distortion on behalf of the government, but rather disconnected elements of government policy that ultimately distorted the market. This fact does not exempt the government from responsibility for the distortions, but it does makes the persecution of banks seem tremendously hypocritical.

The Closer You Think You Are

Magicians like to say “the closer you think you are, the further you are” as a reference to sleight of hand tricks. Similarly, the government is currently trying to distract the public from real issues at hand. This is not an baseless claim: the estimate of the fine was released at the tail end of the debt crisis and immediately caught the attention of most major news organizations, right when government approval hit an astonishing low. Therefore, one cannot help but be suspicious that the prosecution of JP Morgan and the historically unparalleled fine leveled against it is unwarranted and, at least in part, politically motivated. I do not presume to have all the answers, and I am by no means attempting to exonerate the banking sector’s role in the crisis, however, the more I look into this political theater the more I ask myself, who really deserves the punishment for the financial crisis: J.P. Morgan or the very people sending down the sentence?