Watch Out for That Bus
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Every time you leave the house, to go to work or school, you take on the risk of being hit by a bus. You can reasonably try to mitigate that risk by driving carefully, or looking both ways when you cross a street. You can also transfer the risk by buying life insurance to guarantee that your loved ones are cared for if you are hit by the bus. On the other hand, you can try to eliminate the risk entirely by sitting at home and staring at a wall. While you might eradicate the risk this way, you also eliminate the ability to do other things, such as having a job, making a living or doing something fun like seeing a ball game.
So what does this have to do with the upcoming House Financial Services Committee grilling of J.P. Morgan Chase President and CEO Jamie Dimon?
J.P. Morgan was trying to hedge the risk of corporate debt. In other words, issuing corporate debt or loans to businesses is risky—the business could fail and shutter its doors. On the other hand, the business could be a success, pay back the loans and bring more business to the bank. There is a risk of loss—sure, but there is much more upside to success. If you can mitigate the potential loss, the upside is even greater and provides the opportunity to extend more credit.
So what happens if banks can’t hedge risk? Banks will become risk adverse, write fewer loans and extend less credit to businesses. With capital drying up, businesses will not be able to expand, hire new workers and in many cases, simply have to close up shop.
Some pundits are opining that we need to crimp the banks. To do so, they push things like the Volcker Rule, impending money market fund proposals, derivatives and Basel III capital requirements. At the end of the day, all these hurdles end up at the doorstep of the corporate treasurer. So when the treasurer can’t get a loan, is prohibited from mitigating risk and is shut out of the debt and equity markets thanks to all of these regulations, it will be businesses, not banks, that will find themselves in a vise.
Hiding money in a mattress isn’t a strategy for a growing, prosperous, economy, but that seems to be the road some want us to go down. No risk, no reward, no growth, no job creation. Anyone wonder why the growth and job creation numbers are so anemic?
Sure, sitting at home eliminates the risk of being hit by a bus, but your chances of dying in a fire rise dramatically. Just further proof that you can’t eliminate risk, but only transfer it and often in a more harmful and catastrophic way.