Economics 101

Four Lessons of Economics: A Case Study of JP Morgan

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At the Institute for Faith, Work & Economics, we think it is imperative for Christians to understand principles of economics if they are going to embrace the holistic interpretation of stewardship that the scripture proscribes. What we call, “Stewardship with a capital S.”

If we don’t fully comprehend our unique creation, and understand that we have gifts and a purpose, how could we best decide how to use those gifts? If we don’t employ economic thinking, how will we understand the importance of incentives? How can we apply an understanding of opportunity cost? The answer is: we won’t. This is why we have been spending time building the foundation of economic knowledge in our Economics 101 series that can be taken into everyday life and decisions.

Looking at the events of the world is not only the best way to see these principles at work, but also to understand that they are real truths.

One of the biggest stories in the news this week has been about the massive $2.3 billion loss suffered by JP Morgan. The Los Angeles Times reported that JP Morgan stock had fallen by 12% over the following weekend, and losses continue to accumulate for the company. That sounds bad. It is bad!

The President and regulators are scurrying to do something to prevent such things. In fact, the first sentence of the front page article in the Wall Street Journal today says: “In the wake of losses at J.P. Morgan Chase & Co., the White House is seeking to ensure a tough interpretation of a regulation designed to prevent banks from making bets with their own money…” (emphasis mine).

My first response is: do we want them making bets with other people’s money? I would much rather they make bets with their own. It means they have an incentive to be diligent.

Let’s apply four of our recent Economics 101 lessons to the problem.

First, we know in economics that we are always making relative comparisons. It’s one thing to say “This is bad, we have got to do something about it!” But we should first ask, how bad is it? According to a recent report by the Heritage Foundation, Chase is a $2.3 trillion bank with a net worth of $189 billion so this loss took their capital ratio from 8.4 to 8.2 percent. Another way to look at this: if you make $60,000 per year this is equivalent to a loss of $120. This hardly seems to warrant government intervention.

Second, more important than the amount is that when a private company or person takes a risk (and all decisions are risky to some degree because we don’t have perfect information) they are accountable for that risk. They have to pay for their decisions, and J.P. Morgan is paying.

Markets work because they have these accountability systems. They encourage wise bets, not reckless bets. Sometimes the bet is good and sometimes, as in this case, it’s bad. But notice what the market did in response to this very bad decision: it sent J.P. Morgan a signal through losses.

Third, markets harness knowledge. Remember what F.A. Hayek taught us: that knowledge is scattered and not known in any one place or to one person. I call this the “problem with the knowledge problem.” It sounds kind of redundant, but it drives home the point: you don’t know what you don’t know.

Markets help us overcome that problem by bringing people who have discreet knowledge together. So the question as it relates to the J.P. Morgan situation is this: How would we ever solve this problem? Who could craft the perfect legislation that would prohibit losses? Can we build a supercomputer that will do this for us? My guess is that if J.P. Morgan thought they could invent that supercomputer, they would have hired the best minds to do so already.

J.P. Morgan has much better knowledge about how to make bets with their money and their shareholders money than anyone else does. It is in J.P. Morgan’s best interest to have the lowest amount of losses possible, so we can expect them to have a great deal of knowledge over how to minimize bad decisions and maximize good decisions. They can’t be perfect because they too suffer from the knowledge problem and human error. So while the White House and the Treasury have great intentions—it is not physically possible to get the results they so badly want.

Four, these regulations are sure to have unintended consequences because they are drafted by people who are not closest to the necessary knowledge. Regulations with great intentions often have long-run consequences which actually hinder the ability of individuals and companies to serve the common good through their work.

The main lesson for Christians is that economics gives us powerful decision-making tools. Understanding them is important for our own lives and the work we pursue. We should use this knowledge to inform how we react to the world around us.

Question: Does this real-life example help you understand these economic principles as they relate to our lives? 

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