What A Bank Is Supposed To Do?

Banks in a capitalist society are meant to create wealth and decrease risk. JPMorgan and its kind do the opposite.

In his testimony before a congressional panel on the recent Swiss trading debacle, Jamie Dimon, CEO of JPMorgan Chase (JPM), said, “We’re doing what a bank is supposed to do.”

Was Dimon correct? In a capitalist economy, was Chase doing “what a bank is supposed to do”?

The answer is assuredly no. A bank is not supposed to do what JPMorgan Chase and its fellow too-big-to-fail compatriots do every day. They are practicing something other than actual capitalism. As this column has consistently stated, capitalism is not a vague idea. It is an economic system with  well-defined principles designed to create wealth for society. These principles have powered the creation of wealth in America since the nation’s founding and empowered our country with an extraordinary resilience.

But importantly, wealth does not mean profits. Wealth is anything that can be experienced or physically used. Profits are an accounting proxy for the wealth that an entity generates. Like most proxies, the idea of profits as a measure of the wealth created for society may often be a good indicator, but as I have written previously, this proxy has failed spectacularly in the financial sector. The profits generated by today’s financial institutions bear little resemblance to the (lack of) wealth they have created for our society.

Capitalism also means there is no such thing as a “free market.” All markets require rules in order to operate fairly. The word “regulation” is really just another term for the rules that govern how participants in a market must behave. Indeed, one modern example of a free market economy may have been the period of economic chaos in Russia that followed the collapse of the Soviet Union, when the absence of rules led in part to devastating results.

Now let’s turn to the purpose of banks in a capitalist economy. Finance is an intermediary good: You cannot eat it, experience it, or physically use it. The purpose of finance is to support other activities in the economy. Banks are meant to allocate capital (funds) to the best possible use. In a capitalist economy, this means allocating money to the people or entities that will create the greatest wealth for the overall society. At the same time, risk management is supposedly a primary skill for bankers. When capital is allocated well and available to wealth creating entities, societies flourish. When capital is poorly allocated, economies can collapse.

Speaking broadly, banks allocate capital in two ways: through loans and by facilitating investments. Indeed, as we read breathless news reports on the first-day performance of IPOs, it’s easy to forget that the central purpose of an initial public offering (IPO) is to channel investment money into an enterprise that will hopefully create wealth for our entire society.

In light of today’s overly complex, overly concentrated, and overly influential financial sector, the above description may seem far too simplistic. But it’s not. In Judaism, there is a well-known story of the famous Rabbi Hillel describing the essence of Judaism in a simple statement, and then saying “the rest is commentary.” The same holds true in today’s financial sector. All of finance is meant to allocate capital to the best use, the rest is commentary.

Since capitalism is a system designed to create wealth for society, gambling is antithetical not for moral reasons but because no wealth is created. Gambling is a zero-sum game. In a heads I win, tails you lose transaction, it’s impossible to create wealth.

Now, let’s return to Jamie Dimon’s statement before Congress and reframe it. Was Chase “doing what banks are supposed to do”?

First, as numerous commentators have pointed out, Chase was trading to increase its profits. This type of trading is simply gambling by another name. The outcome has no impact on the larger wealth of our society. It had nothing to do with the purpose of banks in the economy. At the same time, many of the so-called brilliant financial innovations of the recent era are, in themselves, nothing more than hidden forms of gambling.

Second, Chase was increasing rather than decreasing the risk associated with its banking functions. It has become blindingly obvious that in trading and creating complex financial instruments (also called weapons of mass destruction) our Masters of the Universe never fully understand the risks they are creating for their own institutions or our larger society.

Mr. Dimon’s idea of what banks are supposed to do does not exist within the principles that makes a capitalist economy function.

I do, however, have one question for him. I strongly suspect he would argue that the purpose of management decisions is to increase shareholder value. In 2011, the value of JPMorgan Chase’s stock price decreased by 20 percent, yet he was paid $23 million. Is this also what a bank is supposed to do?

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