by Chidem Kurdas
To hedge or not to hedge? That’s the question for many an endeavor. Farmers hedge by selling their harvest ahead of time. Building managers hedge by locking in a price for heating oil or natural gas—last year many got it wrong, blindsided by the decline in the price of gas. Most hedges we don’t hear much about.
Until last week, the most infamous hedge was the set of complex trades put on by Goldman Sachs as protection against losses in mortgage securities in the property bust. Financially this worked and Goldman Sachs escaped the 2008 crisis relatively unscathed. Thereupon it became an object of loathing and mockery in the media, inspiring calls for higher taxes and greater regulation.
Now we have the failed trades with resultant loss of $2-$3 billion at JP Morgan Chase. This also inspired calls for greater regulation, in particular of bank trading, which appears to be offensive whether it makes money or loses money.
Two arguments have been advanced against both the Goldman and JP Morgan trades. The first argument is that these were not really hedges for protection but rather active bets. That gets into the Volcker Rule muddle of which trades are to be prohibited by the Dodd-Frank Act. The other argument is that because the federal government bails out losers, taxpayers are on the hook for these trades. In the case of Goldman, the insurer AIG, which had taken the other side of the trade, was bailed out amid the crisis.
Let’s put aside for now the validity of these points. Jerry O’Driscoll’s piece on the issues and comments on my previous post are below.
I don’t believe that these arguments explain why people object to bank bets and hedges. GM and Chrysler were bailed out but carmakers are not prohibited from doing things that make or lose money—it would be comical if they were. Agricultural subsidies have existed since the 1930s but nobody calls on farmers not to hedge the price of their product. The situations are similar, but the outrage is concentrated on banks.
The real reason for this must be that big banks violate our sense of social or distributive justice. Bankers are already rich. Many of them are unemployed, but we’ll leave that aside—the fact remains that on average they are richer than most of us. So we are offended by the efforts of those at Goldman and JP Morgan to get even richer or to protect what they have.
Hayek suggested that feelings for distributive justice come from human beings’ long history of living in small bands of hunter gatherers. Members of a band shared what they hunted and gathered. If one had a windfall, they all had shares in that windfall, subject to gift giving customs. You and I don’t get a nice big customary gift when Goldman makes billions of dollars. It’s easy to be peeved at the tribal injustice.
Hayek’s point is that the Open Society we live in is based on very different rules and these have made us immensely productive and affluent. We all partake of the benefits. However, we can’t get over our ancient history and tend to find modern institutions like global markets distasteful. They’re as different as can be from a world of little bands and face-to-face interactions.
I’d guess some of us are not really comfortable with hedging, either. Presumably our hunter-gatherer ancestors did not hedge. If they could not find food, they all starved together. By comparison, occasional losses from derivatives trading don’t sound bad.
Of course, Hayek worried that inherited instincts for distributive justice supported socialism. So far we’ve escaped the worst of his fears and, who knows, might yet grow out of the mindset of 10,000-plus years ago. “The Atavism of Social Justice,” his 1976 lecture at the University of Sydney, is available in the collection New Studies.