Friday, March 12, 2010

Characterizing Causation

When a catalyst is thought to bring about something positive, we look favorably on the catalyst. When the catalyst is viewed as having engendered harm, we view it with scorn. A court-ordered report has revealed that JPMorgan and Citigroup helped bring about the collapse of Lehman Brothers. The implication here is obvious: by helping cause the collapse of Lehman Brothers, JPMorgan and Citigroup have done something wrong. In fact, a representative of Citigroup quoted in the article even states that after reviewing the report, the examiner "has not identified any wrongdoing on Citi's part." She made the comment because wrongdoing is the implication.

I found the article's headline to be especially irksome because failure is critical to a healthy marketplace and because I knew the article would reference as bad, actions taken by Citigroup and JPMorgan that put Lehman Brothers over the edge, as if the same actions could have put Lehman Brothers over the edge if it weren't so over-leveraged in the first place thanks to the Federal Reserve's easy money policies (since the central bank puts money in the economy, the problem of too much money is the fault of the central bank). Anton Valukas, the examiner, makes this evident when he says that "the demands for collateral by Lehman's lenders had direct impact on Lehman's liquidity." You don't say! But here is what I say: so what?

The problem with trying to erase Citigroup's guilt and JPMorgan's guilt is twofold: they were unquestionably responsible for Lehman Brothers' collapse, and we should be happy that they were. If you as a consumer stop frequenting your local seafood restaurant because you or someone you know was poisoned by it, outside observers would hardly accuse you of wrongdoing if your actions helped bring down the restaurant. In addition, the sooner you and others stop frequenting a restaurant with poisoned food, the better off everyone is because resources previously used in operating a poisoned-food seafood restaurant can now be used for something potentially better. Another example is that of short sellers who uncover accounting fraud at public firms thereby doing society a service by helping to bring about the end of those companies' fraudulent activities and putting them out of business.

When Citigroup and JPMorgan demanded more collateral from Lehman Brothers, this was an indication that Lehman wasn't doing so well. If you lend someone money with his car as collateral, and he keeps coming back to you for more money, chances are you will demand more collateral from him. Not only are you in your right to do so, but you are also smart to do so because by asking for more money, your borrower is demonstrating to you that his default risk is increasing. What Citigroup and JPMorgan did is no different. If your borrower can't put up more collateral and you cut off his loans forcing him to drastically cut back on his extravagant spending habits, this is better for everyone involved (you are no longer throwing good money after bad, and the borrower is forced to reform his behavior).

This financial crisis has really brought the concept of failure in the marketplace to the forefront. It is vital that we understand the importance failure serves in a properly functioning economy, and cease ostracizing institutions or individuals that cause failure to happen.