Frank SanPietro

Frank SanPietro is a Certified Financial Planner™

Frank SanPietro

More on Ancient Philosophy and Goldman Sachs Mortgage Settlement

This Post is the second of two which examine the interplay of asymmetric information and perceived/actual ethical obligations – You can link back to Part 1 here  –   Ancient Philosophers and Mortgage Settlements

In the previous post, the situation posed by Cicero was under consideration.  Specifically, whether or not the merchant should voluntarily disclose to his buyers that there are several ships en route with similar goods, or, if he should simply bargain with them on the basis of his being present with goods for sale.

The argument in support of the merchant making that disclosure is rooted in a morally based position – i.e., the merchant should disclose the information because it would be the right thing to do.  Under this framework, the merchant is seen as having an unfair advantage over his buyers.  He knows that other ships are bound for Rhodes and that on their arrival, the current inflated price for grain will return back to “fair value”.   The economics vs. ethics conflict was analyzed in a 1986 paper, by Kahneman, Knetsch and Thaler , in the American Economic Review.

In the paper entitled ” Fairness as a Constraint on Profit Seeking: Entitlements in the Market”, the authors consider circumstances under which, as they put it, fairness demands that an economic actor behave in a manner contrary to classic economic theory.  Consider the supply-demand relationship.  Kahneman, et al (1986) note that “excess demand for a good creates an opportunity for suppliers to raise prices and that such increases will occur”.  However, they go on to note that while the “market” may view these “profit seeking adjustments” as “ethically neutral, the lay public does not share that indifference”.   In the view of the public (in the paper, the authors elicited responses to survey questions), there were situations where a businessperson had a “right” to raise prices and, situations which were economically identical, but presented differently in which the public viewed the action taken as grossly unfair.   Specifically, in the case of increasing market power (moving towards monopoly) raising prices, especially on a good seen as being essential, was considered to be unfair.

So, what does this have to do with both our ancient grain merchant and our modern money merchants?   We can see in both situations examples of the assumed “buyers entitlement” to the profits of the seller.  In the case of our grain merchant, it is expected that despite having assumed all of the risk of sailing to a foreign port to procure grain, then transporting that grain to Rhodes. (NB – there is an implicit choice here, in that the merchant likely bypassed other ports where the grain could have been sold for less profit, but with less risk) and then providing that to the buyers in Rhodes, at a time where they are in great need… that the seller should somehow work against his own self interest and share information that will only motivate his buyers to demand a lower price.

What if the other ships fail to make it to Rhodes?  What if there are at least some of the buyers who do not want to wait for the other ships, but take a “bird in the hand” approach and decide to fill their own storehouses with grain from this merchant?  The critical point? The most efficient process for allocating goods in this case and in others is through the use of price to allow for the natural forces of supply and demand to clear the market.

Bringing the matter full circle – it appears that the penalties levied against Goldman and the other large banks are largely in this vein; namely, the Bankers knew  that the mortgages they were securitizing were overpriced (or more precisely under priced given their level of risk) and took advantage of their market power to make “unfair profits”.  Finally, there is also the sense that “the Banks can afford it” when it comes to paying fines and penalties.  This misses the point, of course, that the Banks pay nothing.  The shareholders of these banks (many of whom are working class people with stock in a retirement plan) are making these payments, in the form of lowered earnings and value for their stock.

Looks like it may take another 2000 or so years for us to figure this one out.  Thanks for stopping by.

About the Author: Frank SanPietro is a Doctoral Candidate in Business Administration /Finance at the Fogelman College of Business and Economics, University of Memphis.



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