It dawned on me a while back that there’s a fundamental asymmetry between financial gains and losses, in that gains are strictly positive events from a utility or other subjective preference perspective, whereas losses are strictly negative events, but with the possibility to cause catastrophic knock-on events. Specifically, gains will never cause a default, whereas a loss can. That is, if someone gives you money, or your net worth appreciates for some other reason, this simply cannot cause a default. In contrast, if someone steals your money, or your net worth otherwise decreases for some other reason, you could default on existing liabilities, which will create not only losses for others, but potentially catastrophic financial consequences on an individual level (e.g., homelessness or even death in the case of losing health insurance). This implies that we should seek to avoid defaults as a society, as opposed to losses, which are not innately harmful to others, and not generally catastrophic to individuals (e.g., just because you lose some money in the market doesn’t mean you’ll lose your home).

The problem is that default risks are idiosyncratic, in that one firm could be perfectly fine incurring a million dollars in losses over some period of time, whereas another would go bankrupt. This means that the market for hedging loss of income (which doesn’t to my knowledge exist yet) is going to be heterogeneous, and probably not exchange traded. But so what, so is lending, and that’s nothing new to banks.

In fact, you can posit a simple market that is basically unfinanced credit exposure, where firm A buys protection on some level of income for a fixed period of time, from bank B. Specifically, firm A pays bank B to underwrite the risk that a particular asset ends up generating less than a particular amount of revenue over a particular amount of time. For example, imagine a large food chain buys such a contract from a bank, so that if one of their franchises fails to produce at least $1,000,000 in revenue per year, for a window of let’s say 5 years, the bank writes them a check for $1,000,000 – X, where X is the revenue actually generated in the year the shortfall occurred. The bank would charge a fee based upon the revenue history of the particular franchise, which is distinct from (but of course related to) the credit risk of the franchise. In fact, the whole point of this, is for the franchise itself to avoid contributing to an overall default by the food chain. I would call it a revenue shortfall swap.

This is potentially a really attractive product from the perspective of the bank, because they can contract with the food chain holding company, presumably a much better credit than the specific franchise location. As a result, the bank gets a corporate quality credit (as a counterparty), but the exposure is to a potentially highly diversified set of revenue streams, across huge, and individually selected geographies, with different consumer profiles. This should be attractive to the corporates as well, because they can micromanage revenue risk, over specific periods of time, where they might be willing e.g., to forgo some profit, in exchange for stability.

In thinking further about this, I think it could set the stage for individual employment insurance, something this country (the U.S.) desperately needs. Specifically, banks can probably use in-house municipal bond experts that have knowledge of state and local economies. This would allow them to at least contribute to the knowledge necessary to create the corporate products above, but also potentially create a market where people can buy insurance on their income (e.g., get fired, get a payout for one year equal to your previous income). This will probably be too expensive for most low income people, and frankly, banks won’t write those contracts because they’re probably bad credits, and also they won’t trust poor people to maintain employment. As a fix, I think we could instead require everyone in e.g., New York to buy employment insurance, unless you have one year in after-tax savings. This would be paid for by the state, and the high income earners (including seriously high earners that in this state make $10 million and $100 million per year), would also have to participate, unless they again have one year’s worth of after-tax cash. So e.g., Jamie Dimon would not pay into this system today, because he’s worth over a $1 billion, and makes about $40 million per year. However, a young Jamie Dimon would have to pay in, until his savings reached the one year after-tax threshold. That kind of revenue, will attract banks, and might even be enough revenue to pay for the system (people like that generally don’t get fired, and banks know this, in particular J.P. Morgan).