market distortions

Kling hits secondary market — misses benefits

by Fran Smith on October 3, 2008 · 2 comments

in Bailout Watch, Economy

Arnold Kling hits the creation of the secondary market for mortgage loans as the major factor — 50 percent — causing the current financial crisis. As Kling wrote:

In hindsight, I think that the crisis was caused by
a) creation of the secondary mortgage market (50 percent)
b) low down payment mortgages (30 percent)
c) the “suits vs. geeks” divide (15 percent)
d) other (5 percent)

The more I think about the secondary mortgage market, the less I like it. Any widespread benefits, such as lower mortgage interest rates, are microscopic. On the other hand, several times (not just recently), the market has been used to create or enhance regulatory loopholes that undermined the safety of the financial system as a whole.

I am surprised that Kling so lightly dismisses the benefits as “microscopic” of one of the most positive innovations in the mortgage market.  Just think about it.  Financial institutions — primarily savings and loans — prior to the creation of the secondary market, took in short-term deposits and made long-term, fixed-rate loans (30 years).  Until the early 1980s, Regulation Q set the limit on the interest rates that could be paid on deposits.

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Financial Regulators Not the Answer

by Iain Murray on September 18, 2008

in Economy

With the British financial markets in meltdown, most of the blame has attached to speculators. In a desperate attempt to be seen to be doing something, the Financial Services Authority has reportedly banned short selling of stocks in “disorderly markets.” In other words, shorting a stock in a normal market is fine but when prices start falling rapidly, the practice will be banned.

This is a foolish, knee-jerk reaction that attempts to have it both ways. For clear explanations of why short selling is an important market discipline, conveying valuable information especially in difficult markers, see here and here. To sum up, the author of the second piece, Andrew Lilico, says, “Let me say this overly frankly: curtailing short selling would be a really really stupid idea, pandering to the most incoherent rantings of incoherent, nay ignorant anti-capitalists.”

As Hans and John have demonstrated repeatedly below, the dead hand of government is responsible for most of the market distortions that have led to this crisis. A regulator in the UK may have just made things much worse, and potentially caused the end of London as one of the world’s great financial centers.

UPDATE 7:40pm: I was unaware that the US had a similar regulation in place until 2007. Andrew Stuttaford argues that it was a good thing.