My latest essay is on Engineering the Financial Crisis, by Jeffrey Friedman and Wladimir Kraus. I think that their book demonstrates that regulation falls victim to the socialist calculation problem.
Centralizing risk assessment through regulatory risk weights and rating agency designations has several weaknesses. Local knowledge, such as detailed understanding of individual mortgages, is overlooked. At a macro level, regulators’ judgment of housing market prospects were no better than those of leading market participants. Moreover, regulators imposed a uniformity of risk judgment, rather than allowing different assessments to emerge in the market.
Forgot to include the link?
fixed. http://www.econlib.org/library/Columns/y2015/Klingregulators.html
Regulation only sets minimums though. Markets may turn those into maximums, but those are markets. While lack of regulation may induce more idiosyncratic risk with some more stable and others likely to blow up sooner, with more spectacular individual successes and failures, markets would just drive towards even lower maximums.
I suppose that is what regulators think. But then they say “you must have X% TripleA securities.” Then to solve the “market problem” they say “we’ll give 3 ratings agencies a monopoly.” All of a sudden the ratings aren’t very good, but at least the regulators get to blame the “market.”
In other words, it might be nice if regulators always just set minimums, without things such as implied backstops and bailouts. The FDA could plainly state “we think this stuff isn’t a total disaster.” That is what they do now anyway, really (except for the disasters they let through. If that were possible, it would allow a move toward local knowledge.
Speculators, Politicians, and Financial Disasters
11/10/08 – WSJ.com from Commentary by John Steele Gordon
How Washington created a financial panic in 1836 and 2008.
( search for Community Reinvestment Act )
In the US, people hate the banks and “Wall Street” for being bigots. They supposedly refused mortgages and loans to deserving members of minorities merely for living in low-income neighborhoods. This has been political proof that business is bigotted, even if this goes against their rational self interest to make loans to credit-worthy people.
What is not usually known. In 1934 the US Government created “red lining” as a quick, bureaucratic way to assess risk. Always look to the government for intelligent, nuanced decisions.
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[edited] Historically there was also a class for whom home ownership was out of reach, made up mostly of American blacks. Simple racial prejudice had long been a factor here, but ironically, the New Deal institutionalized discrimination against blacks seeking mortgages.
The Federal Housing Administration was established in 1934 to insure home mortgages. The Home Owner’s Loan Corporation was another New Deal agency created to help prevent foreclosures. In 1935, the FHA asked the HOLC to draw maps of residential areas according to the risk of lending in them. Affluent suburbs were outlined in blue, less desirable areas in yellow, and the least desirable in red.
The FHA used the maps to decide whether or not to insure a mortgage, which in turn caused banks to avoid the redlined neighborhoods. These tended to be in the inner city and to comprise largely black populations. As most blacks at this time were unable to buy in white neighborhoods, the effect of redlining was largely to exclude even affluent blacks from the mortgage market.
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Cherchez la gouvernement.
On the other hand, I wonder how much worse off they really because of that specifically, considering all the other distortions. The banks are playing with house money, pardon the pun.
When credit is widely available that is not always a blessing.
To Andrew,
I think your question is, “Were those blacks much worse off due to the redline policy?”
Some people are bigots and some not. The market rewards people who do business on objective principles. Bigotry reduces income because it excludes some good customers. Competition rewards those companies with enough knowledge to accept business that the bigots decline. Some companies will always choose not to discriminate on non-economic differences such as skin color.
But, the government said it would not insure mortgages in some areas. That made those mortgages risky for every lender. The government became the bigot of last resort. It painted with a broad brush that many banks would not have done on their own.
A side note. Bus companies in the South did not discriminate against Blacks when those companies were private. Blacks were a majority of their customers. When those companies became state agencies or state regulated, then the bigotry of the state was imposed. Blacks had to sit in the back of the bus.
Actually, my question was weirder. Like, for example, what if blacks were denied mortgages from 2003 to 2006? Would they actually have been better off on average?
I got your point, mine was a minor whimsy tacked on.
Interesting, Michael Pettis actually commented on this very same problem in his book – “The great rebalancing” I cannot cite the exact paragraph, but I do recall it being mentioned.