Arnold Kling  

The Market and the Government

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On the one hand, The Washington Post reports,


high fuel prices are having disparate effects: the end of free pizza deliveries at major franchises, a plunge in the sales of sport-utility vehicles, a steep drop in the price of houses that are far from jobs or mass transit.

On the other hand, from another story on the front page,

In 2004, as regulators warned that subprime lenders were saddling borrowers with mortgages they could not afford, the U.S. Department of Housing and Urban Development helped fuel more of that risky lending.

Eager to put more low-income and minority families into their own homes...HUD stuck with an outdated policy that allowed Freddie Mac and Fannie Mae to count billions of dollars they invested in subprime loans as a public good that would foster affordable housing.

...From 2004 to 2006, the two purchased $434 billion in securities backed by subprime loans, creating a market for more such lending. Subprime loans are targeted toward borrowers with poor credit, and they generally carry higher interest rates than conventional loans.

These stories illustrate that markets adapt while government regulation can exacerbate problems. However, I doubt that this will alter the standard narrative, which is that every imperfection in markets requires more government regulation.


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TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/849
The author at The American Mind in a related article titled Economics Links–06.12.08 writes:
    James Pethokoukis looks at Sen. Obama’s chief economic adviser, Jason Furman, and notices some differences of opinion. A new paper questions the fears of service jobs being outsourced overseas. [via Mark Perry] Arnold Kling notices a difference ... [Tracked on June 12, 2008 3:24 AM]
COMMENTS (12 to date)
hutch writes:

But Arnold, don't you see? It wasn't the government who actually originated the subprime loans, so the government is really in the clear here. Obama has said himself that Countrywide is as responsible for the housing problem as anyone. The greedy market's reaction to what the government did is precisely why it is the market, not government, that is in the wrong.

Chuck writes:

I think these stories are part of a larger collection of stories indicating that markets have stregths and weaknesses and govts. have strengths and weaknesses.

To finish out the collection of stories, we link (in theory) to a story explaining the CDO crisis that forced Fed intervention in the collapse of Bear Stearns.

The CDO market, a pretty free market, a pretty unregulated market, it seems to me, was judged such a preposterous disaster that its failure put the economy at large at risk. It would have benefitted from some free-market liberal reforms, like making a real time trading market for them, and perhaps some accounting rule reform so that the risks are properly scored in companies that require public disclosure of financial info.

The fourth story would be about the govts role in the creation of the internet. I can't imagine a reality where private corporations invented the internet.

John Thacker writes:

These stories illustrate that markets adapt while government regulation can exacerbate problems. However, I doubt that this will alter the standard narrative, which is that every imperfection in markets requires more government regulation.

Prof. Kling, they impose that standard narrative even in the second article itself. Lots of quotes from people claiming that regulations forcing and encouraging Freddie and Fannie to buy affordable loans was really a case of not enough regulation.

The CDO market, a pretty free market, a pretty unregulated market, it seems to me,

A market where regulations force government-backed lenders to buy securities is not "pretty free" in my book. It's no wonder that there were too many of these loans when those making them knew that Freddie and Fannie were directed by the government to buy them.

Chuck writes:

I granted that the loan purchase requirement was foolish, part of govt. doing something poorly.

I'm interested to know how it is that Freddie and Fannies hunger for subprime loans created CDO's on Bear Stearns balance sheet that went bust and created such massive losses for them.

I'm far from a financial expert, but as far as I can see there is not a connection between Freddie and Fannie buying sub prime's and Bear Stearns implosion. It was the CDO angle of their implosion that required the Fed to intervene on their behalf.

Futhermore, reading the article, it sounds like the (dreaded) bureaucracy at HUD had a handle on what was going on, but some Bush political appointee at HUD simply wanted to do a solid to some buddies from skull and bones. So instead of ratcheting back on an activity that was making a lot of money for his friends from the B-school, he threw fuel on the fire.

"In 2001, HUD researchers warned of high foreclosure rates among subprime loans.

"Given the very high concentration of these loans in low-income and African American neighborhoods, the growth in subprime lending and resulting very high levels of foreclosure is a real cause for concern," an agency report said.

But by 2004, when HUD next revised the goals, Freddie and Fannie's purchases of subprime-backed securities had risen tenfold. Foreclosure rates also were rising.

That year, President Bush's HUD ratcheted up the main affordable-housing goal over the next four years, from 50 percent to 56 percent. John C. Weicher, then an assistant HUD secretary, said the institutions lagged behind even the private market and "must do more.""

emphasis added

If you put hacks in charge of govt (that is, the Bush crew) you get very poor results. Publicly held corporations require active stockholders and sufficient transparency to work. The same is true of the govt - it requires transparency and active voters.

pls pardon the spelling

loki on the run writes:
The fourth story would be about the govts role in the creation of the internet. I can't imagine a reality where private corporations invented the internet.

Creationist says: Sitting here in my armchair I can't imagine any reality that does not require a god to get all those creatures created ...

You are in good company there Chuck.

Chuck writes:

@loki

Thanks for your thoughtful reply to my post.

While we are exploring the difference between reality and faith, please share with me a real world example of a small libertarian government in charge of a 1st world economy. Or perhaps you are part of a faith based community yourself?

To expand on my point:
In fact, the govt did create the internet. The key aspect of the internet that makes it useful is that it is an open format. It is very unlikely that an open formatted enterprise like the internet would ever come out of a private enterprise. Lots of examples of closed format technologies and networks like AOL, Compuserve, wireless phone formats, document formats, etc, etc. Check the link above for the MBA logic of the situation.

Futhermore, networks utility increases as something like the cube of the number of people on the network. The scale of investment to create the internet and the long term of the payoff once the internet was created (while you waited for uses to come around) results in a very high barrier to entry that, apparently, no private enterprise had the foresight to create. Instead you had closed networks like AOL, etc.

James writes:

Chuck: Instead of introducing non-sequiturs (The present day number of libertarian governments says no more about the desirability of libertarianism than the small number of mass franchise democracies in the 1500s said about the desirability of democracy. Learn to reason more cleary.), why don't you just address the point loki raised?

That is, tell us why you think the limits of your imagination are binding on reality?

Dr. T writes:
regulators warned that subprime lenders were saddling borrowers with mortgages they could not afford
The media uncritically reports the government's spin. Lenders forcing mortgages on borrowers certainly is a new spin. (The old spin was lenders turning down high risk buyers.) It must go something like this:

Customer: I'm trying to buy a $450,000 house, but I only have $5,000 in savings.

Lender: You should take this $600,000 ARM! Payments (for the first 3 years) are lower than with a 20 year $450,000 loan. [Twists customer's arm.]

Customer: (Ouch!) You talked me into it. We'll buy a bigger house.

I agree with Dr. Kling that governments (and many people) see every problem as an opportunity for bigger governments and more laws or regulations. I believe these effects increase exponentially with government size, and I see no way to stem the accelerating growth in governments and regulations.

TGGP writes:

Chuck, see Caplan on networks here. A number of historical examples show that markets can create just what you claim they cannot.

Chuck writes:

@TGGP

I read the paper and it is interesting. Ultimately though it seems a key premise is a world full of rational actors. I just don't see that.

Seriously, though, there are lots of areas where I think abstraction undermines the argument. I'm reading a book at the moment that, in part, discusses the origins of the wire services.

Wire service after wire service was started up, but the specific purpose of creating the wire service was to facilitate gambling - to get results to bookies in a timely way. The mob started most of these wire services, and they muscled in on legitimate ones, etc. Often all that was required was to threaten the guy who owned the wire network to sell it or they'd kill him. In some way, that would be a way to get 100% participation in a cartel.

My point is that, while the paper makes some good arguements that it isn't theortically impossible for this kind of network to happen spontaneously, so to speak, it doesn't seem to me, given human nature, to be practical.

To put it in another way, while someone might be able to prove that faster than light travel is in fact possible, that doesn't make it something that is ever going to happen - the energy requirements might be too great, or it may be that it requires a perfect vacuum, etc. (This aspect of the argument might be why 'imagine', that inflammatory word, got into my original post.)

Hayek writes:

"Imagine" was the wrong word. The limits of capital and time-horizon are significant, as they would be for forming a private militia adequate to defend against an acquisitive government. Doctrinaire libertairians defend private militias, in spite of their constitutional prohibition.

With the state's monopoly on organized aggressive force, we have always been in a mixed economy. DARPA is one of the most innovative research labs in existence. And it was researchers from Bell Labs that won the Nobel Prize in physics b/c of their research into the Big Bank background radiation. DARPA/Bell Labs: a couple of socialized entities. But good examples of long-term capital-intensive research.

I agree that Leviathan will grow until some revolutionary movement radically excises power. But since we are constitutionally mixed, there's no way out of this cycle.

Michael writes:

I don't find it at all difficult to imagine a reality in which private corporations invent the internet. They created the telephone, the personal computer, fax and cable -- what's so hard to imagine about them establishing the internet as a means of connecting them?

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