Friday, August 31, 2007

The Wasteful Side of Free-Market Competition

Every now and then you come across a piece of financial writing that is gleefully unaware of the case that they are making - a seemingly game-theoretic model in which competition incents excess:

The combination of 'teaser' interest rates on adjustable rate mortgages and institutional money flowing into the mortgage market seeking higher returns resulted in intense competition in the subprime mortgage origination market. The reason vintage years 2005 and 2006 are looked at with more scrutiny is because increased competition in the subprime mortgage arena led to relaxed underwriting standards.
All the more reason why "free markets" is just a important rally point, but not a serious going analytical effort (or all that is required).

Oh, and just to be complete, here is something from today's speech by Bernanke that indicates how important it is to design the right kind of curbs:

The original rationale for deposit ceilings [rate regulation under reg-Q] was to reduce "excessive" competition for bank deposits, which some blamed as a cause of bank failures in the early 1930s. In retrospect, of course, this was a dubious bit of economic analysis. In any case, the principal effects of the ceilings were not on bank competition but on the supply of credit.
From which we can go the last step, beyond designing the right kinds of curbs, to the apt removal of curbs that outlive their usefulness. To wit, it was the relaxation of reg-Q that eventually created the enormously taxpayer-costly S&L thrift crisis ...

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