Assets and the market for lemons

I have spent so much time blabbing about asymmetric information without every explaining what I meant. As a result I feel that everyone deserves a little explanation. Thanks goes out to Akerlof and the lemons hypothesis.

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Was it the availability of credit that lead to the housing bubble?

A popular explanation of the booming in house prices according to, well, everyone is that there was lots of “credit washing around” which convinced people that they should go and bid up house prices. An example of this logic is shown in this statement at the very good Big Picture blog:

The bubble in home prices, fueled by the ready availability of credit, resulted in an underestimate of the risks of residential real estate

Personally, I think this type of thinking has the causality all mixed up – if there was any error it was because people “underestimated the risks” associated with the price of residential real estate, and therefore given the “price” of credit the housing market appeared to be a better bet than it actually was. As a result, the entire blame for the bubble and associated crisis should lie with the fact that risk wasn’t being appropriately identified – not with some mystical belief that credit was springing up all over the place. If the risk problem was unsolvable, then we can blame central banks for leaving the price of credit (not its “availability) to low – however, this is a secondary issue to risk.

The whole concept of the “availability of credit” is somewhat of a misnomer.

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Credit crisis: Doomsaying in perspective

It appears that many people fear a contraction in the economy – and are determined to bring to justice any factors that could lead to such a situation.

As of late, one such factor was the “credit crisis”, which has lead to a sudden freeze in lending and potentially to a contraction in economic growth in many of the worlds largest economies.

Given that it was a seemingly inevitable freezing in the credit market that has caused this reduction in economic activity many people state that it we should have regulated the credit market more – to prevent this sort of contraction from happening.

However, even if we do take the current slump in the credit market as inevitable – I am not convinced that this type of regulation would have improved the situation.

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Is the US taxpayer being forced to surrender to Wall Street?

I don’t like thinks that sound like conspiracy theories – and the title of this post does! However, I am starting to get the impression that this is one situation where it may actually be the case. Overall it stinks like socialism for the rich (good cartoon here, good article here)

Two articles from Bloomberg this morning have pushed me into this view:

Bernanke Signals U.S. Should Pay More for Bad Debt

Bernanke Says Normal Markets Needed or Growth to Halt

As Felix Salmon states here, Bernanke’s interest in paying the hold to maturity price for assets just doesn’t make sense when a good proportion of the assets aren’t going to mature – and even if they wish to take into account risk, the US Treasury does not have time to sufficiently evaluate the risks.

Surely the aim of the bailout should be to do as little as possible to ensure that credit markets start functioning again – in this sense, over paying for assets seems excessive.

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Credit crisis mark 2: How will it impact on New Zealand

I see that this is a popular topic at the moment, so I thought I would add my two cents.

Before doing so I’d like to point out that the Rates Blog has a good piece on it, and this Stuff article gives the opinion of most of the banks (BNZ’s currency strategist also gives a good breakdown on the Rates blog).

Now the way I see it, there are two channels that this crisis can and will impact on the New Zealand economy:

  1. Impact on export/import prices and volumes,
  2. Impact on domestic interest rates.
  3. Update: Impact on capital investment

Outside of these two channels global events will have no impact on New Zealand. This involves assuming that external factors don’t beat around our consumer and producer confidence for no reason, and that net migration does not change. Although these assumptions aren’t completely true, I think it is fair to assume that the impact of these factors is relatively minor.

As a result, lets talk about these channels.

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8% weekly interest rates: What’s going on

Following the “revelation” that a loan shark in Porirua was charging 8% interest per week on loans, the government has offered to do nothing. Blogs on the left hand side of the spectrum were irritated by this, as they feel that people are being taken advantage of (the Standard) (Tumeke) (Frontline – prior to this incident). Lets investigate the issue.

Now I am not disputing the fact that people are, in some sense, “being taken advantage of”, however I do disagree with the solution that the other blogs follow – setting a cap on interest rates. In this sense I am in agreement with government policy. Read more