Wednesday, October 22, 2008

Feds in the Money Market

Ok, I am more interested in food, with a side of business/economics, than say, a dude like Tyler Cowen, the George Mason econ professor, with a foodie side.  But the current business/economic discourse in the media just seems so wrong that I can't just talk about food here.  

So skip this if you're looking for food pictures.

I read this USAToday Op-Ed about the benefits of small banks today.  The basic argument is that small banks (whatever that means.. though the authors allude to a George Bailey-esque bank - from A Wonderful Life - as the model) are better than big banks because they make loans that do not default.  "Better" loans makes for "better" banks.  Small banks can make such better loans because they have an "informational" advantage - they know their customers and know the good credit risk from the bad. For good measure, the Op-Ed proposes some sort of special tax on securitizations.

Wow, what a load of naive crock.   

There are no banks that serves big population centers in America that works this way.  The closest thing to a "small" bank that most of us see is our local credit union.  Credit unions are not inherently better at assessing risk than my Citibank branch - the only extra information they may have on me is the activity in my accounts. What's my savings history, my checkwriting history, etc.  But if you get a regular mortgage (as opposed to those "no-documentation" ones), you've disclosed such account history to Citibank as well.

And what's wrong with making loans to folks with higher credit risks?  If there is any failure here in this mortgage business, it is the failure to properly price risk.

Now the momentum has swung the other way.  People with money (banks and investors) are charging too much for risk. That is why the markets are stuck - no one is lending at prices that are business appropriate.  

Thankfully, the Feds are stepping in to not only issue commercial paper directly (i.e. short term loans to provide working capital to functioning businesses), it also has just set up a money market facility to buy current commercial paper from financial institutions that are seeing massive redemptions from their money market investors.

If the Feds play their cards right (i.e. pay appropriate prices for the asset purchases), they (or we, as taxpayers) can end up making a killing when markets are talked down from this pricing panic.

Of course, we're talking about the US government here, so the "we" who will end up making money will not be the taxpayers, but political cronies.  Sounds like current day Vietnam.

No comments: