27 September 2008

Mortgages and scale

Arnold Kling, who knows what he's talking about, says that the idea that mortgages will turn out to have a better return than their current market prices indicate is rubbish. In his view, the market prices are likely to accurately reflect the true value.

As far as I can see, that is unlikely. In a simplistic model, underpriced mortgages will be bought by investors who can make profits by holding them. But surely any such model assumes capital is plentiful relative to the assets under discussion. The crucial fact here is that, because of the past hideous underestimate of risk, the size of the mortgages held by institutions who shouldn't be holding them is, apparently, in the high hundreds of billions of dollars. Many other investors have felt they are a good long-term bet. But most of those investors have already bought as much as they can afford, or else are holding on for better bargains, knowing that there is no competition to bid the prices back up in the short term.

On that argument, a buy-up by the US government is indeed a profitable opportunity for it. I think it could be defended on those terms. If I were drawing it up, however, I would want it explicitly to aim at making a profit. I would set a fund of fixed size to buy assets, planned to ensure that some of them are left over, and then spend it over a shortish period buying whatever seemed to be most competitively priced. The aim would be to make profits, and hopefully do some general good in the process; not to save overexposed financial institutions at any cost.

Is this counter to my principles? Yes. I do not consider myself a "naive libertarian", in that I recognise that state intervention can be beneficial in some cases. However, I think that forgoing such benefits, by separation of economy and state, would be a better general policy than allowing fallible politicians to identify allegedly beneficial interventions. This intervention, even if beneficial, sets a horrific precedent, and will terribly undermine all free-market arguments for years to come. It could usher in an era of big government. That's why it should be opposed.

Indeed look at the converse. If it doesn't happen now, and the system survives with less damage than the proponents are claiming, what a valuable example it will be of how markets are able to adjust to the most severe problems.

1 comment:

A Nonny Mouse said...

The problem here is that the whole basis of Banking practice is wrong. The notion that economically active people should own their own dwellings is base in the conception and satanic in the execution. The EU, a much derided institution, set out as its first principle the free movement of labour. But obviously, nothing slows the movement of labour down so much as the need to sell and buy a house. And nothing impoverishes society and the individual as much as an inability to move to where the work is.

A mortgage, as conceived in English Common Law, works as follows. A man owns a house: he needs to free up capital, so he takes out a loan on the strength of his ownership. All very right and proper, and meaning that those who lent money in earlier times, got it back, or got the house. However, our bankers have elaborated this instrument to facilitate the purchase of houses, a very undesirable procedure, which has led to the current crisis. If you want to buy a house, you should be saving up until you can afford it.

Should the state intervene? A certain Spaniard of my acquaintance, back in the 90s, put his meagre fortune into an obvious pyramid scheme. Although advised by all his sane acquaintances to get it out asap, he persisted until the inevitable crash. Bankers have proven tendency to turn into pyramid merchants, if given free rein.

Equally, it is rather boring to receive an message from a Nigerian who wants to put £10,000,000 in my account every fortnight, a phone call telling me about the cruise I’ve won twice a week, and have a website flash up that I’m the 1,000,000th customer every hour. My idea of a useful state would be one that closes such people down. Equally, I could be owed money by the Spaniard, and having him wiped out would prejudice my chance of being paid.

However, for those whose rhetoric demands a denunciation of the evil fascist state, I would say that it is arguable that the stampede to get everyone to own their own homes is a creation of the state. In this country, as I recall, Mrs Thatcher had a lot to do with it: selling off Council Houses and the like. Certainly the bubble is maintained by the state’s planning regulations.

What’s happening in the US I do not know. But house ownership in Germany is comparatively low. In Cyprus, a house is worth something when it’s new, and then loses its value progressively as it gets older, rather like a car does.