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.