I wrote about the problems created by excess liquidity and the diversification of risk yesterday. So too did John Kay in the FT. He said:
The financial economics I once taught treated risk as just another commodity. People bought and sold it in line with their varying preferences. The result, in the Panglossian world of efficient markets, was that risk was widely spread and held by those best able to bear it.
Real life led me to a different view. Risk markets are driven less by different tastes for risk than by differences in information and understanding. People who know a little of what they are doing pass risks to people who know less. Since ignorance is not evenly distributed, the result may be to concentrate risk rather than spread it. The truth began to dawn when I studied what happened at Lloyd's two decades ago.
It's good to see I'm not alone. He concluded:
The structured credit markets of the new millennium have reproduced events at Lloyd's. There are only a few basic models of financial folly. Each generation repeats the experience of its predecessors, not in broad outline but in considerable detail. The Ponzi scheme was the basis of speculative excess in the roaring 1920s and the boisterous 1990s. The financial version of the card game Old Maid brought Lloyd's to its knees and is replayed in today's credit markets. The only certainty is that, sooner or later, the party ends. The most costly investment advice of all is the expert assurance that "it's different this time".
Perhaps you've got to have been around for a while to see it this way. But it is, if you'll excuse the phrase, bleeding obvious. As is the fact that markets do not create optimal outcomes.
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“As is the fact that markets do not create optimal outcomes.”
Perhaps. But we must remember that such an observation is not sufficient to justify any pet solution you may care to offer. You have to demonstrate that it will do *better*.
Richard
Actually, you’re wrong Richard. Once markets do not produce optgimal results all is fair game. Markets get no preference.
Indeed, the argument might be why something that produces the wrong result is considered in any way superior, and should justify being considered.
I happen to think they should be, but only if the case is made, not by default.
Richard
“Actually, you’re wrong Richard. Once markets do not produce optgimal results all is fair game. Markets get no preference.”
I think we may be talking at cross purposes but I’ll try to address that. Are you arguing against markets in general or markets in risk (or credit or whatever)? Just because one example fails to produce what you regard as an optimal outcome doesn’t mean that all other solutions suddenly become credible. We already *know* that, in general, market-based approaches tend to work. That they sometimes go wrong is not news and it doesn’t somehow make other untried (or tried and proven to fail) methods somehow “correct”.
Of course, if I were being mischeivous, I *could* characterise the current turmoil as having had a rather pleasant social outcome: the helping of many Americans onto the housing ladder who would otherwise not have had the chance. Some of those who were given the chance couldn’t make good on their committment to pay back their loans but many others did. You could say that the banks who bought these debts (along with their shareholders and fund investors) have just engaged in one of the largest voluntary private transfer payments in history.
I’m surprised you’re not crowing about such a large act of private altruism 🙂