ruveyn wrote:
Price expansion totally unrelated to productivity. It can only occur when the amount of credit issued far exceeds the ability of borrowers to repay.
We need credit to expand the economy, but the amount of credit put forth must have some reasonable relation to the ability to repay.
ruveyn
Actually, bubbles can easily occur in the absence of easy credit. The Tulip Bulb Bubble and the South Sea Bubble both occurred in economies with standardized currencies and capitalized lending. Bubbles only require stupid investors who are prepared to buy in late and who don't get out in time. Smart investors get into bubbles when they are starting and then get out before it's too late.
Subprime lending is not misguided
per se provided that the risk and the return are properly balanced. Neither are credit default swaps. They are, in fact, quite rational instruments. Where things started to get irrational was when real circumstances started to veer outside of the mathematical models of risk behaviours.
When the market starts to get creative, (Keynes' "innovations of leverage"), government has to fulfill its function of monitoring the marketplace. Not only active regulation to counteract abuses like fraud and insider dealing, but also strategic oversight. What this recession proves, perhaps more than anything else, is that markets are neither wise nor decent. And, frankly, we should not expect them to be.
But knowing that they are not, we must ensure that someone is standing in the way of unwise or rash activity in the market, and we must ensure that the people doing so have the intellectual capacity and the policy mandate to do so.
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--James
06 Jun 2010, 12:33 pm
