Sunday, January 27, 2008

ECON 365: Regulation in Financial Markets

Here's an interesting NYTimes article in which Yale economist Robert Schiller argues that we need more government intervention in financial markets. In particular, he believes that consecutive bubbles (stock and real estate) have reduced confidence in markets and the government needs to intervene (as it did during the depression) to help restore confidence:

The Depression-era problems he studied are mirrored by similar issues today, and they need urgent attention. The very fact that many people feel they can no longer rely on some of our financial institutions may bring a self-fulfilling prophecy, which could then fundamentally harm economic activity.

The mortgage market is suffering. People are having a hard time getting mortgages, and mortgage originators are finding it harder to sell their mortgages to those who would repackage them in mortgage securities.

The commercial paper market is suffering, too. The amount of outstanding asset-backed commercial paper, which has become a main element of an unregulated, uninsured, shadow banking system, has fallen 30 percent since August.

Other credit markets are also having problems. For example, some municipal borrowers have already had the credit ratings of their debt lowered because of the downgrading of Ambac, a municipal bond insurer, by Fitch Ratings. Problems in the bond market are likely to multiply if there are further downgradings of Ambac, or downgradings of other insurers like MBIA.

CONFIDENCE in our brokerage firms is suffering. With every announcement of major losses, some people start to wonder whether they can rely on these companies.

Schiller clearly believes that markets are operating inefficiently, but he doesn't seem to kow yet what to do about it basically arguing that we need to think about what to do.

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