by Patrick Appel

A reader writes:

I don't think that classical economists would make the argument that the market never gets things wrong, but they may have a different take as to why mistakes get repeated/aggregated and what to do about them.  In the subprime mortgage example given, classical economists would point to three market problems - information asymmetry, agency problems and government intervention.  Information asymmetry shows up when investors buy mortgage pools, but have no idea about the underlying credit-worthiness of the borrowers.  Agency problems arise when the mortgage broker offering the mortgage has no downside exposure to default.  Government intervention makes it all possible when Fannie and Freddie implicitly back the debt with the taxpayer's future income streams.
 
Anti-market types will search for solutions in more regulation. Market disciples would call for a break-up of Fannie and Freddie and increased information availability regarding the mortgages in the pools.  We had plenty of regulations and regulators on the job already, and they couldn't get past Barney Frank and his gang. So going forward, this market disciple would prefer we go with the approach of increased information and less government involvement.  Of course, we are getting exactly the opposite.

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