Tuesday, June 28, 2016

Destabilizing the commercial equilibrium

This article (HT: CH) is a case study in the central role of regulatory burdens in reducing economic growth.  It outlines some of Amazon's hurdles in France.  An excerpt, regarding the temerity of Amazon to improve its service without letting the local authorities warn the city's commercial rentiers and concoct obstacles:
"While this operation is liable to severely destabilize the commercial equilibrium of Paris, this large American enterprise only decided to inform authorities a few days before its launch," the mayor's office said.
Another excerpt:
Earlier this year, it was reported that Amazon was planning to acquire the French shipping company Colis Priv√©, in which it already owns a 25 percent stake, but the US company told the AFP last month that it had abandoned those plans for "reasons exterior to Amazon and beyond our control." French newspaper Les Echos later reported that the acquisition fell apart during negotiations with France's competition authority. 
This is really exactly the sort of thing that I have been studying in the housing market.  The fact that moderate rhetoric is built around the consensus that deregulation has been our problem is the central problem of our time.  In housing, the same sort of capital repression that is on display in France keeps out "destabilizing" expansion of the housing stock.  In the case of housing, the rentiers include neighborhood groups and tenant advocates, so the public face of privilege and stagnation is a face we empathize with.  Human nature pushes us to identify with interest groups based on identity and sympathy.  But, it is process that is important over time.

Regulatory limits were raising the cost of housing in our productive cities, and the public reaction to that has been to blame banks for facilitating the funding of the market value of those houses.  It looked like bankers were profiting from rising values, and it bothers people when financiers make profits that are too high.  It seems like they are just pushing papers around - not doing anything useful.  And, they have the capital.  They are the definition of the Man.  If financial repression could have held home prices down so that there was some other form of rationing that determined who would be able to own homes and collect above-market returns, that delivers profits to households individually.  It is actually a system that is more tilted against equity, but we like capital-rich people better in the form of families than we do in the form of financial corporations.

This is the system we have instituted since 2007.  All financial institutions have been nudged to a posture where mortgage finance is unavailable to the bottom half of the economic distribution.  This made the process of economics worse, so while it distributes the profits in a politically friendly way, it creates more economic stress.   This is what is happening in France.  Local merchants are more appealing than a foreign internet retailer, so the politically appealing move is the move that imposes stagnation on Paris while the rest of the world explodes with new retail opportunities.

I have concluded that this tendency was part of the problem in the early part of the housing boom and bust.  There was a legitimate concern in the Bush administration that the GSEs were taking on unnecessary risks and were becoming too large.  But, as has typically been the case in these developments, the political reaction was diverted from the real problem of process to the sensational issue of who was profiting from it.

In the 1990s, the GSEs had begun to utilize capital to keep mortgages on their balance sheet.  Normally, they take the default risk while private investors take the interest rate risk on the mortgages they facilitate.  That takes very little capital.  But, the GSEs started using debt to hold mortgages on their books, adding interest rate risk to their business model.  There are a lot of facets to that story, and maybe there is some justification for doing that, in terms of risk diversification.  But, it changed their business model to one with fairly simple accounting to one where the accounting was complicated.

The concerns about the use of debt and the added risks, once they were filtered through the political process, ended up being expressed in terms of who was profiting.  High CEO salaries and high profits were the salient issues, and the whole affair ended up just becoming a trumped up accounting scandal.  The CEO's were kicked out, and the firms restated earnings.  But, the actual problem was left unaddressed.  Simply increasing the capital required to hold mortgages on their balance sheet would have moderated their activity in that market, but instead, they were required to increase the capital they needed to hold for all activities, including the core activity of facilitating mortgages for securitizations for third party investors.

The whole process ended up causing the GSEs to retrench in 2003 and 2004, leading to the rise of private securitizations to take their place.  Falling interest rates in 2003 also led to a massive round of refinancing at lower rates, which also temporarily cut into GSE profits.  The GSEs continued to manage their balance sheets as they had, since nothing was fundamentally done to actually address that problem.  So, the end result of those political pressures was to reduce GSE activity in conventional mortgages and to increase their activity in the subprime and Alt-A securities that rose up in their place.

What followed were a series of liquidity crises in the mortgage market, and as each financial institution reacted, the public outcries always ignored the underlying processes that were falling apart in order to concentrate on who was profiting.  Who was profiting from making loans, from securitizing them, from concocting synthetic securitizations after we had destroyed the market for actual homebuyers, from foreclosing on defaulted borrowers.  Remember how much concern there was about whether AIG should pay bonuses after they were recapitalized by the federal government?

What we care about is that the wrong sorts of people might profit, and on the whole, we are quite content to obstruct broad economic abundance in order to attend to that concern.


  1. Great post, excellent last paragraph.

    It does seem at times the US has become a circular firing squad.

    1. Ha! Yes. A la Deirdre McCloskey, I try to be grateful for the functionality we do have and the historical anomalies in attitudes and rhetoric that make our lives, as they are, possible. But, yeah. It seems as though protracted periods of economic distress are mostly self-imposed due to the human concern for status and our discomfort with emergent order. We are probably lucky that we ever escape it.