Category Archives: Market Failure

Market Failure – Public Value Failure : An Intersection

When you have a program, such as the one described in this NYT article on private Medicare insurance, that relies on the market to solve a public value problem, and that program fails — you end up in the total failure quadrant.

(need a picture here)

Private health insurance plans, which serve nearly a fourth of all Medicare beneficiaries, have increased the cost and complexity of the program without any evidence of improving care, researchers say in studies to be published Monday.

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Market Failure — Fixing Flats

Friedman rightfully pops a cork over Nardelli’s spin that Detroit is asking for $25 billion to innovate, not as a bailout:

It wasn’t a bailout, he said. It was a way to enable the car companies to retool for innovation. I could not help but shout back at the TV screen: “We have to subsidize Detroit so that it will innovate? What business were you people in other than innovation?” If we give you another $25 billion, will you also do accounting?

The budget of US DOE basic research is $4.7 billion — and that IS for innovation.  Total NSF budget is less than $7 billion.  Total NIH budget is approx. $28 billion.  Who knows how much DOD is spending.  Nonetheless… Why do we need to subsidize the private sector to innovate?

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Market Failure – Deflation

A term no one wants to hear from economists.  Especially when the comparison is to the burst of the Japanese economy in the 1980’s or the Great Depression.

Banks and other financial institutions are reckoning with hundreds of billions of dollars worth of disastrous investments. As they struggle to rebuild their capital, they are halting loans to many customers, demanding swift repayment from others and dumping assets — homes sold out of foreclosure, investments linked to mortgages and corporate loans. Selling is pushing prices down further, making the assets left on balance sheets worth less, in some cases prompting another round of sales. “You get this adverse feedback loop where assets keep falling in value,” Mr. Barbera said. “You’re essentially putting big downward pressure on the global economy.”

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Market Failure – WallStreet to blame for Subprime Crisis?

That is what Alan Greenspan thinks:

But Mr. Greenspan, who was first appointed by President Ronald Reagan, placed far more blame on the Wall Street companies that bundled subprime mortgages into pools and sold them as mortgage-backed securities. Global demand for the securities was so high, he said, that Wall Street companies pressuredlenders to lower their standards and produce more “paper.”

“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower,” he said.

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Market Failure – Timeline – A decade or more

NYT continues to ask questions about who knew what when

In an hourlong interview with The New York Times, Mr. Paulson defended Treasury’s actions, saying that he and his aides had done everything they could, given the deep-rooted problems of financial excess that had built up over the past decade. “I could have seen the subprime problem coming earlier,” he acknowledged in the interview, quickly adding in his own defense, “but I’m not saying I would have done anything differently.”

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Government by Gold(man) Standards

NYT piece confirms the ubiquitous nature of the GS machine present within government:

Indeed, Goldman’s presence in the department and around the federal response to the financial crisis is so ubiquitous that other bankers and competitors have given the star-studded firm a new nickname: Government Sachs.

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Justification for Public Intervention in light of Market Failure

Bernanke, using history of the Great Depression, opines:

Finally, Mr. Bernanke, who is an authority on the Great Depression, said that the country and its federal officials had learned from history that inaction or delayed reaction to financial calamity could be disastrous.

“This is not the situation we face today,” he said, predicting that official Washington’s fast response “together with the natural recuperative powers of the financial markets” will pave the way toward recovery.

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Mark-to-Market : Public Interest causes Market Failure?

From Congressional testimony excerpted in the NYT:

AIG says the rules forcing information into the market regarding debts caused their downfall:

In his testimony, Mr. Willumstad attributed the company’s failure largely to mark-to-market accounting rules that forced A.I.G. to recognize tens of billions of dollars in accounting losses, as well as a “tsunami” of market instability ignited by the collapse in value of mortgage-backed securities.

Congressman Waxman thinks otherwise:

“A.I.G. is blaming its downfall on accounting rules which require it to disclose losses to its investors,” the specialist, Lynn E. Turner, the former chief accountant at the Securities and Exchange Commission, said. “That’s like blaming the thermometer, folks, for a fever.”

So, basic econ theory says there is an assumption of perfect information which supports an efficient marketplace.  But, AIG (and others) say a rule forcing disclosure of “more” information than the company ordinarily would have disclosed — caused the market to devalue their company.

This argument causes one to question whether the markets were overvalued because of inefficiencies due to imperfect information.

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Market Failure — a teaching moment

Review in the Chronicle discusses whether the current financial crisis causes one to consider whether economics is taught well.  Here are a couple of interesting quotes:

At some point, and this is as good as any, we have to ask ourselves if we have been teaching theory or ideology.

What about a return to the idea that economic theory does not offer settled answers but instead offers only an engine of analysis? Are we fearful that if we allow for too much ambiguity in the use of our theories, we will no longer be perceived as proper scientists? If anything, this episode should remind us to remind our students that there may not always be a unique right answer.

And —

This crisis is built on the foundations of financial illiteracy.

And —

It is very ironic that the end result of the misplaced application of incentives in the Soviet Union led to the increased role of the market system in that country. In the United States, the misplaced application of incentives is bringing about greater government intervention in the economy.

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Gold(man) Standards — Fannie Mae

Article in NYT concerning the evolution at Fannie Mae.  The pressure to take more risky loans came during the heyday of the Republican Congress. But it wasn’t just Congress, as Gov. Palin said during the debate on Oct 2.  Wall Street, investors and the White House pressured Fannie Mae to underwrite the subprime mortgages being written by Countrywide and others.

Seems Fannie Mae had connections to GS:

But earlier this year, Treasury Secretary Henry M. Paulson Jr. grew concerned about Fannie’s and Freddie’s stability. He sent a deputy, Robert K. Steel, a former colleague from his time at Goldman Sachs, to speak with Mr. Mudd and his counterpart at Freddie.

Mr. Steel’s orders, according to several people, were to get commitments from the companies to raise more money as a cushion against all the new loans. But when he met with the firms, Mr. Steel made few demands and seemed unfamiliar with Fannie’s and Freddie’s operations, according to someone who attended the discussions.

Rather than getting firm commitments, Mr. Steel struck handshake deals without deadlines.

That misstep would become obvious over the coming months. Although Fannie raised $7.4 billion, Freddie never raised any additional money.

Mr. Steel, who left the Treasury Department over the summer to head Wachovia bank, disputed that he had failed in his handling of the companies, and said he was proud of his work .

Mr. Steel now has a court fight over to whom he can sell Wachovia (disaster seems to follow him, no?).  Wonder what color his parachute is?

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