The Hidden Costs and Underpinnings of Debt Market Liquidity
Amar V. Bhide
The Fletcher School of Law and Diplomacy
May 30, 2014
Columbia University Center on Capitalism and Society Working Paper No. 79
This article offers three propositions about the liquidity of financial claims in general and about the liquidity of “securitized” interests in mortgages and other small loans in particular: I) Standardized practices and rules and that restrict the use of detailed case-specific information undergird the liquidity of financial claims. Specifically in the case of mortgages and other small loans, securitization is undergirded by mechanistic lending practices that rely on abridged or condensed information rather than detailed information about borrowers. II) By restricting the use of case-specific details, the practices and rules that undergird the liquidity of financial claims impose hidden costs. In particular, practices that enable securitization impair the underwriting and contracting of small loans and, in conjunction with the liquidity they help create, the practices also promote the hazardous conjoining of risks in the banking system. III) Regulation, more than autonomous technological advances, has underpinned the expansion of liquid markets in the last thirty years. Specifically, small loans have been securitized to an exceptional degree in the US because housing policies, securities laws, and banking rules have favored (a) liquid markets and (b) lending based on condensed or abridged information over relationship-based lending based on case-specific details.
Number of Pages in PDF File: 53
Keywords: securitization, financial stability, financial regulation, liquidity, contracting
JEL Classification: G10, G18, G28, G38, K22, N21working papers series
Date posted: January 27, 2013 ; Last revised: May 31, 2014
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