The Hidden Costs and Underpinnings of Debt Market Liquidity
Amar V. Bhide
The Fletcher School of Law and Diplomacy
Columbia University Center on Capitalism and Society Working Paper No. 79
This paper argues that, like central planning, liquid financial markets suppress heterogeneity and ignore idiosyncrasy. This de facto collectivization imposes hidden costs beyond the misalignment of incentives or excessive trading: imposing uniformity and disregarding specific circumstances increases financing errors and promotes a systemically hazardous conjoining of risks. I also claim that regulation, more than autonomous advances in information and financial technologies, has underpinned the expansion of liquid markets in the last thirty years. Most notably, traditional mortgages and other small loans have been securitized to an exceptional degree in the US because of the bias of housing policies, securities laws, and banking rules. Instead of beneficial creative destruction, the displacement of relationship-based finance may thus be an undesirable – and in some ways unintended – consequence of policy choices.
Number of Pages in PDF File: 48
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: November 24, 2013
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